UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K/A


(Amendment
No. 2)




(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




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


For the
transition period from ____________ to _________





Commission
file number:001-34080





CHINA
SKY ONE MEDICAL, INC.


(Exact
name of registrant as specified in its charter)





Nevada
                                
                                87-0430322(State
      or other jurisdiction of
                                  incorporation
      or organization)
                                
                                (I.R.S.
      Employer
                                  Identification
      No.)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
      ApplicableSecurities
      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 submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).


Yes
o     No
o





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





EXPLANATORY
NOTE





This
Amendment No. 2 to the Annual Report on Form 10-K (“Amended Form 10-K”) of
China Sky One Medical, Inc. (the “Company”) amends the Company’s Annual Report
on Form 10-K for the year ended December 31, 2009, filed with the
Securities and Exchange Commission (“SEC”) on March 16, 2010, as previously
amended by the filing of a Form 10-K/A on March 17, 2010 (the “Form
10-K”).





As
announced in a Current Report on Form 8-K (the “Form 8-K”) the Company filed
with the SEC on May 11, 2010, on May 7, 2010, the Company’s management
determined that the Company’s previously filed financial statements for the
fiscal year ended December 31, 2009, included in the Form 10-K, should no longer
be relied upon due to an error in such financial statements with respect to the
accounting forcertain derivative
instruments (warrants it issued in 2008 discussed below), which were previously
recorded as equity instruments in accordance with generally accepted accounting
principles in effect through December 31, 2008.The Company received
comments from the SEC, which led to management’s conclusion that the historical
financial statements in the Form 10-K require restatement to properly record
750,000 common stock purchase warrants, issued in connection with its January
31, 2008 private placement (the “Warrants”), as a derivative
liability.





The
Company has performed a complete assessment of the Warrants and has concluded
that the Warrants are within the scope of Accounting Standards Codification
815-40, “Derivatives and
Hedging – Contracts in Entity’s Own Equity” (“ASC 815-40”), formerly
Emerging Issues Task Force Issue No. 07-05, “Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF
07-05”), due to the inclusion in the Warrants of aprovision requiring a
weighted average adjustment to the exercise price of the Warrants in the event
the Company issues common stock, or securities convertible into or exercisable
for common stock, at a price per share lower than such exercise
price.  Accordingly, ASC 815-40, formerly EITF 07-05, which was
effective as of January 1, 2009, should have been applied resulting in a
reclassification of the warrants as a derivative liability, measured at fair
value, with changes in fair value recognized as part of other income or expense
for each reporting period thereafter.





The
Company previously recorded a derivative liability of approximately $1.3 million
in connection with registration rights obligations with respect to securities
issued in the Company’s January 31, 2008 private placement.  Also, on
May 7, 2010, the Company determined that, because the obligations do not require
a cash settlement and the Warrants can be settled in unregistered shares,
paragraphs 14-18 of EITF 00-19 do not apply to the registration rights
obligation.  As a result, no liability is required to be recorded with
respect to this obligation and the Company is recharacterizing the $1.3 million
liability previously recorded as of December 31, 2009.





After
discussions with the Audit Committee of its Board of Directors and the Company’s
independent registered public accounting firm, management has determined to file
the Amended Form 10-K to reflect the corrections made in response to these
accounting errors.  The correction of the errors impacts each of the
Company’s consolidated financial statements, but has no impact on the Company’s
income from operations or cash flows.





The
following tables ($ in thousands, except per share information) show the effects
of the restatement on the Company's consolidated balance sheet as of
December 31, 2009 and consolidated statements of operations and
comprehensive income:





As of December 31, 2009As Previously
                        Recorded
                      
                      
                      As RestatedLIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIESWarrant
      liability
                      
                      $
                      1,330
                      
                      
                      $
                      11,435TOTAL
      CURRENT LIABILITIES
                      
                      $
                      9,389
                      
                      
                      $
                      19,494SHAREHOLDERS'
      EQUITYAdditional
      paid in capital
                      
                      $
                      41,376
                      
                      
                      $
                      37,188Retained
      earnings
                      
                      $
                      83,702
                      
                      
                      $
                      77,785TOTAL
      SHAREHOLDERS' EQUITY
                      
                      $
                      130,974
                      
                      
                      $
                      120,869TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                      
                      $
                      140,363
                      
                      
                      $
                      140,363




i




Year Ended December 31, 2009As Previously
                                Recorded
                              
                              
                              As RestatedINCOME
      FROM OPERATIONS
                              
                              $
                              46,251
                              
                              
                              $
                              46,251OTHER
      INCOME (EXPENSE)Change
      in fair value of derivative liability
                              
                              $
                              (1,330
                              )
                              
                              $
                              (4,807
                              )Total
      other income (expense)
                              
                              $
                              (1,291
                              )
                              
                              $
                              (4,768
                              )INCOME
      BEFORE PROVISION FOR INCOME TAXES
                              
                              $
                              44,960
                              
                              
                              $
                              41,483NET
      INCOME
                              
                              $
                              34,457
                              
                              
                              $
                              30,980BASIC
      EARNINGS PER SHARE
                              
                              $
                              2.08
                              
                              
                              $
                              1.87DILUTED
      EARNINGS PER SHARE
                              
                              $
                              2.07
                              
                              
                              $
                              1.86COMPREHENSIVE
      INCOME
                              
                              $
                              34,769
                              
                              
                              $
                              31,292




In
addition to the foregoing, in response to the SEC’s comments, the Company has
made additional revisions to the Form 10-K to enhance its disclosure regarding
its research and development activities and to provide additional information on
the income taxes of the Company.  The Company also has corrected
certain typographical errors it discovered upon review of the Form
10-K




Except
as described above, no other amendments are being made to the Form
10-K.  This Amended Form 10-K does not reflect events occurring after
the Form 10-K, or modify or update the disclosure contained therein in any other
way other than as required to reflect the amendments discussed
above.




The
Company has attached to this Amended Form 10-K updated certifications executed
as of the date of this Amended Form 10-K by the Chief Executive Officer and
Chief Financial Officer as required by Sections 302 and 906 of the Sarbanes
Oxley Act of 2002.  These updated certifications are attached as
Exhibits 31.1, 31.2, 32.1 and 32.2 to this Amended Form 10-K.


ii


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
                  50Item
      8.
                  Financial
      Statements and Supplementary Data
                  F-1Item
      9.
                  Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
                  52Item
      9A.
                  Controls
      and Procedures
                  52Item
      9B.
                  Other
      Information
                  53PART
      III
                  
                  54Item10.
                  Directors,
      Executive Officers and Corporate Governance
                  54Item
      11.
                  Executive
      Compensation
                  59Item
      12.
                  Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters...
                  64Item
      13.
                  Certain
      Relationships and Related Transactions, and Director
      Independence
                  66Item
      14.
                  Principal
      Accounting Fees and Services
                  66Item
      15.
                  Exhibits,
      Financial Statement Schedules
                  67Signatures
                  
                  S-1


iii





SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS




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




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




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




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




1


PART
I




Item
1.   Business.




General




We are
engaged, through our China-based indirect subsidiaries described below, in the
development, manufacture, marketing and sale of over-the-counter, branded
nutritional supplements and over-the-counter plant and herb-based pharmaceutical
and medicinal products. Our principal products are external use Traditional
Chinese Herbal Remedies/Medicines, commonly referred to in the industry as
“TCM.”  We have evolved into an integrated manufacturer, marketer and
distributor of external-use TCM products sold primarily in the People’s Republic
of China (“China” or “PRC”) and through Chinese domestic pharmaceutical
chains.  Recently, we have been expanding our worldwide sales effort
as well. Prior to 2009, we sold both our own manufactured products, as well as
medicinal and pharmaceutical products manufactured by others (the sale of third
party products is referred to herein as “Contract Sales”).  Commencing
in 2009, we discontinued all of our Contract Sales as part of our revised
strategic 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 United States (“U.S.”) holding company subsidiary,
and ACPG’s direct and indirect subsidiaries located in the People’s Republic of
China (the “PRC”).




ACPG, was
incorporated on December 16, 2003, under the name “QQ Group, Inc.”  QQ
Group changed its name to “American California Pharmaceutical Group, Inc.” in
anticipation of the stock exchange transactions with our predecessor filer (then
known as “Comet Technologies, Inc.”) and Harbin City Tian Di Ren Medical Co., a
company organized under the laws of the PRC (“TDR”), as further described
below.  On December 8, 2005, ACPG completed a stock exchange
transaction with TDR and TDR’s subsidiaries, each of which was a fully operating
company in the PRC.  In connection with this transaction, ACPG
exchanged 100% of its issued and outstanding common stock for 100% of the
capital stock of TDR and its subsidiaries.




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




TDR was
originally formed in 1994 and its principal executive office is located in
Harbin City, Heilongjiang Province, PRC.  On December 29, 2000, TDR
was reorganized and incorporated as a limited liability company under the
“Corporation Laws and Regulations” of the PRC.  At the time of TDR’s
acquisition by ACPG, in December of 2005, TDR had two wholly-owned subsidiaries,
Harbin First Bio-Engineering Company Limited  (“First”) and Kangxi
Medical Care Product Factory (“Kangxi”).  In July, 2006, First and
Kangxi merged, with First as the surviving subsidiary of TDR.




As of
October 16, 2006, we organized Harbin Tian Qing Biotech Application Company as a
wholly-owned PRC subsidiary of TDR (“Tian Qing”), to conduct research and
development in the areas of tissue and stem cell banks, which is described in
further detail below.  As of December 31, 2009, Tiang Qing had no
operating activities.




On April
3, 2008, TDR completed its acquisition of Heilongjiang Tianlong Pharmaceutical,
Inc., a company organized under the laws of the PRC (“Tianlong”), that has a
variety of medicines approved  by the PRC’s State Food and Drug
Administration (the “SFDA”) and new medicine applications, and which is in the
business of manufacturing external-use pharmaceuticals.  TDR
previously acquired the Beijing sales office of Tianlong in
mid-2006.  In connection with this transaction, TDR acquired 100% of
the issued and outstanding capital stock of Tianlong from its sole stockholder,
in consideration for an aggregate purchase price of approximately $8,300,000,
consisting of $8,000,000 in cash, and 23,850 shares of our common stock (valued
at $12.00 per share).




2


On April
18, 2008, TDR consummated its acquisition of Heilongjiang Haina Pharmaceutical
Inc., a company organized under the laws of the PRC (“Haina”), licensed as a
wholesaler of TCM, bio-products, medicinal devices, antibiotics and chemical
medicines.  Haina did not have an established sales network and was
acquired for its primary asset, a Good Supply Practice (“GSP”) license (License
No. A-HLJ03-010), issued by the Heilongjiang Province office of the SFDA as of
December 21, 2006.  The SFDA only issues such licenses to
pharmaceutical resellers that maintain certain quality control
standards.  The GSP license will be up for renewal on January 29,
2012.  In connection with this transaction, TDR acquired 100% of the
issued and outstanding capital stock of Haina from its three 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 its subsidiaries in the PRC, in the development,
manufacture, marketing and sale of over-the-counter, branded nutritional
supplements and over-the-counter plant and herb-based pharmaceutical and
medicinal products.  We have evolved into an integrated manufacturer,
marketer and distributor of external use Chinese medicine products sold
primarily to and through domestic pharmaceutical chains in the
PRC.  Historically, we handled sales of both our own manufactured
products and Contract Sales of medicinal and pharmaceutical products
manufactured by others. However, commencing in 2009, we discontinued all
Contract Sales as part of our revised sales strategy.




With the
exception of Peng Lai, which is located in Shan Dong Province, PRC, all of our
manufacturing facilities are located in Heilongjiang Province,
PRC.  In addition, we have sales offices located in 24 provinces
across China.




Our
principal products are external use TCMs. Using various formulas, we produce a
number of TCM products with several forms of delivery including ointments,
sprays, medicated skin patches, injections, capsules, suppositories, tablets and
granules.  We also develop and sell bio-engineering products in the
form of diagnostic kits, which are used  for testing for
different diseases.  Over the next few years, we intend to concentrate
much of our efforts on the development, production and sales of TCM products and
testing kits, and antibiotic products.




Our
principal operations are in the PRC, where TDR and its subsidiaries have
manufacturing facilities and sales distribution channels covering most of the
provinces in the PRC.  Part of our sales strategy is to expand our
worldwide sales by locating qualified distributors and sales agents outside of
the PRC.  Our overall revenues were approximately $130,092,000 in
2009, of which export overseas sales were approximately $10,121,000, accounting
for approximately 7.8% of our total revenue.  Overseas sales were
$7,570,000 in 2008, accounting for approximately 8.2% of our total
revenues.  Overseas sales were $12,404,000 in 2007, accounting for
approximately 25.2% of our total revenue in 2007.




3


All of
our significant operations and long lived assets are located in the PRC. Below
is a chart depicting our corporate organizational structure:









SFDA
Licenses




The SFDA
issues the licenses to manufacture and market pharmaceutical products in the
PRC.  Our licenses relate primarily to pharmaceutical production
licenses, which are needed mainly for topical products, ointments and external
test kits. TCM products also require a permit for sales, which permits are
generally granted on a non-exclusive basis for four to five years depending on
the product and subject to periodic review for renewal.  For the year
ended December 31, 2009, we commercialized 91 products through TDR and its
subsidiaries.  We have the necessary licenses and permits for all of
our products.




4


Our
TDR Subsidiary Owns the Following Subsidiaries in China




Harbin
First Bio-Engineering




On
September 26, 2003, TDR formed First under the laws of the PRC as its wholly
owned subsidiary, with an authorized capital of approximately $1,460,000
(10,000,000 RMB).  First focuses on research and development of the
use of natural medicinal plants and biological technology products, such as our
diagnostic kits.  First, which officially commenced production on July
21, 2006, is one of the first companies in Heilongjiang Province conducting
research and development of high technology biological products.  First has
two product lines:




·
            an
      enzyme immunity reagent kit product line;
and




·
            a
      colloid gold product line.




Harbin
Tian Qing Biotech Application




On
October 16, 2006, TDR organized Tian Qing under the laws of the PRC as its
wholly owned subsidiary, to conduct research and development in the areas of
tissue and stem cell banks, which is described in more detail below. (See
“Research and Development” below.)  As of December 31, 2009, Tian Qing
had no significant operations.




Heilongjiang
Tianlong Pharmaceutical




On April
3, 2008, TDR completed the acquisition of Tianlong, which is in the business of
manufacturing external-use pharmaceuticals.  Tianlong’s assets
included, among other things, GMP certified manufacturing facilities,
state-of-the-art manufacturing equipment, a research and development center, and
production and operating rights to a portfolio of 69 medicines approved by the
SFDA.




Heilongjiang
Haina Pharmaceutical




On April
18, 2008, TDR consummated its acquisition of Haina, which is licensed as a
wholesaler of TCM, bio-products, medicinal devices, antibiotics and chemical
medicines.  At the time of the acquisition, Haina did not have an
established sales network and was acquired for its primary asset, a GSP license
issued by the Heilongjiang Province office of the SFDA as of December 21,
2006.  The SFDA only issues such licenses to resellers of medicines
that maintain certain quality control standards.  The GSP license will
be up for renewal on January 29, 2012.  Obtaining this license has
enabled us to expand our sales of medicinal products without having to go
through a lengthy license application process.




Peng
Lai Jin Chuang Pharmaceutical




On
September 5, 2008, TDR acquired Peng Lai, which received GMP certification from
the SFDA, and was organized to develop, manufacture and distribute
pharmaceutical products in the PRC.  In connection with the
acquisition of Peng Lai , 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.




Product
Line




In 2009,
we manufactured and marketed 91 products.  Our manufacturing
operations are conducted in our indirect subsidiaries’ facilities located in
Heilongjiang Province and Shan Dong Province in the PRC.




For the
year ended December 31, 2009, we sold our products under five main
categories:




·
            Patches  (7
      products);




·
            Ointments
      (18 products);




·
            Sprays
      (15 products);




5




·
            Diagnostic
      Kit (3 products);




·
            Others
      (48 products)




A
description of our principle products, which generated a majority of our sales
revenue in 2009, is as follows:




Patch
Category:




Sumei
Slim Patch




The Sumei
Slim Patch is marketed and sold within and outside the PRC as a more natural
treatment to lose weight.  The Sumei Slim Patch uses Saponin as its
major ingredient, and is effective in regulating and restraining the excessive
secretion of certain hormones, while promoting others to foster weight loss as
well as prevent weight gain.




Pain
Relief  Patch




A pain
relief patch is designed to apply to the area of neck, shoulder, and
waist.  The patch is used for a number of ailments, including fever,
headache, heart dysentery, diarrhea, and stiffness and pain caused by
hypertension.




Anti-Hypertension
Patch




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




Ointment
Category:




Hemorrhoids
Ointment




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




Compound
Camphor Cream




This
product is made for the 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 is used for the treatment of  dental ulcers, pharyngitis, and
faucitis.  It is made with pure herbal medicines and, thus,
has  minimum side effects to human bodies.




Diagnostic
Kit Category:




Cardiac
Arrest Early Examination Kit




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




6


Kidney
Disease Testing Kit




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




Other
Product Category:




We
include 48 of our products under the “Other” product category, because the
categories of applications for these products do not separately represent a
material amount of our revenues.  The Other product category includes
suppositories, eye drops, nasal drops, capsules, granules, injections, tablets
and wash fluids.




Naftopidil
Dispersible Tablet




This
tablet is designed to treat benign enlargement of the prostate among males in
their middle age.  It is effective in its treatment because its
ingredients can be easily digested and absorbed by the human body.




Naphazoline
Hydrochloride Eye Drop




Naphazoline
is recommended for the temporary relief of eye redness associated with minor
irritations.  This product can comfort the eyes by lubricating them
and relieving such irritations.




Revenues
by Product Categories




We
believe that the most meaningful presentation of our products is by categories
of method of delivery.  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 for the fiscal years ended
December 31, 2009, 2008, and 2007:




FortheYearsEndedDecember31
                      ($inthousands)2009
                    
                    
                    2008
                    
                    
                    2007ProductCategory
                    
                    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 and development (“R&D”) activities either
internally or through collaborative arrangements with universities and research
institutions in the PRC.  We have our own research, development and
laboratory facilities located in the facilities of First and
Tianlong.  Our internal R&D team currently consists of 38
people.  Many of our team members are professors affiliated with
universities in the PRC.




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




7




·
            Established
      a gene medicine laboratory for Small RNA project with Harbin Medical
      University; and




·
            Established
      a laboratory for Antroquinonol from Antrodia Camphorata with Taiwan Golden
      Biotechnology Corporation.




Under our
partnership arrangements with universities and research institutions, we will
generally hold the intellectual property rights to any developed
technology.  For example, as a result of our collaboration with Harbin
Medical University, a product known as “Endostatin” is currently under
development as a cancer suppressing product.  Although this technology
still bears the name of Harbin Medical University, we own the intellectual
property rights pertaining to this technology.  Additional information
relating to this product and other products being developed is set forth under
“Products Under Development” below and under the general product descriptions
throughout this report.




We
invested approximately $14,960,000, $7,413,000, and $3,158,000 in
R&D for the years ended December 31, 2009, 2008, and 2007,
respectively.  Additional information about our R&D investments is
included in the financial statements in Item 8 of this report (and notes
thereto) and our “Management Discussion and Analysis on Financial Condition and
Results of Operations” section below.




Products
Under Development




The
projects which accounted for a majority of our 2009 research and development
expenses, grouped by subsidiary, are as follows:




TDR




Breast
Cancer Technology




Hyperplasie
Globulaire is the early stage of Hyperplasia 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.  Our Breast Cancer Technology is designed to effectively
treat the Hyperplasie Globulaire with Traditional Chinese Medicine and with
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.  This project is the only project that represented
more than 10% of our total R&D expenditures in 2009.




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 amounts of pure antibodies with desired
substance.  Tumor cells that can replicate endlessly are fused with
mammalian cells that produce an antibody.  The result of this cell
fusion will continually produce antibodies.  These antibodies are
called monoclonal because they come from only one type of cell, the hybridoma
cell.  We believe Monoclonal antibodies have tremendous applications
in the field of diagnostics, therapeutics, targeted drug delivery systems, not
only for infectious disease caused by 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, for application
and  performance appraisal.  As of December 31, 2009, we
completed this project and are able to manufacture and commercialize these
antibody materials.




Endostatin
Research




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 nutrients upon which the cancer cells
survive.  We have already completed teratogenicity testing, and have
established quality standards for this drug.  Further
developments are underway to improve the product quality of
Endostatin.  We spent approximately $439,000, or 2.9% of total R&D
expenditure in 2009, for acute and long term toxicity testing.




8


Patch
Products




We spent
approximately $1,820,000, or 12.2% of total R&D expenditure in 2009, for the
optimization experiments of several patch products including slim patch,
anti-hypertension patch, asthma patch, and pain relief patch.  The
optimization experiments are focusing on optimization of the extracted
ingredients and irritation  tests.




First




Diagnostic
Kits




In 2009,
we had 6 diagnostic kits under clinical trials.  We spent
approximately $2,727,000, or 18.2% of total R&D expenditure in 2009, on
clinical trials for these 6 diagnostic kits.




Tianlong




Antroquinonol
Extracted from Antrodia Cinnamomea




Antrodia
Cinnamomea is 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 expenditure on this project in
2009.




Injections




In 2009,
we had 3 injections under clinical trials.  We spent approximately
$1,944,000, or 13.1% of total R&D expenditure in clinical trials for these
projects in 2009.




Peng
Lai




We spent
an aggregate of approximately $879,000, or 5.9% of total R&D expenditure in
2009, in optimizing effectiveness test for Naftopidil Dispersible tablets for
prostate treatment, Sertraline Hydrochloride capsules for the treatment of
mental depression, and Radix Isatidis granules and syrup to treat Influenza
(flu).




Set
forth below is certain information regarding our major research and development
projects in 2009.  The additional costs and expected completion dates
set forth in the table below are subject to change, which may be material, based
on various factors, many of which are out of our control:




9


Projects
                                        
                                        Stage
                                        
                                        2008 Expense
                                        
                                        
                                        2009 Expense
                                        
                                        
                                        Aggregate
                                          Expenses Since
                                          Commencement of
                                          Project
                                        
                                        
                                        Estimated
                                          Additional Costs to
                                          Complete Research
                                          and Development
                                        
                                        Remaining Activities and Expected Research and
                                          Development Completion Date***Diagnostic Kits -
      19 products*
                                        
                                        Clinical  trial
                                        
                                        $
                                        2,261,000
                                        
                                        
                                        $
                                        2,727,000
                                        
                                        
                                        $
                                        4,988,000
                                        
                                        
                                        
                                        $800,000
                                        
                                        13
      projects are estimated to be submitted to the SFDA in later half of 2010,
      with an estimated aggregate cost of $500,000; Another 6 products are
      estimated to complete clinical trial in fiscal 2010, then get into the
      stage of long term stability testing through 2013, with estimated cost of
      $300,000Injections
      - 6 projects
                                        
                                        Clinical
      trial
                                        
                                        $
                                        614,000
                                        
                                        
                                        $
                                        1,944,000
                                        
                                        
                                        $
                                        2,558,000
                                        
                                        
                                        
                                        $300,000
                                        
                                        One
      product is pending SFDA approval; 3 products are planned to be submitted
      to the SFDA within fiscal 2010, with an estimated cost of $100,000; The
      other 2 products are going into long term stability testing stage with an
      estimated cost of $200,000Breast
      Cancer Technology
                                        
                                        Efficacy
      testing, Acute and Long Term Toxicity testing
                                        
                                        $
                                        0
                                        
                                        
                                        $
                                        2,272,000
                                        
                                        
                                        $
                                        2,272,000
                                        
                                        
                                        
                                        $8.3
      million
                                        
                                        Efficacy
      stage has been completed in 2009, long term stability testing is estimated
      to be completed during the first half of 2011, with an estimated cost of
      $300,000, then apply to the SFDA for getting into the clinical trial. The
      clinical trial is estimated to be completed in  2015, with an
      estimated cost of $6-8 million, afterwards, we intend to apply to the SFDA
      to enter into the production stage.Patches
      - 4 products
                                        
                                        Extraction
      optimization testing
                                        
                                        $
                                        0
                                        **
                                        
                                        $
                                        1,820,000
                                        
                                        
                                        $
                                        1,820,000
                                        
                                        
                                        $
                                        **
                                        CompletedMonoclonal
      Antibody
                                        
                                        Completed
                                        
                                        $
                                        948,000
                                        
                                        
                                        $
                                        965
      ,000
                                        
                                        
                                        $
                                        1,913,000
                                        
                                        
                                        $1.8
      to $2 million
                                        
                                        Continue
      study in 2010; does not require SFDA approvalEndostatin
                                        
                                        Efficacy
      testing, Acute and Long Term Toxicity testing
                                        
                                        $
                                        1,192,000
                                        
                                        
                                        $
                                        439,000
                                        
                                        
                                        $
                                        1,631,000
                                        
                                        
                                        $8
      to $10 million
                                        
                                        Clinical
      trials; estimated to be completed in 2016 and submitted for SFDA
      approvalAntroquinonol
                                        
                                        Clinical
      trial
                                        
                                        $
                                        0
                                        
                                        
                                        $
                                        387,000
                                        
                                        
                                        $
                                        387,000
                                        
                                        
                                        $16 to $18 million
                                        
                                        Efficiency,
      acute and long-term toxicity testing; pre-clinical and clinical trials are
      estimated to be completed in 2018 and submitted for SFDA
      approvalRadix
      Isatidis granule and
      syrup
                                        
                                        Production
      process optimization
                                        
                                        $
                                        0
                                        
                                        
                                        $
                                        282,000
                                        
                                        
                                        $
                                        282,000
                                        
                                        
                                        
                                        $400,000 - $500,000
                                        
                                        Estimated
      to be completed in 2010Naftopidil
      Dispersible tablets
                                        
                                        Production
      process optimization
                                        
                                        $
                                        0
                                        
                                        
                                        $
                                        256,000
                                        
                                        
                                        $
                                        256,000
                                        
                                        
                                        
                                        $400,000 - $500,000
                                        
                                        Estimated
      to be completed in 2010Sertraline
      Hydrochloride capsules
                                        
                                        Production
      process optimization
                                        
                                        $
                                        0
                                        
                                        
                                        $
                                        249,000
                                        
                                        
                                        $
                                        249,000
                                        
                                        
                                        
                                        $400,000 - $500,000
                                        
                                        Estimated
      to be completed in
2010


____________________________


*   During
2008, we conducted long-term stability testing on clinical trials on a total of
13 projects for an aggregate expense of $2,261,000.  We spent an
immaterial amount on further research and development of the projects in 2009
and expect to submit those projects for SFDA approval during the second half of
2010 at an estimated aggregate additional expense of
$500,000.


**  The
amount is not meaningful.
 ***  Does
not include time required for SFDA approval, if any.
 10




In
addition to the projects set forth in the table above, we commenced clinical
trials or efficacy, acute and long-term toxicity testing on several other
projects.  We expect to complete testing and/or trials for these
projects between 2012 and 2014 at an estimated cost of $600,000 to $1,000,000
per project.




Total
research and development expenses in fiscal 2009 were
$14,960,000.  The above listed projects comprise 75.6% of our total
research and development expenses in fiscal 2009.  The other projects
and miscellaneous materials make up the remaining 24.2% of total research and
development expenses for the year.




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 granted us, through Tian Qing, the exclusive right and
license to become engaged in tissue and stem cell bank activities in
Heilongjiang Province, PRC, through December 2010.  Since the
development of this project will require substantial managerial, technical and
financial resources, and a number of significant risks, management is still
evaluating the proper timing and strategy in launching this
project.




Sales
Approach




Over the
past several years, we have continuously expanded our distribution channels for
our products.   As a result, we have established a sales network
covering 24 provinces of mainland China, and have positioned sales managers and
representatives in each of these markets.




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.  Commencing 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.  These changes to our product
distribution channels resulted in our direct customer base decreasing from 943
customers at December 31, 2007 to 212 customers at December 31,
2009.  Our change in sales strategy is further described in “Customers
and Distribution” below.




We also
managed to establish a marketing network through independent agents to develop
an international market for our products.  At present, our primary
initial growth focus remains in the PRC.  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 other suppliers
accounted for 10% or more of our total inventory purchases in 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 ended December 31, 2009, sales to Harbin Shiji Baolong Medicine Company and
Shanxi Xintai Medicine Company accounted for approximately 16% and 11% of total
revenues, respectively.  Harbin Bao Da Medicine Company and Harbin
Shiji Baolong Medicine Company accounted for approximately 16% and 14% of our
accounts receivable in 2009, respectively.  For the year ended
December 31, 2008, sales to Shanxi Xintai and Harbin Shiji Baolong accounted for
15% and 12% of our total revenues, respectively.  Harbin Shiji Baolong
and Shanxi Xintai accounted for approximately 29% and 11% of our accounts
receivable in 2008, respectively.  For the year ended December 31,
2007, sales to Ning BoYue Hua Trading Company and Guang Zhou Xing He Trading
Company accounted for approximately 14% and 11% of our total revenues,
respectively.  Hua Li Jiu Zhou Company accounted for approximately 11%
of our accounts receivable in 2007.  No other customers accounted for
10% or more of our total revenues or accounts receivable in 2009, 2008, and
2007.




In 2009,
we implemented various initiatives toward promoting and marketing our
products.  Our advertising costs for the fiscal years ended December
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 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 in China, and throughout the world.  We compete with various
firms, many of which produce and market products similar to our products, and
many of which have greater resources than us in terms of manufacturing and
marketing capabilities, management expertise and breadth, and financial
wherewithal.  Some of these competitors are far larger, have more
resources then us and have stronger sales and distribution
networks.




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




12


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




Government
Regulation




Regulatory
Environment




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




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




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




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




Compliance
with Environmental Law




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




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 increased due to growth, increased research and
development activities and expanded marketing and distribution efforts for our
products.  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 both 305 full time employees and
1,849 individuals 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 agreements in place with our executive
officers.  None of the employees are covered by a collective
bargaining agreement, however, we believe our relationship with employees is
good.




Available
Information




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




We also
make available free of charge through our website (www.cski.com.cn) our Annual
Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K, and, if applicable, amendments to those reports filed or furnished pursuant
to the Exchange Act as soon as reasonably practicable after we electronically
file such material with, or furnishes it to, the SEC.




15


Item
1A.  Risk Factors.




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




Risks
Related to Our Business




Adverse
economic conditions may harm our business.




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




Certain
officers and directors have significant control over our company.




Liu
Yan-qing and Han Xiao-yan, who are officers and directors of ours, also serve as
officers and directors of ACPG, TDR and its subsidiaries.  As of the
date hereof, Dr. Liu and Ms. Han own, in the aggregate, approximately 36.5% of
the issued and outstanding shares of our common stock.  As a result,
these shareholders are effectively able to control certain corporate governance
matters requiring shareholders’ approval.  Such matters may include
transactions in which they have an interest other than as a shareholder of ours,
the approval of significant corporate transactions such as increasing the
authorized number of our shares to complete acquisitions or raise capital, if
necessary, and any other transactions requiring a majority vote without seeking
other shareholders’ approval.  These persons also have the ability to
control other matters requiring shareholder approval including our election of
directors which could result in the entrenchment of management.




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




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




Our
expansion plan may not be successful.




Part of
our strategy is to continue our growth through increasing the distribution and
sales of our products by penetrating existing markets in the PRC, and entering
new geographic markets in the PRC as well as Asia, the United States and other
countries. However, many obstacles to entering such new markets exist,
including, but not limited to, international trade and tariff barriers,
regulatory constraints, product liability concerns, shipping and delivery costs,
costs associated with marketing efforts abroad and maintaining attractive
foreign exchange ratios.  Moreover, our expansion strategy may be
based on incorrect assumptions and may be flawed, and may even damage our
performance, competitive position in the market and, ultimately, even our
ability to survive in the marketplace.  We cannot, therefore, assure
shareholders that we will be able to successfully overcome such obstacles and
establish our products in any additional markets.  Our inability to
implement this growth strategy successfully may have a negative impact on our
growth, future financial condition, results of operations or cash
flows.




16


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




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




We
do not maintain any insurance and are exposed to all risks of loss, including
resulting from product liability, property loss or damages, or other harm that
we may cause to customers, vendors, suppliers and other third parties, or
securities 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
products as well as similar products distributed by other
companies.  Thus, the mere publication of reports asserting that such
products may be harmful could have a material adverse effect on our business,
regardless of whether these reports are scientifically supported.




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




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




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




17


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 raw materials.  In fiscal year
2009, Harbin Zhong Jia Medicine Company and Heilongjiang Kangda Medicine Company
accounted for approximately 16% and 42% of our total inventory purchases,
respectively.  Heilongjiang Kangda Medicine Company accounted for
approximately 33% of our total inventory purchases for the year ended December
31, 2008.  For the 2010 fiscal year, we expect that our raw material
suppliers will be substantially similar to last year and the amount of raw
materials will increase commensurate with the increase in the demand of our
products.  If any of our major suppliers 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 products which would be harmful to our
sales reputation and business.  If supply is disrupted the increased
amount 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 results could be
negatively impacted by the lost sales or decreased margins.




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 for
approximately 16% and 11% of total revenues, respectively.  For the
year ended December 31, 2008, sales to Shanxi Xintai and Harbin Shiji Baolong
accounted for 15% and 12% of our total revenues, respectively.  For
the year ended December 31, 2007, sales to Ning BoYue Hua Trading Company and
Guang Zhou Xing He Trading Company accounted for approximately 14% and 11% of
our total revenues, 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 are developing and/or offering, or
can be expected to develop and offer, products similar to ours.  Our
market is a large market with many competitors.  Many of our
competitors are more established than we are, and have significantly greater
financial, technical, marketing and other resources than 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 requirements and may be able to undertake
more extensive promotional activities, offer more attractive terms to customers,
and adopt more aggressive pricing policies.  We cannot assure
investors that we will be able to compete effectively with current or future
competitors or that the competitive pressures we face will not harm our
business.




We
are subject to market and channel risks.




In fiscal
year 2009, over 92% of our sales were made in the PRC, where we primarily sell
our products through drug chain stores.  Because of this, we are
dependent to a large degree upon the success of our PRC-based distribution
channel, as well as the success of specific retailers in the distribution
channel.  We rely on these distribution channels to purchase, market,
and sell our products.  Our success is dependent, to a large degree,
on the growth and success of the drug stores, which may be outside our
control.  There can be no assurance that the drug store distribution
channels will be able to grow or prosper as they faces price and service
pressure from other channels, including the mass market.  There can be
no assurance that retailers in the drug store distribution channel, in the
aggregate, will respond or continue to respond to our marketing commitment in
these channels.




18


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




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




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




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




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




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




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




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




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




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




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




In
addition, when seeking regulatory approval for some of our products, we are
required to certify to regulatory authorities, including the SFDA that such
products do not infringe upon third party patent rights.  Filing a
certification against a patent gives the patent holder the right to bring a
patent infringement lawsuit against 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 in substantial 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
are found to infringe a patent held by a third party and become subject to such
treble damages, these damages could have a material adverse effect on our
results of operations and financial condition.




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




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




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




Our
business must be conducted in compliance with various government regulations and
in particular, the SFDA’s regulations.  Government regulations may
have material impact on our operations, increase costs and could prevent or
delay the manufacturing and selling of our products.  Research,
development, testing, manufacturing and marketing activities are subject to
various governmental regulations in China, including health and drug
regulations.  Government regulations, among other things, cover the
inspection of and controls over testing, manufacturing, safety and environmental
considerations, efficacy, labeling, advertising, promotion, record keeping and
sale and distribution of pharmaceutical products.  We will not be able
to license, manufacture, sell and distribute the vast majority of our products
without a proper approval from government agencies and in particular the
SFDA.  This approval process is lengthy, with approvals for TCM
products typically occurring 18-24 months after the application is initially
filed.  There is no assurance that we will obtain such approvals on a
timely basis, or at all.  Delays in obtaining approvals will delay our
ability to market products and denial of approval for a specific product will
result in our inability to market the product and recoup the expenses incurred
in that products development and testing.




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




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




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




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




Moreover,
the laws and regulations regarding acquisitions of the pharmaceutical and
nutraceutical industries in the PRC may also change and may significantly impact
our ability to grow through acquisitions.




20


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




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




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




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




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




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




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




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




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




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




21


Risks
Related to Doing Business in China




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




In 2009,
2008, and 2007, approximately 92%, 92% and 75% of our total revenues,
respectively, were from sales in the PRC.  The manufacture and sale of
pharmaceutical products in China is heavily regulated by many state, provincial
and local authorities.  The SFDA requires pharmaceutical manufacturers
to obtain GMP certifications.  We currently have the certifications
needed for our current operations.  However, should we fail to receive
or maintain the GMP certifications in the future, we would no longer be able to
manufacture pharmaceuticals in China, and our businesses would be materially and
adversely affected.  These regulations significantly increase the
difficulty and costs involved in obtaining and maintaining regulatory approvals
for marketing new and existing products.  Our future growth and
profitability depend to a large extent on our ability to obtain regulatory
approvals.  Additionally, the law could change so as to prohibit the
use of certain pharmaceuticals.  If one of our products becomes
prohibited, this change would cease the productivity of that
product.  The China National Development and Reform Commission
(“CNDRC”), has recently implemented price adjustments on many marketed
pharmaceutical products.  We have no control over such governmental
policies, which may impact the pricing and profitability of our
products.




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




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




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




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




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




22


There
are risks inherent in doing business in China.




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




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




The PRC
legal system is a civil law system.  Unlike the common law system, the
civil law system is based on written statutes in which decided legal cases have
little value as precedents.  In 1979, the PRC began to promulgate a
comprehensive system of laws and has since introduced many laws and regulations
to provide general guidance on economic and business practices in the PRC and to
regulate foreign investment.  Progress has been made in the
promulgation of laws and regulations dealing with economic matters such as
corporate organization and governance, foreign investment, commerce, taxation
and trade.  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 affected by unexpected changes in regulatory requirements in the
jurisdictions in which we operate.




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




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,
over 92% of our sales are in the PRC.  We are in the process of
attempting to establish marketing and sales presence in the U.S. and other
countries.  We expect to establish an office in the U.S. for investor
relations.  In the future, we may explore expanding its operations in
other countries throughout the world.  Upon effecting any such
expansion, we may not be able to identify and retain qualified personnel due to
its lack of understanding of different cultures and lack of local
contacts.  This may impede international expansion.




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




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




24





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




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




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




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




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




Since
1994, the exchange rate for RMB against the U.S. dollar has remained relatively
stable, most of the time in the region of approximately RMB 8.00 to
U.S.$1.00.  However, in 2005, the Chinese government announced that
would begin pegging the exchange rate of the Chinese RMB against a number of
currencies, rather than just the U.S. dollar.  Currently, exchange
rates are approximately RMB 6.84 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.  For example, to the extent that we need to convert United
States dollars into Chinese RMB for operations, appreciation of this currency
against the U.S. dollar could have a material adverse effect on our business,
financial condition and results of operations.  Conversely, if we
decide to convert Chinese RMB into 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 required to be in compliance with the registered capital requirements of 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.




26





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.




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 and our Capital
Structure




Application
of guidance related to the Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock has negatively
impacted our  statement of operations for the year ended December 31,
2009 (restated) and could continue to negatively impact our statement of
operations.




For
the year ended December 31, 2009 (restated), we reported an unrealized loss on
derivatives in the consolidated statements of operations of $4,807,000 as a
result of the issuance of warrants to purchase up to an aggregate of 750,000
shares of common stock in our January 2008 private placement.  Our
comprehensive income will continue to fluctuate as a result of the impact of
such warrants and will be adversely effected in each reporting period in which
the fair value of the warrants that remain outstanding continue to
increase.





Our
stock price is likely to be highly volatile.




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




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




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




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




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




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




As of
March 15, 2010, we had 16,790,851 shares of common stock outstanding, many of
which are freely transferable under Rule 144.  The sale of these
shares may have an adverse effect on the market price for our common
stock.




In
addition, as of March 15, 2010, we had issued and outstanding warrants to
purchase an aggregate of 593,800 shares of our common stock, which are
exercisable at a price of $12.50 per share.  Our issuance of
additional shares of common stock upon exercise of our outstanding warrants will
reduce the percentage equity ownership of holders of shares of our common stock.
Further, the exercise of a significant number of warrants, and subsequent
sale of shares of common stock received upon such exercise, could cause a
sharp decline in the market price of our common stock.





28




FORWARD-LOOKING
STATEMENTS




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




·
            future
      sales and financings;




·
            the
      future development of our business;




·
            our
      ability to execute our business
strategy;




·
            projected
      expenditures; and




·
            the
      market for our products.




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




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





29





Item.
1B.  Unresolved Staff Comments.




None.




Item
2.  Properties.




Under
Chinese law, the government owns all of the land in the PRC and companies and
individuals are authorized to use the land only through land use rights granted
by the PRC government.




Our
manufacturing facilities are located in the cities of Harbin and Peng Lai in the
PRC.  These facilities are operated in accordance with
GMP.  We own these facilities and are not subject to costs associated
under 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:




SubsidiariesFacilitiesasofMarch15,2010,inSquareMetersTDR
                    
                    
                    First
                    
                    
                    Tianlong
                    
                    
                    PengLaiLand
      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, our subsidiaries Haina and Tian 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, Related Stockholder Matters and Small
Business Issuer Purchases of Equity Securities.




Market
Information




Until May
28, 2008, our common stock was traded on FINRA’s Over-the-Counter Bulletin Board
under the trading symbol “CSKI.”  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 qualified
to be listed on Nasdaq Global Select Market.  The high and low sales
prices for our common stock in the fiscal years of 2009 and 2008 are as
follows:




Year Ended December 31, 2009
                    
                    
                    Year Ended December 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




On March
15, 2010, the closing price 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 expected that any
dividends on the common stock will be declared and paid in the foreseeable
future.  We do not currently have any restrictions that would limit
our ability to pay dividends, and we are not currently aware of any restrictions
that are likely to limit our ability to pay dividends in the
future.




Holders




At March
15, 2010, there were 381 holders of record of our common stock, with 16,790,851
shares issued and outstanding.  Such number of record owners was
determined from our shareholder records and does not include beneficial owners
whose shares are held in nominee accounts with brokers, dealers, banks and
clearing agencies.




Securities
Authorized For 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
                        
                        Numberofsecurities
                          tobeissuedupon
                          exerciseof
                          outstandingoptions,
                          warrantsandrights
                        
                        
                        Weighted-
                          averageexercise
                          priceof
                          outstanding
                          options,
                          warrantsand
                          rights
                        
                        
                        Numberof
                          securities
                          remaining
                          availableforfuture
                          issuanceunder
                          equity
                          compensationplans
                          (excluding
                          securitiesreflected
                          incolumn(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 issued during fiscal
2008.   There were no underwriting discounts or commissions paid
in connection with the sale of these securities, except as otherwise
noted.   Certain information previously included in prior
Exchange Act reports we filed has not been furnished in this
report.




As of
December 26, 2009, we issued 52,844 “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.




Restatement
of 2009 Financial Statements




As
discussed in Note 2 to the Financial Statements, the Company restated its
financial statements for the year ended December 31, 2009.  On May 7,
2010, the Company determined that ASC 815-40, which was effective January 1,
2009, should have been applied to warrants issued in the Company’s 2008 private
placement, resulting in a reclassification of the warrants as a
derivative liability, measured at fair value, with changes in fair value
recognized as part of other income or expense for each reporting period
thereafter.  In addition, the Company previously recorded a liability
in connection with certain registration rights provided to investors in the
private placement.  On May 7, 2010, the Company determined that
because the obligations do not recognize cash settlement and the warrants can be
settled in unregistered shares, paragraphs 14 – 18 of EITF 00-19 do not apply to
the registration rights obligation.  As a result, no liability is
required to be recorded with respect to this obligation and the Company has
recharacterized this previously recorded liability.




Key
financial data from the fiscal years ended December 2005 to 2009 is set forth in
the following table.




FortheYearsEndedDecember31,
                      ($inthousands,exceptpersharedata)2009
                      (restated)
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    2006
                      (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)
                    
                    
                    (4,768
                    )
                    
                    
                    814
                    
                    
                    
                    38
                    
                    
                    
                    (228
                    )
                    
                    
                    (18
                    )Provision
      for income taxes
                    
                    
                    10,503
                    
                    
                    
                    7,616
                    
                    
                    
                    3,319
                    
                    
                    
                    1,080
                    
                    
                    
                    356Net
      Income
                    
                    
                    30,980
                    
                    
                    
                    28,857
                    
                    
                    
                    15,333
                    
                    
                    
                    624
                    
                    
                    
                    2,089Basic
      Earnings Per Share
                    
                    
                    1.87
                    
                    
                    
                    1.91
                    
                    
                    
                    1.27
                    
                    
                    
                    0.05
                    
                    
                    
                    0.19Diluted
      Earnings Per Share
                    
                    
                    1.86
                    
                    
                    
                    1.87
                    
                    
                    
                    1.15
                    
                    
                    
                    0.05
                    
                    
                    
                    0.19Balance
      Sheet Data:Total
      Assets
                    
                    $
                    140,363
                    
                    
                    $
                    101,259
                    
                    
                    $
                    37,285
                    
                    
                    $
                    16,681
                    
                    
                    $
                    8,992Total
      Current Liabilities
                    
                    
                    19,494
                    
                    
                    
                    6,326
                    
                    
                    
                    5,040
                    
                    
                    
                    2,370
                    
                    
                    
                    1,641Working
      Capital
                    
                    
                    56,895
                    
                    
                    
                    49,509
                    
                    
                    
                    15,447
                    
                    
                    
                    7,798
                    
                    
                    
                    2,858Stockholder's
      Equity
                    
                    
                    120,869
                    
                    
                    
                    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
Results of Operation.




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




FORWARD
LOOKING STATEMENTS




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




DISCUSSION




We are
engaged, through our China-based indirect subsidiaries described below, in the
development, manufacture, marketing and sale of over-the-counter, branded
nutritional supplements and over-the-counter plant and herb-based pharmaceutical
and medicinal products.  Our principal products are external use
TCMs.  We have evolved into an integrated manufacturer, marketer and
distributor of external-use TCM products sold primarily in the PRC and through
Chinese domestic pharmaceutical chains.  Recently, we have been
expanding our worldwide sales effort as well.  Prior to 2009, we sold
both our own manufactured products, as well as medicinal and pharmaceutical
products manufactured by others on a contract basis, categorized by us as
Contract Sales.  Commencing in 2009, we discontinued all of our
Contract Sales as part of our revised strategic plan.




In
2009, we achieved continued growth on the sale of our own product line through
our sustained efforts to expand our distribution channels and promote our
products.  For the year ended December 31, 2009, total revenues were
$130,092,000, compared to $91,816,000 and $49,318,000 for the years ended
December 31, 2008 and 2007, respectively. Net income was $30,980,000, or $1.86
per share, in 2009, compared to net income of $28,857,000, or $1.87 per share,
in 2008, and net income of $15,333,000, or $1.15 per share, in 2007, as
calculated on a diluted basis for all periods presented.




All of
our business is conducted through our wholly-owned subsidiary, ACPG which, in
turn, wholly owns Harbin TDR, and TDR’s subsidiaries.




Recent
Developments




On April
3, 2008, TDR completed its acquisition of Tianlong, a company that had a variety
of medicines approved by the SFDA and new medicine applications, and which was
in the business of manufacturing external-use pharmaceuticals.  TDR
previously acquired the Beijing sales office of Tianlong in
mid-2006.  In connection with this transaction, TDR acquired 100% of
the issued and outstanding capital stock of Tianlong from its sole stockholder,
in consideration for an aggregate purchase price of approximately $8,300,000,
consisting of $8,000,000 in cash, and 23,850 shares of our common stock (valued
at $12.00 per share).




On April
18, 2008, TDR consummated its acquisition of Haina, licensed as a wholesaler of
TCM, bio-products, medicinal devices, antibiotics and chemical
medicines.  Haina did not have an established sales network and was
acquired for its primary asset, a GSP license issued by the Heilongjiang
Province office of the SFDA.  The SFDA only issues such licenses to
pharmaceutical resellers that maintain certain quality control
standards.  The GSP license was issued as of December 21, 2006 and
will expire on January 29, 2012.  This GSP license has enabled us to
expand our sales of medicinal products without having to go through a lengthy
license application process.  In connection with this transaction, TDR
acquired 100% of the issued and outstanding capital stock of Haina from its
three stockholders in consideration for payment of approximately
$437,000.




34




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).




Trends
and Uncertainties




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.  However, since all of our business operations, and most of
our sales, are currently conducted in the PRC, we have not been greatly affected
by the economic downtown.




We have
benefited from the overall economic development in the PRC in recent years and
the increase in the number of elderly people in China, which together have
resulted in increased expenditures on medicine in the PRC, including
TCMs.




In fiscal
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 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, 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 resulted in
our direct customer base decreasing from 943 customers at December 31, 2007 to
212 customers at December 31, 2009.




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 its 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 to be partially
offset by product price incentives we grant to the larger agents with 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




Results
of Operations




Restatement
of Financial Statements




As
discussed in Note 2 to the Financial Statements, the Company restated its
financial statements for the year ended December 31, 2009.  On May 7,
2010, the Company determined that ASC 815-40, which was effective January 1,
2009, should have been applied to warrants issued in the Company’s 2008 private
placement, resulting in a reclassification of the warrants as a derivative
liability, measured at fair value, with changes in fair value recognized as part
of other income or expense for each reporting period thereafter.  In
addition, the Company previously recorded a liability in connection with certain
registration rights provided to investors in the private
placement.  On May 7, 2010, the Company determined that because the
obligations do not recognize cash settlement and the warrants can be settled in
unregistered shares, paragraphs 14 – 18 of EITF 00-19 do not apply to the
registration rights obligation.  As a result, no liability is required
to be recorded with respect to this obligation and the Company has
recharacterized this previously recorded liability.




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




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




The
following table sets forth our revenues, cost of goods sold,  gross
profit and gross profit margin during the fiscal years ended December 31, 2009,
2008, and 2007:




FortheYearsEndedDecember31,
                                  ($inthousands)2009
                                
                                
                                Variance
                                
                                
                                2008
                                
                                
                                Variance
                                
                                
                                2007RevenuesProduct
      Sales (net of sales allowance)
                                
                                $
                                130,092
                                
                                
                                
                                51
                                %
                                
                                $
                                86,161
                                
                                
                                
                                137
                                %
                                
                                $
                                36,320Contract
      Sales
                                
                                
                                0
                                
                                
                                
                                -
                                
                                
                                
                                5,655
                                
                                
                                
                                (57
                                )%
                                
                                
                                12,998Total
      Revenues
                                
                                $
                                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, 2009.  The
increase in our revenues is primarily attributable to increase in our product
sales related to:




·
            strong
      performances from our sales distribution channels, obtained by our hiring
      of additional direct territory managers and sales
  agents;




·
            our
      efforts to locate and cooperate with more reputable distributors for
      certain of our products;




·
            the
      increase in marketing and advertising expenditures of 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 products of Tianlong, which generated
      approximately $43,138,000 and approximately $13,803,000 in 2009 and 2008,
      respectively, and Peng Lai, which generated approximately $11,188,000 and
      approximately $2,164,000 in 2009 and 2008, respectively, two of the
      businesses we acquired in fiscal
2008.




36




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 increased by approximately $9,268,000, or 41%, to approximately
$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%, from approximately $69,413,000 in 2008 to approximately
$98,422,000 in 2009.  Our gross margin remained constant at
approximately 76%.




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.  The increase
in revenue is primarily attributable to strong performances from our sales
distribution channels, and our sales of products of 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 products
of 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 the most meaningful presentation of our products is by categories
of method of delivery. 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 each of the fiscal years
ended December 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
                    %




Year
over year – 2009 to 2008




During
the fiscal year ended December 31, 2008, we acquired Tianlong  (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 agents and distributors, which have been able to put our
products in more extensive sales networks, and the full-year effect of sales of
products of Tianlong and Peng Lai, two of the businesses we acquired in fiscal
2008.  As a result of signing agreements with these distributors, the
sales revenues for products in the patches, sprays, and diagnostic kits
categories increased 14.9%, 74.3%, and 16.6% year over year.  The
revenue increase of approximately $5,794,000 in the ointment category, and the
revenue  increase of approximately $23,507,000 in other products
category, are primarily due to our increased spending in marketing and
advertising for certain products in these categories.  Tianlong’s
products generated approximately $43,138,000 and $13,803,000 in 2009 and
2008, respectively.  Revenue generated by Tianlong’s products are
included in the ointment, spray and other product categories.  Peng
Lai’s products generated approximately $11,188,000 and $2,164,000 in 2009 and
2008, respectively.  Revenue generated by Peng Lai’s products are
included in 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 91 products we commercialized in fiscal year 2009, 10 products accounted for
approximately 68% of the total revenue.  Out of the 97 products we
commercialized in fiscal year 2008, 10 products accounted for approximately 72%
of total revenue.




Year
over year – 2008 to 2007




Our
increase in revenues in 2008 as compared to 2007 was due to a combination of our
sale of products of Tianlong and Peng Lai, two of the businesses we acquired in
fiscal 2008, as well as our internal growth driven 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 Tianlong products 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 established sales network and was acquired only for its GSP
license.




Operating
Expenses




The
following table summarizes the changes in our operating expenses for the years
ended December 31, 2009, 2008 and 2007:




For the Years ended December
      31,
                    ($in
      thousands)2009
                  
                  
                  Variance
                  
                  
                  2008
                  
                  
                  Variance
                  
                  
                  2007Operating
      ExpensesSelling
      expense
                  
                  $
                  30,763
                  
                  
                  
                  34
                  %
                  
                  $
                  22,969
                  
                  
                  
                  55
                  %
                  
                  $
                  14,784General
      and administrative expense
                  
                  
                  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 increased by approximately $7,794,000 in 2009 compared with 2008. This
increase was primarily related to increased costs of advertising from
approximately $7,299,000 in 2008 to approximately $14,527,000 in 2009, resulting
from our increased marketing and sales efforts.




General
and administrative expenses for the year ended December 31, 2009 increased
approximately $1,677,000, or 67%, compared with 2008.  This increase
was primarily due to an expense for share-based compensation, of approximately
$1,242,000, for common shares we issued in December 2009 ($316,000 in
2008).




Depreciation
and amortization expenses in 2009 increased by approximately $1,397,000, or
163%, compared with 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 amortized over a period of 10 years;
and




·
            the
      full year effect of depreciation and amortization of tangible and
      intangible assets we 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 certain information regarding our major research and development
projects in 2009.  The additional costs and expected completion dates
set forth in the table below are subject to change, which may be material, based
on various factors, many of which are out of our control:




40




Projects
                                          
                                          Stage
                                          
                                          2008 Expense
                                          
                                          
                                          2009 Expense
                                          
                                          
                                          Aggregate
                                            Expenses Since
                                            Commencement of
                                            Project
                                          
                                          
                                          Estimated
                                            Additional Costs to
                                            Complete Research
                                            and Development
                                          
                                          Remaining Activities and Expected Research and
                                            Development Completion Date***Diagnostic Kits -
      19 products*
                                          
                                          Clinical  trial
                                          
                                          $
                                          2,261,000
                                          
                                          
                                          $
                                          2,727,000
                                          
                                          
                                          $
                                          4,988,000
                                          
                                          
                                          
                                          $800,000
                                          
                                          13
      projects are estimated to be submitted to the SFDA in later half of 2010,
      with an estimated aggregate cost of $500,000; Another 6 products are
      estimated to complete clinical trial in fiscal 2010, then get into the
      stage of long term stability testing through 2013, with estimated cost of
      $300,000Injections
      - 6 projects
                                          
                                          Clinical
      trial
                                          
                                          $
                                          614,000
                                          
                                          
                                          $
                                          1,944,000
                                          
                                          
                                          $
                                          2,558,000
                                          
                                          
                                          
                                          $300,000
                                          
                                          One
      product is pending SFDA approval; 3 products are planned to be submitted
      to the SFDA within fiscal 2010, with an estimated cost of $100,000; The
      other 2 products are going into long term stability testing stage with an
      estimated cost of $200,000Breast
      Cancer Technology
                                          
                                          Efficacy
      testing, Acute and Long Term Toxicity testing
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          2,272,000
                                          
                                          
                                          $
                                          2,272,000
                                          
                                          
                                          
                                          $8.3
      million
                                          
                                          Efficacy
      stage has been completed in 2009, long term stability testing is estimated
      to be completed during the first half of 2011, with an estimated cost of
      $300,000, then apply to the SFDA for getting into the clinical trial. The
      clinical trial is estimated to be completed in  2015, with an
      estimated cost of $6-8 million, afterwards, we intend to apply to the SFDA
      to enter into the production stage.Patches
      - 4 products
                                          
                                          Extraction
      optimization testing
                                          
                                          $
                                          0
                                          **
                                          
                                          $
                                          1,820,000
                                          
                                          
                                          $
                                          1,820,000
                                          
                                          
                                          $
                                          **
                                          CompletedMonoclonal
      Antibody
                                          
                                          Completed
                                          
                                          $
                                          948,000
                                          
                                          
                                          $
                                          965
      ,000
                                          
                                          
                                          $
                                          1,913,000
                                          
                                          
                                          $1.8
      to $2 million
                                          
                                          Continue
      study in 2010; does not require SFDA approvalEndostatin
                                          
                                          Efficacy
      testing, Acute and Long Term Toxicity testing
                                          
                                          $
                                          1,192,000
                                          
                                          
                                          $
                                          439,000
                                          
                                          
                                          $
                                          1,631,000
                                          
                                          
                                          $8
      to $10 million
                                          
                                          Clinical
      trials; estimated to be completed in 2016 and submitted for SFDA
      approvalAntroquinonol
                                          
                                          Clinical
      trial
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          387,000
                                          
                                          
                                          $
                                          387,000
                                          
                                          
                                          $16 to $18 million
                                          
                                          Efficiency,
      acute and long-term toxicity testing; pre-clinical and clinical trials are
      estimated to be completed in 2018 and submitted for SFDA
      approvalRadix Isatidis
      granule and
      syrup
                                          
                                          Production
      process optimization
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          282,000
                                          
                                          
                                          $
                                          282,000
                                          
                                          
                                          
                                          $400,000 - $500,000
                                          
                                          Estimated
      to be completed in 2010Naftopidil
      Dispersible tablets
                                          
                                          Production
      process optimization
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          256,000
                                          
                                          
                                          $
                                          256,000
                                          
                                          
                                          
                                          $400,000 - $500,000
                                          
                                          Estimated
      to be completed in 2010Sertraline
      Hydrochloride capsules
                                          
                                          Production
      process optimization
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          249,000
                                          
                                          
                                          $
                                          249,000
                                          
                                          
                                          
                                          $400,000 - $500,000
                                          
                                          Estimated
      to be completed in
2010
 ____________________________




*   
 During 2008, we conducted long-term stability testing on clinical trials
on a total of 13 projects for an aggregate expense of $2,261,000.  We
spent an immaterial amount on further research and development of the projects
in 2009 and expect to submit those projects for SFDA approval during the second
half of 2010 at an estimated aggregate additional expense of
$500,000.


**  
The amount is not meaningful.
 ***  Does
not include time required for SFDA approval, if any.
 41


In
addition to the projects set forth in the table above, we commenced clinical
trials or efficacy, acute and long-term toxicity testing on several other
projects.  We expect to complete testing and/or trials for these
projects between 2012 and 2014 at an estimated cost of $600,000 to $1,000,000
per project.




Other
Income




For
the year ended December 31, 2009 (restated), we incurred a charge of $4,807,000
due to the change in fair value of a derivative warrant liability resulting from
an increase in the fair value of warrants issued in the Offering (as defined
under the caption “ – Private Offering”).




Year
over year – 2008 to 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 increased by approximately $8,185,000 in 2008 compared with
2007.  The higher selling expenses are primarily related
to:




·
            increased
      costs of advertising, from approximately $4,385,000 in 2007, to
      approximately $7,299,000 in 2008;
and




·
            increased
      sales commissions resulting from our increased
  revenues.




General
and administrative expenses for the year ended December 31, 2008 increased
approximately $1,134,000, or 82%, over the 2007.  The higher general
and administrative expenses are primarily due to the increases in salaries and
other administrative expenses resulting from the business acquisitions we made
in fiscal 2008.  In 2008, we recorded share-based compensation expense
of $316,000, as compared to $235,000 in 2007.




Depreciation
and amortization in 2008 increased by approximately $415,000 compared
2008. The higher depreciation and amortization expenses are primarily due to the
increased tangible and intangible assets we acquired through the business
acquisitions we consummated in 2008.




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 increased
R&D expenses in 2008 were primarily due to our taking over of the ongoing
research and development projects in Tianlong and Peng Lai because of these two
acquisitions and other technologies we acquired in 2008 and 2009.  We
also increased our research and development activities relating to certain
previously developed technologies.




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.




42




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
amounts of pure antibodies.  Therefore, Monoclonal antibodies have
tremendous applications in the field of diagnostics, therapeutics, and targeted
drug delivery systems, not only for infectious disease caused by 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 nutrients upon
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.





43





Liquidity
and Capital Resources




The
following table summarizes our cash and cash equivalents position, our working
capital, and our cash flow activity as of December 31, 2009 and 2008 and for
each of the years then ended:




As of December 31,
                    ($ in thousands, except ratio and days)2009
                    (restated)
                  
                  
                  2008Cash
      and cash equivalents
                  
                  $
                  52,756
                  
                  
                  $
                  40,288Current
      ratio
                  
                  
                  3.9
                  
                  
                  
                  8.8Quick
      ratio
                  
                  
                  3.8
                  
                  
                  
                  8.8Average
      accounts receivable collection days
                  
                  
                  51.6
                  
                  
                  
                  45.5Average
      inventory turnover days
                  
                  
                  21.6
                  
                  
                  
                  18.2Working
      capital
                  
                  $
                  56,895
                  
                  
                  $
                  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, 2009, 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, 2009 of approximately $56,895,000, compared to $49,509,000 at
December 31, 2008. Our increase in working capital in 2009 was principally due
to increased cash and cash equivalents funded by the increased cash flows
generated from our operating activities of $33,449,000 for the year
ended December 31, 2009, compared to $27,538,000 for the year
ended December 31, 2008. The increase in working capital in 2009 was offset
by the increased change in value of derivative liability of $4,807,000 between
 January 1, and December 31, 2009 using the Monte Carlo valuation model.
 We consider current working capital and borrowing capabilities adequate to
cover our current operating and capital requirements for the full year
2010.




Cash
flows used in investing activities was approximately $21,154,000 for the year
ended December 31, 2009 compared to approximately $23,115,000 in 2008. Cash
flows used in investing activities in 2008 was primarily related to our purchase
of properties and equipment in connection with the business acquisitions we
consummated in 2008.  Cash flows used in investing activities in 2009
was primarily related to our expenditures in construction in progress of
approximately $9.9 million, in connection with our construction of our new
corporate headquarters, as well as the purchase of proprietary technologies for
Antroquinonol, 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
flows provided from financing activities was approximately $29,000 for the year
ended December 31, 2009 compared to approximately $25,355,000 for the same
period in 2008. Our higher cash flows provided from financing activities in 2008
were primarily due to the private offering we completed in January 31, 2008, as
well as cash generated from the exercise of warrants by 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.




44




Our
current ratio was 3.9 at December 31, 2009 compared to 8.8 at December 31, 2008
and the quick ratio was 3.8 at December 31, 2009 compared to 8.8 at December 31,
2008. We endeavor to ensure that funds are available to take advantage of new
investment opportunities and that funds are sufficient to meet future liquidity
and capital needs.




We
calculate accounts receivable turnover by averaging the opening and closing
balances of out accounts receivable during that period and dividing that amount
by our average daily sales during that period.  Since accounts
receivables 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.




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 ended December 31, 2009 and 2008
calculated by using average daily costs of goods sold and average inventory for
each quarter were as the following:




45




Quarter Ended
                                  
                                  Average Daily COGS
                                    ($ in thousands)
                                  
                                  
                                  Average Inventory
                                    ($ in thousands)
                                  
                                  
                                  TurnoverDaysMarch
      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”).




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.




46




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 became 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 are subject to adjustment for
      standard dilutive events, as well as for 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 is not 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.




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.




47




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 of  December 31, 2009 our allowance
for doubtful accounts was $56,000 and $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





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, we will measure the
impairment loss as the amount by which the carrying value of the asset exceeds
its fair value.  We did not record any impairment charges in the years
ended December 31, 2009, 2008 and 2007.




48




Derivative
Liabilities




The
Class A Warrants (“the Warrants”) issued under our January 31, 2008 private
placement memorandum include a reset provision triggered if the Company issues
common shares below the exercise price of $12.50 as defined under the Warrant
Agreement. Effective January 1, 2009 the reset provision of these warrants
preclude equity accounting treatment under ASC 815 (formerly EITF 07-5).
 Accordingly, effective January 31, 2009, the Company is required to
reclassify the Warrants at their fair value to liabilities each reporting period
under ASC 815-40. The Company used the Monte Carlo valuation model to estimate
the fair value of the Warrants. Significant assumptions used at December 31,
2009 include a term of approximately 3.7 years; volatility of 60.0% and a risk
free interest rate of 2.72%




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.  We did not record any impairment charges for the
years ended December 31, 2009, 2008 and 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.




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.




49




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.




We
incurred research and development expenses of approximately $14,960,000,
$7,413,000, and $3,158,000, for the years ended December 31, 2009, 2008, and
2007, respectively in research and development costs.




Recent
Accounting Pronouncements




Refer
to Note 4 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, 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.




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 ended December 31,
2008 were denominated primarily in RMB, the currency of China, and were
converted into U.S. dollars at the exchange rate of 6.96225 RMB to 1 U.S.
Dollar.  In the third quarter of 2005, the RMB began 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
results of operations. We do not engage in currency hedging.




Off-Balance
Sheet Arrangements




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




Item
7A.  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.





50




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 RMB 8.00 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 RMB 6.8
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 index in China was 5.9%, 4.8%, and 1.9% 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 income of approximately $71,000,
$112,000 and $10,000 for the years ended December 31, 2009, 2008 and 2007,
respectively.





51





Item
8.  Financial Statements and 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 Years Ended
      December 31, 2009 (restated), 2008 and 2007
                  
                  F-6Consolidated
      Balance Sheets at December 31, 2009 (restated) and
2008
                  
                  F-7Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31, 2009
      (restated),  2008 and 2007
                  
                  F-8Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2009 (restated),
      2008  and 2007
                  
                  F-9Notes
      to Consolidated Financial Statements
                  
                  F-10
      – F-36





F-1





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders of


China
Sky One Medical Inc. and Subsidiaries





We
have audited the accompanying consolidated balance 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 and comprehensive
income, stockholders’ equity, and cash flows for each of the fiscal years in the
two-year period ended December 31, 2009. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements 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 audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.





In our
opinion, the consolidated financial statements present fairly, in all material
respects, the financial position of China Sky One Medical Inc. and subsidiaries
as of December 31, 2009 and 2008, and the results of their operations and
their cash flows for each of the fiscal years in the two-year period ended
December 31, 2009, in conformity with accounting principles generally
accepted in the United States of America.





As
discussed in Note 2 to the consolidated financial statements, the accompanying
2009 financial statements have been restated.





We
have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company’s internal control over
financial reporting as of December 31, 2009, based on the criteria
established in Internal
Control—Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 15,
2010 (June 18, 2010 as to the effects of the material weakness described in
Management’s Report on Internal Control over Financial Reporting (as revised))
expressed an adverse opinion on the Company’s internal control over financial
reporting because of the material weakness.





/s/
MSPC


Certified
Public Accountants and Advisors,


A
Professional Corporation


New
York, New York


March 15,
2010 (June 18, 2010 as to the effects of the restatement discussed in Note
2)





F-2




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders of


China Sky
One Medical Inc. and Subsidiaries




We
have audited China Sky One Medical Inc. and subsidiaries (the “Company”)
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control — Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission. The Company’s management is responsible 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
(as revised). Our responsibility is to express an opinion on the Company’s
internal control over financial reporting based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on that risk, and performing such other procedures as we considered necessary in
the circumstances. We believe that our audit provides a reasonable basis for our
opinion.





A
company’s internal control over financial reporting is a process designed by, or
under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company’s board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) 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 (3) 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 the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.





In our
report dated March 15, 2010, we expressed an unqualified opinion on
internal control over financial reporting. As described in the following
paragraph, a material weakness was subsequently identified as a result of the
restatement of the previously issued financial statements. Accordingly,
management has revised its assessment about the effectiveness of the Company’s
internal control over financial reporting and our present opinion on the
effectiveness of the Company’s internal control over financial reporting as of
December 31, 2009, as expressed herein, is different from that expressed in
our previous report.





A
material weakness is a deficiency, or a combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of the company’s annual or interim financial
statements will not be prevented or detected on a timely basis. The following
material weakness has been identified and included in management’s
assessment:





The
Company received comments from the staff of the SEC, which led to the historical
financial statements in the 2009 Form 10-K requiring restatement to properly
record 750,000 common stock purchase warrants , issued in connection with its
January 31, 2008 private placement (the “Warrants”), as a derivative
liability.


F-3





The
Company has performed a complete assessment of the Warrants and has concluded
that the Warrants are within the scope of Accounting Standards
Codification  815-40, “Derivatives and Hedging – Contracts in Entity’s
Own Equity” (“ASC 815-40”), formerly Emerging Issues Task Force No. 07-05,
“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock” (“EITF 07-05”), due to the inclusion in the Warrants of a
provision requiring a weighted average adjustment to the exercise price of the
Warrants in the event the Company issues common stock or securities convertible
into or exercisable for common stock, at a price per share lower than the
exercise price. Accordingly, ASC 815-40, formerly EITF 07-05, which was
effective as of January 1, 2009, should have been applied resulting in a
reclassification of the Warrants as a derivative liability, measured at fair
value, with changes in fair value recognized as part of other income or expense
for each reporting period thereafter.





This
material weakness was considered in determining the nature, timing, and extent
of audit tests applied in our audit of the consolidated financial statements of
the Company as of and for the year ended December 31, 2009, and this report
does not affect our report on such financial statements.





In our
opinion, because of the effect of the material weakness identified above on the
achievement of the objectives of the control criteria, the Company has not
maintained effective internal control over financial reporting as of
December 31, 2009, based on the criteria established in Internal Control — Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission.





We
have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended December 31, 2009, of the Company
and our report dated March 15, 2010 (June 18, 2010 as to the effects of the
restatement discussed in Note 2 to the financial statements) expressed an
unqualified opinion on those financial statements and included an explanatory
paragraph regarding the restatement.




/s/
MSPC


Certified
Public Accountants and Advisors,


A
Professional Corporation


New York,
New York


March 15,
2010 (June 18, 2010 as to the effects of the material
weakness)


F-4


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders of


China Sky
One Medical, Inc.




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




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




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




/s/
      Sherb & Co., LLPCertified
      Public Accountants





Boca
Raton, Florida


March 25,
2008


F-5


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Statements of Operations and Comprehensive Income


$
in thousands, except share and per share data





Years Ended December 31,2009
                            (Restated)
                          
                          
                          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 warrant liability
                          
                          
                          (4,807
                          )
                          
                          
                          -
                          
                          
                          
                          -Total
      Other Income (Expenses)
                          
                          
                          (4,768
                          )
                          
                          
                          814
                          
                          
                          
                          38Income
      Before Provision for Income Tax
                          
                          
                          41,483
                          
                          
                          
                          36,473
                          
                          
                          
                          18,652Provision
      for income taxes
                          
                          
                          10,503
                          
                          
                          
                          7,616
                          
                          
                          
                          3,319Net
      Income
                          
                          $
                          30,980
                          
                          
                          $
                          28,857
                          
                          
                          $
                          15,333Basic
      Earnings Per Share
                          
                          $
                          1.87
                          
                          
                          $
                          1.91
                          
                          
                          $
                          1.27Basic
      Weighted Average Shares Outstanding
                          
                          
                          16,575,885
                          
                          
                          
                          15,101,833
                          
                          
                          
                          12,094,949Diluted
      Earnings Per Share
                          
                          $
                          1.86
                          
                          
                          $
                          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
                          
                          
                          30,980
                          
                          
                          
                          28,857
                          
                          
                          
                          15,333Comprehensive
      Income
                          
                          $
                          31,292
                          
                          
                          $
                          32,152
                          
                          
                          $
                          17,183





See
accompanying notes to the consolidated financial statements.


F-6


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Balance Sheets


$
in thousands, except share data





2009
                
                
                2008(Restated)ASSETSCurrent
      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
                
                
                
                1,945Land
      and construction 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
                
                
                11,435
                
                
                
                -Total
      current liabilities
                
                
                19,494
                
                
                
                6,326Commitments
      and Contingencies
                
                
                -
                
                
                
                -Stockholders'
      EquityPreferred
      none issued and outstanding stock  ($0.001 par value, 5,000,000
      shares authorized)
                
                
                -
                
                
                
                -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
                
                
                37,188
                
                
                
                40,105Retained
      earnings
                
                
                77,785
                
                
                
                49,245Accumulated
      other comprehensive income
                
                
                5,879
                
                
                
                5,567Total
      stockholders' equity
                
                
                120,869
                
                
                
                94,933Total
      Liabilities and stockholder’s equity
                
                $
                140,363
                
                
                $
                101,259





See
accompanying notes to the consolidated financial statements.


F-7


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Statements of Stockholders' Equity


$
in thousands, except share data




Shares
                              
                              
                              Amount
                              
                              
                              Additional
                                Paid-in
                                Capital
                              
                              
                              Retained
                                Earnings
                              
                              
                              Accumulated
                                Other
                                Comprehensive
                                Income
                              
                              
                              Total
                                Stockholders'
                                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 acquisitions
                              
                              
                              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
                              
                              
                              
                              94,933Cumulative
      effect adjustment upon  adoption of ASC 815 (formerly EITF 07-5)
      Note 2
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (4,188
                              )
                              
                              
                              (2,440
                              )
                              
                              
                              
                              
                              
                              
                              (6,628
                              )Warrants
      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 (restated)
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              30,980
                              
                              
                              
                              
                              
                              
                              
                              30,980Balance
      at December 31, 2009 (Restated)
                              
                              
                              16,714,267
                              
                              
                              $
                              17
                              
                              
                              $
                              37,188
                              
                              
                              $
                              77,785
                              
                              
                              $
                              5,879
                              
                              
                              $
                              120,869





See
accompanying notes to the consolidated financial
statements.


F-8


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


$
in thousands





Years Ended December 31,2009
                            (Restated)
                          
                          
                          2008
                          
                          
                          2007Cash
      Flows From Operating ActivitiesNet
      income
                          
                          $
                          30,980
                          
                          
                          $
                          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
                          
                          
                          4,807
                          
                          
                          
                          -
                          
                          
                          
                          -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 and cash equivalents
                          
                          
                          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-9


China
Sky One Medical, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements







1.           Description
of Business




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




China Sky
One is a holding company whose principal operations are through its wholly-owned
subsidiaries; it has no revenues separate from its subsidiaries, and has
expenses related to its status as a public reporting company and to its
ownership interest in American California Pharmaceutical Group, Inc. (“ACPG”)
and Harbin City Tian Di Ren Medical Co. (“TDR”).




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




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




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




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.           Restatement




On May
7, 2010, the Company’s management determined that the Company’s previously filed
financial statements for the fiscal year ended December 31, 2009, included in
the Form 10-K, should no longer be relied upon due to an error in such financial
statements with respect to the accounting forcertain derivative
instruments (warrants it issued in 2008 discussed below), which were previously
recorded as equity instruments in accordance with generally accepted accounting
principles in effect through December 31, 2008.Management concluded
that the historical financial statements in the Original Form 10-K require
restatement to properly record 750,000 common stock purchase warrants, issued in
connection with its January 31, 2008 private placement (the “Warrants”), as a
derivative liability.


F-10


China
Sky One Medical, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements





2.           Restatement
(Continued)





The
Company has performed a complete assessment of the Warrants and has concluded
that the Warrants are within the scope of Accounting Standards Codification
815-40, “Derivatives and
Hedging – Contracts in Entity’s Own Equity” (“ASC 815-40”), formerly
Emerging Issues Task Force Issue No. 07-05, “Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF
07-05”), due to the inclusion in the Warrants of aprovision requiring a
weighted average adjustment to the exercise price of the Warrants in the event
the Company issues common stock, or securities convertible into or exercisable
for common stock, at a price per share lower than such exercise price.
Accordingly, ASC 815-40, formerly EITF 07-05, which was effective as of January
1, 2009, should have been applied resulting in a reclassification of the
warrants as a derivative liability, measured at fair value, with changes in fair
value recognized as part of other income or expense for each reporting period
thereafter.





The
Company previously recorded a derivative liability of approximately $1.3 million
in connection with registration rights obligations with respect to the
securities issued in the Company’s January 31, 2008 private
placement.  Also, on May 7, 2010, the Company determined that, because
the obligations do not require a cash settlement and the warrants can be settled
in unregistered shares, paragraphs 14-18 of EITF 00-19 do not apply to the
registration rights obligation.  As a result, no liability is required
to be recorded with respect to this obligation and the Company is
recharacterizing the $1.3 million liability previously recorded as of December
31, 2009.





After
discussions with the Audit Committee of its Board of Directors and the Company’s
independent registered public accounting firm, management has determined to file
the Amended Form 10-K to reflect the corrections made in response to these
accounting errors.  The correction of the errors impacts each of the
Company’s consolidated financial statements, but has no impact on the Company’s
income from operations or cash flows.  Additionally, the Company
determined that the application of ASC 815-40 did not have a material impact on
its financial statements for the quarterly periods ended March 31, 2009, June
30, 2009 and September 30, 2009.





The
following table ($ in thousands, except per share information) show the effects
of the restatement on the Company's consolidated balance sheet as of
December 31, 2009 and consolidated statements of operations and
comprehensive income for the year ended December 31, 2009:





As of December 31, 2009As Previously
                      Recorded
                    
                    
                    As RestatedLIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIESWarrant
      liability
                    
                    $
                    1,330
                    
                    
                    $
                    11,435TOTAL
      CURRENT LIABILITIES
                    
                    $
                    9,389
                    
                    
                    $
                    19,494SHAREHOLDERS'
      EQUITYAdditional
      paid in capital
                    
                    $
                    41,376
                    
                    
                    $
                    37,188Retained
      earnings
                    
                    $
                    83,702
                    
                    
                    $
                    77,785TOTAL
      SHAREHOLDERS' EQUITY
                    
                    $
                    130,974
                    
                    
                    $
                    120,869TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                    
                    $
                    140,363
                    
                    
                    $
                    140,363


F-11




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


2.           Restatement
(Continued)





Year Ended December 31, 2009As Previously
                      Recorded
                    
                    
                    As RestatedINCOME
      FROM OPERATIONS
                    
                    $
                    46,251
                    
                    
                    $
                    46,251OTHER
      INCOME (EXPENSE)Change
      in fair value of derivative liability
                    
                    $
                    (1,330
                    )
                    
                    $
                    (4,807
                    )Total
      other income (expense)
                    
                    $
                    (1,291
                    )
                    
                    $
                    (4,768
                    )INCOME
      BEFORE PROVISION FOR INCOME TAXES
                    
                    $
                    44,960
                    
                    
                    $
                    41,483Provision
      for income taxes*
                    
                    $
                    10,503
                    
                    
                    $
                    10,503NET
      INCOME
                    
                    $
                    34,457
                    
                    
                    $
                    30,980BASIC
      EARNINGS PER SHARE
                    
                    $
                    2.08
                    
                    
                    $
                    1.87DILUTED
      EARNINGS PER SHARE
                    
                    $
                    2.07
                    
                    
                    $
                    1.86COMPREHENSIVE
      INCOME
                    
                    $
                    34,769
                    
                    
                    $
                    31,292









*
            The
      loss resulting from the change in fair value of the derivative
      warrant liability for the year ended December 31, 2009 was incurred at the
      corporate level (a Nevada corporation).  The Company did not
      recognize any income tax benefits associated with the change in fair value
      of the derivative warrant liability for the year ended December 31,
      2009 (see Note 15).  Therefore, the restatement of net income in
      2009 as discussed above did not have an effect on the Company’s provision
      for income taxes for the year ended December 31,
  2009.




3.           Acquisition
of Businesses




On April
3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement
dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical,
Inc., a corporation with a multitude of medicines approved 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
acquired the Beijing sales office of Tianlong in mid 2006. Pursuant to the
Equity Transfer Agreement, TDR acquired 100% of the issued and outstanding
capital stock of Tianlong from Tianlong’s sole stockholder, in consideration for
an aggregate purchase price of approximately $8,300,000, consisting of
(i) $8,000,000 in cash, and (ii) 23,850 shares of China Sky One (at $12 per
share). The acquisition received regulatory approval and closed on April 3,
2008.




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




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




F-12




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


3.           Acquisition
of Businesses (Continued)




On April
18, 2008, China Sky One through its subsidiary TDR consummated a share
acquisition pursuant to an Equity Transfer Agreement with the shareholders of
Heilongjiang Haina Pharmaceutical Inc., a recently formed corporation organized
under the laws of the PRC (“Haina”) licensed as a wholesaler of TCD,
bio-medicines, bio-products, medicinal devices, antibiotics and chemical
medicines. Haina does not have an established sales network and was acquired for
its primary asset, a Good Supply Practice (GSP) license (License No.
A-HLJ03-010) issued by the 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
      assets acquired
                
                $
                437




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




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




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




$ in thousandsFixed
      assets
                  
                  $
                  4,177Intangible
      assets - SFDA licenses for drug batch numbers
                  
                  
                  2,917Net
      assets acquired
                  
                  $
                  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-13




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


4.           Summary
of Significant Accounting Policies




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 statements
include the accounts of the Company and its wholly-owned subsidiaries, ACPG,
TDR, First, Tian Qing, Tianlong, Haina and Peng Lai. All significant
inter-company transactions and balances were eliminated.




These
financial statements are stated in U.S. Dollars and have been prepared in
accordance with accounting principles generally accepted in the 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 income of approximately
$71,000, $112,000 and $10,000  for 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 of  December 31, 2009 and 2008, the Company’s allowance
for doubtful accounts was $56,000 and $50,000, respectively.


F-14




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





4.           Summary
of Significant Accounting Policies (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 its fair value. The
Company did not record any impairment charges of property and equipment in the
years ended December 31, 2009, 2008 and 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 charges for the
years ended December 31, 2009, 2008 and 2007.


F-15




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements
 4.           Summary
of Significant Accounting Policies (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 Class A Warrants (“the Warrants”) issued under our January 31, 2008 private
placement memorandum include a reset provision triggered if the Company issues
common shares below the exercise price of $12.50 as defined under the Warrant
Agreement. Effective January 1, 2009 the reset provision of these warrants
preclude equity accounting treatment under ASC 815 (formerly EITF 07-5).
Accordingly, effective January 31, 2009, the Company is required to reclassify
the Warrants at their fair value to liabilities each reporting period under ASC
815-40. The Company used the Monte Carlo valuation model to estimate the fair
value of the Warrants. Significant assumptions used at December 31, 2009
include a term of approximately 3.7 years; volatility of 60.0% and a risk free
interest rate of 2.72.




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.


F-16




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





4.           Summary
of Significant Accounting Policies (Continued)




The
Company incurred research and development expenses of approximately $14,960,000,
$7,413,000, and $3,158,000, for the years ended December 31, 2009, 2008, and
2007, respectively.




Advertising–TheCompany signs contracts
with agents who then place its advertising in the mediums of television, radio
and internet.  Advertising expense is incurred in the period the
advertisements take place. Thus, costs of advertising are expensed as incurred.
Advertising costs for the years ended December 31, 2009, 2008, and 2007 were
approximately $14,527,000, $7,299,000 and $4,385,000,
respectively.  An immaterial amount of the Company’s advertisement
expenses in 2009, 2008 and 2007 were related to advertising production
costs.  Advertising costs are reported as part of selling expenses in
the statements of 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” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. The following table sets forth the Company’s income
tax rate for TDR and its subsidiaries for the years ended December 31, 2009,
2008 and 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-17




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





4.           Summary
of Significant Accounting Policies (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 incurred costs of $209,000,
$89,000, and $22,000 for the years ended December 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 events through the date of filing of this Form
10-K/A 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.


F-18




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


4.           Summary
of Significant Accounting Policies (Continued)




In
December 2007, the FASB issued new accounting guidance on business combinations.
The new guidance establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any noncontrolling interest in the acquiree
and the goodwill acquired. The new accounting guidance also establishes
disclosure requirements to enable the evaluation of the nature and financial
effects of 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
was adopted by the Company in the first quarter of Fiscal 2009.




In
April 2008, the FASB issued new accounting guidance regarding the determination
of useful lives of intangible assets that amends the factors that should be
considered in developing renewal or extension assumptions used for purposes of
determining the useful life of a recognized intangible asset. This guidance is
intended to improve the consistency between the useful life of a recognized
intangible asset under accounting guidance related to goodwill and other
intangible assets and the period of expected cash flows used to measure the fair
value of the asset under accounting guidance related to business combinations
and other U.S. GAAP. This guidance is effective for fiscal years beginning after
December 15, 2008, and was adopted by us in the first quarter of Fiscal 2009.
The  adoption of this guidance did not have a material effect on the
Company’s results of operations and financial condition.




In
June 2008, the Emerging Issues Task Force issued EITF Consensus No. 07-5
“Determining Whether an Instrument (or Embedded Feature) is indexed to an
Entity’s Own Stock”. Under EITF 07-5, instruments which contain full ratchet
anti-dilution provisions will no longer be considered indexed to a company’s own
stock for purposes of determining whether it meets the first part of the scope
exception in paragraph 11 (a) of Statement 133. The adoption of this EITF
required us to (1) evaluate our instrument’s contingent exercise provisions
and (2) evaluate the instrument’s settlement provisions. Based upon applying
this approach to instruments within the scope of this exception , we have
determined that the Class A Warrants  issued under our Private
Placement which were classified in stockholders’ equity on December 31, 2008, no
longer meet the definition of Indexed to a Company’s Own Stock provided in the
Consensus. Accordingly effective on January 1, 2009, we were required to
reclassify the Class A Warrants to liabilities under ASC 815-40 (formerly EITF
07-5). The adoption of this new guidance in 2009 had a material impact on our
financial statements.




In April
2009, the FASB issued new accounting 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 instruments in interim financial statements, in addition to the
annual financial statements as already required. This new accounting guidance
became effective for interim periods ending after June 15, 2009, and was adopted
by 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 issued new accounting guidance regarding the determination of
fair value when the volume and level of activity for assets or 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 quoted prices may not be indicative of fair value and a
significant adjustment may need to be made to those prices to estimate fair
value. Additionally, an entity must consider whether the observed transaction
was orderly (that is, not distressed or forced). If the transaction was orderly,
the obtained price can be considered a relevant observable input for determining
fair value. If the transaction is not orderly, other valuation techniques must
be used when 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, but had no material impact on our consolidated
financial statements.


F-19




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


4.           Summary
of Significant Accounting Policies (Continued)




In May
2009, the FASB issued new accounting guidance, “Subsequent Events”, which
established general standards of accounting for and disclosure of events that
occur after the balance sheet date but before the financial statements are
issued or available to be issued. The guidance requires new disclosure in
financial statements of the date through which reporting entities have evaluated
events or transactions that occur after the balance sheet date but before the
financial statements are issued or available to be issued. The guidance requires
public entities, including the Company, to evaluate subsequent events through
the date that the financial statements are issued. Financial statements are
considered issued when they are widely distributed to stockholders and other
financial statement users for general use and reliance 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 applied on a
prospective basis.




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.




5.           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
                                  
                                  
                                  %
      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
                                  %




F-20




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


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




Year
over year – 2009 to 2008




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




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




Year
over year – 2008 to 2007




During
the fiscal year ended December 31, 2008, the Company acquired
Tianlong  (April 2008), Haina (April 2008) and Peng Lai (September
2008).  The Company’s increase in revenues in 2008 as compared to 2007
was due to a combination of these business acquisitions, as well as the
Company’s internal growth driven 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.




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 established sales network and was acquired only for its GSP
license.




6.           Concentrations
of Business and Credit Risk




Substantially
all of the Company's long-lived assets and business operations are located in
the PRC.


F-21




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




6.           Concentrations
of Business and Credit Risk (Continued)




The
Company maintains certain bank accounts in the PRC which are not protected by
FDIC insurance or other insurance. As of December 31, 2009 the Company held
approximately $1,960,000 of cash balances within the U.S. and all of the
deposits were within  the FDIC insurance limits. At December 31, 2009,
the Company had approximately $50,796,000 in China bank deposits, which is not
insured..




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




The
Company provides credit in the normal course of business. The Company performs
ongoing credit evaluations of its customers and maintains allowances for
doubtful accounts based on factors surrounding the credit risk of specific
customers, historical trends, and other information.




The
Company is self-insured for all risks and carries no liability or property
insurance coverage of any kind. The Company does not set aside any reserves for
product liability risks or other potential claims. The Company’s policy is to
record losses associated with its lack of insurance coverage at such time as a
realized loss is incurred. Historically, the Company has not had any material
losses in connection with its lack of insurance coverage and was not party to
any material pending legal proceedings as of December 31, 2009. Management’s
intention is to use the Company’s working capital to fund any such losses
incurred due 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 ended December 31, 2009, Harbin Shiji Baolong Medicine Company and Shanxi
Xintai Medicine Company accounted for approximately 16% and 11% respectively of
total revenues. For the year ended December 31, 2009, Harbin Bao Da Medicine
Company and Harbin Shiji Baolong Medicine Company accounted for approximately
16% and 14% respectively of all accounts receivable. For the year ended December
31, 2008, Shanxi Xintai and Harbin Shiji Baolong accounted for 15% and 12%
respectively of total revenues. Harbin Shiji Baolong and Shanxi Xintai accounted
for approximately 29% and 11% respectively of all accounts receivable. For the
year ended December 31, 2007, Ning BoYue Hua Trading Company and Guang Zhou Xing
He Trading Company accounted for approximately 14% and 11% of total revenues,
respectively. Hua Li Jiu Zhou Company accounted for approximately 11% of all
accounts receivable. No other customers accounted for 10% or more of our total
revenues or accounts receivable in 2009 and 2008.




Major
Suppliers




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




7.           Earnings
per Share




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


F-22




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







7.           Earnings
per Share (Continued)




Stock
warrants to purchase 750,000 shares of common stock were outstanding and
exercisable as of December 31, 2009. Stock warrants and options to purchase
1,151,000 shares of common stock, all were exercisable and outstanding during
the year ended December 31, 2008. These common stock equivalents were included
in the computation of diluted earnings per share because the option exercise
prices were less than the average market price of our common stock during these
periods. As of December 31, 2008, there were 12,500 options with exercise price
of $3.65 outstanding and remained unvested, These options were all cashless
exercised during the fiscal year of 2009.  Stock warrants and 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 warrants and options is calculated in
accordance with the treasury stock method, which assumes that proceeds from the
exercise of all warrants and options are used to repurchase common stock at the
average market price of the common stock during the relevant period. The amount
of shares remaining after the proceeds are exhausted represent s the potential
dilutive effect of the securities.




The
following table sets forth our computation of basic and diluted net income per
share for the years ended December 31, 2009, 2008 and 2007:




$
      in thousands,
                                              except
      share and per share dataFor
      the years ended December 31,2009
                                              (restated)
                                            
                                            
                                            2008
                                            
                                            
                                            2007Numerator:Net
      income used in calculation of basic and diluted earnings per
      share
                                            
                                            $
                                            30,980
                                            
                                            
                                            $
                                            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:Warrants
      and 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
                                            
                                            $
                                            1.87
                                            
                                            
                                            $
                                            1.91
                                            
                                            
                                            $
                                            1.27Diluted
                                            
                                            $
                                            1.86
                                            
                                            
                                            $
                                            1.87
                                            
                                            
                                            $
                                            1.15





8.           Equity
and Share-based Compensation




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


F-23




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


8.           Equity
and Share-based Compensation (Continued)




In July
2006, the Company’s stockholders approved the 2006 Stock Incentive Plan (the
“2006 Plan”). The 2006 Plan, provides for the grant of stock options, restricted
stock awards, and performance shares to qualified employees, officers,
directors, consultants and other service providers. The 2006 Plan originally
authorized the Company to grant options and/or rights to purchase up to an
aggregate of 1,500,000 shares of common stock.  As of December 31,
2009, there have been a total of 198,202 common shares granted based on the 2006
Plan to Company employees and consultants. These 198,202 common shares are
consisted as the following:




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 exercised at various prices during 2009 in exchange for 85,295 common
shares.




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




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




In 2009,
a total of 52,844 common shares were granted to certain company employees,
consultants, and independent directors. The fair value of these shares is
determined to be approximately $1,242,000 based on the stock closing price at
the date of the grant.




In 2009,
we issued an aggregate of 355,239 shares of our common stock in connection with
their exercise of outstanding warrants and stock options of ours, as
follows:




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




·
            In
      January and May 2009, warrants to 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 consummated in May 2006, were exercised on a cashless basis
      at 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 exercised in various prices during 2009 in
      exchange for  85,295 common
shares.




9.           Securities
Purchase Agreement and Related Transaction





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


F-24




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


9.           Securities
Purchase Agreement and Related Transaction (Continued)




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




In
connection with the 2008 Offering, the Company and the Investors entered into a
Put Agreement whereby the Investors were granted the right, but not the
obligation, to require the Company to repurchase certain common shares issued
under the Purchase Agreement at $10.00 per share (the Unit Purchase
Price).  The Investors could only exercise their Put Right in the
event that either:




1.
            the
      Adjusted EPS of the Company for the fiscal year ending December 31, 2007
      was less than $0.80 per share, as set forth in the fiscal year 2007
      audited financial statements;
or




2.
            the
      Company’s accounts receivable exceeded $12.0 million at December 31, 2007,
      as set forth in the fiscal year 2007 audited financial
      statements.




As of
the Closing Date, based on preliminary financial results for the fiscal year
ended December 31, 2007 available on December 31, 2007, the Company determined
that the events triggering the Investors’ put right would not occur and the put
right would expire unexercised on or prior to March 31, 2008 (the date the
Company’s 2007 Form 10-KSB was required to be filed with the
SEC).  Based upon these preliminary results, the Company determined
that the value of the put obligation was deemed to be immaterial and did not
record it as a liability. Both of the targets were met upon the filing of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2007 on
March 31, 2008, and the Investors’ rights under the Put Agreement
terminated unexercised.




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




The Class
A Warrants represent the right to purchase an aggregate of 750,000 shares of
common stock, at an exercise price of $12.50 per share. Additional information
relating to these Class A Warrants is provided in Note
10.


F-25




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


10.           Outstanding
Warrants and Options





Weighted
                  
                  
                  
                  
                  
                  Weightedaverage
                  
                  
                  
                  
                  
                  averageShares
                  
                  
                  Exercise
                  
                  
                  Shares
                  
                  
                  ExerciseUnderlying
                  
                  
                  Price
                  
                  
                  underlying
                  
                  
                  PriceWarrants
                  
                  
                  Warrants
                  
                  
                  Options
                  
                  
                  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
                  
                  
                  
                  -
                  
                  
                  $
                  -





The
following table summarizes information about stock warrants outstanding 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
Class A Warrants represented the right to purchase an aggregate of 750,000
shares of Common Stock of the Company granted with the Securities Purchase
Agreement, at an exercise price of $12.50 per share, all were exercisable as of
December 31, 2009, and have the following additional
characteristics:




The
Class A Warrants issued in our January 2008 Offering described in Note 9 above,
represent the right to purchase an aggregate of 750,000 shares of common stock,
at an exercise price of $12.50 per share, and have the following additional
characteristics:




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




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




·
            The
      Exercise Price and number of Warrant Shares are subject to adjustment for
      standard dilutive events, such as dividends or distributions on the
      Company’s common stock paid in shares of common stock, reclassifications
      or reorganizations of the common stock, distributions of indebtedness or
      assets (other than cash) to all holders of the common stock, a merger or
      consolidation with another corporation in which the Company is not the
      survivor, or sale, transfer or other distribution of all or substantially
      all of the Company’s assets to another corporation to prevent dilution to
      the holders of the Class A Warrants as a result of such
      event.  The Exercise Price is also subject to adjustment on a
      weighted-average basis for 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 (a “Trigger
      Issuance”).  In the event of a Trigger Issuance, the
      then-existing Exercise Price shall be reduced, as of the close of business
      on the effective date of the Trigger Issuance, to a price determined as
      follows:




F-26





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


10.           Outstanding
Warrants and Options (Continued)




Adjusted
Warrant Price = (A x
B) + D


A+C





where





“A”
equals the number of shares of the Company’s common stock outstanding, including
Additional Shares of Common Stock (as defined below) deemed to be issued
hereunder, immediately preceding such Trigger Issuance;





“B”
equals the Exercise Price in effect immediately preceding such Trigger
Issuance;





“C”
equals the number of Additional Shares of Common Stock issued or deemed issued
hereunder as a result of the Trigger Issuance; and





“D”
equals the aggregate consideration, if any, received or deemed to be received by
the Company upon such Trigger Issuance;





provided,
however, that in no event shall the Exercise Price after giving effect to such
Trigger Issuance be greater than the Warrant Price in effect prior to such
Trigger Issuance.




For
purposes of hereof, “Additional Shares of Common Stock” shall mean all shares of
common stock issued by the Company, or deemed to be issued in connection with a
the Trigger Issuance, other than certain excluded issuances (as defined in the
Class A Warrants).




Upon
any adjustment to the Exercise Price for a standard anti-dilution adjustment
(other than in the case of a dividend or distribution of indebtedness or assets
(other than cash)), or for a below exercise price issuance, the number of
Warrant Shares is adjusted to a number of shares obtained by multiplying the
number of Warrant Shares immediately prior to such adjustment by a fraction, the
numerator of which shall be the Exercise Price in effect immediately prior to
such adjustment and the denominator of which shall be the Exercise Price in
effect immediately after such adjustment.  On the Closing Date, the
Company’s management assessed the Class A Warrants and concluded the Class A
Warrants were indexed to the Company’s own stock and as such equity
classification was proper pursuant to the scope exception in ASC 815-10-15-74
(formerly paragraph 11(a) of SFAS 133).  There was no issuance of
securities during 2009 which would have resulted in an adjustment to the
Exercise Price or number of Warrant Shares.




In
June 2008, the Emerging Issues Task Force issued EITF Consensus 07-05 (“Issue
07-05) “Determining Whether an
Instrument (for Embedded Feature) is Indexed to an Entity’s Own
Stock”.  Under Issue 07-05, instruments which contain certain
anti-dilution provisions will no longer be considered indexed to a company’s own
stock for purposes of determining whether it meets the first part of the scope
exception in paragraph 11(a) of SFAS 133.  Issue 07-05 provides new
guidance for determining whether equity instruments are indexed to a company’s
own stock, and as a result, whether those contracts should be
marked-to-market.  Issue 07-05 contains 20 examples illustrating its
application.  In particular, Example 8 addresses an exercise price
reset feature that is common in many arrangements.  Example 8,
concludes that because of the reset feature, the Class A Warrants will no longer
be considered indexed to a company’s own stock for purposes of determining
whether it meets the first part of the scope exception in paragraph 11(a) of
SFAS 133.  The adoption of Issue 07-05 required the Company to (1)
evaluate the Class A Warrants contingent exercise provisions and (2) evaluate
the instrument’s settlement provisions.  The Company determined that
the Class A Warrants are akin to Example 8 of EITF 07-05 and not Example 16 of
EITF 07-05, as the weighted-average anti-dilution provision is designed to
protect the holder from issuances below the exercise price (rather than below
market price issuances.)  At December 31, 2009, the Company recorded
an expense of $4,807,000 representing the increase in the fair value of the
derivative warrant liability between January 1, 2009, the effective date of ASC
815-40, and December 31, 2009, and a related derivative liability of $11,435,000
and cumulative effect adjustments of $4,188,000 and $2,440,000 to additional
paid-in-capital and retained earnings, respectively, resulting from the adoption
of ASC 815-40 effective January 1, 2009.


F-27


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




10.           Outstanding
Warrants and Options (Continued)




The
Company’s significant assumptions to calculate the derivative liability at
December 31, 2009 included (i) life of warrants of 3.7 years (the remaining
exercise period of the Class A Warrants, which is extended beyond its original
term due to the term due to the terms of the registration rights agreement as
described below); (ii) expected volatility of 60%; (iii) a risk free interest
rate of 2.72% and a (iv) a risk-neutral  probability 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 declared effective, we will have the ability to call the Class A
      Warrants at a price of $0.01 per Class A Warrant, upon thirty (30) days
      prior written notice to the holders of the Class A Warrants, provided (i)
      the closing price of the Common stock exceeded $18.75 for each of the ten
      (10) consecutive trading days immediately preceding the date that the call
      notice is given by the Company, and (ii) the Company has attained an
      Adjusted EPS of at least $1.75 per share for the fiscal year ending
      December 31, 2008, as set forth in our audited financial statements of the
      Company.




·
            If,
      among other things, we fail to cause a Registration Statement covering the
      Warrant Shares to be declared effective prior to the applicable dates set
      forth in the Registration Rights Agreement, the expiration date of the
      Class A Warrants shall be extended one day for each day beyond the
      Effectiveness Deadlines.  The registration rights do not require
      a cash settlement and the Class A Warrants can be settled in unregistered
      shares.  Therefore, paragraphs 14-18 of EITF 00-19 do not apply
      to the registration rights associated with the Class A
      Warrants.  As a result, no liability accounting is
      required.




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




11.           Inventories




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




As of
December 31, 2009 and 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.


F-28




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




11.           Inventories
(Continued)




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.




12.           Property
and Equipment, net




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





$
      in thousandsDecember
                31,
              
              
              December
                31,2009
              
              
              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
              )
              
              
              (1,296
              )Property
      and Equipment, Net
              
              $
              15,491
              
              
              $
              14,797





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.




13.           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.


F-29




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


13.           Intangible
Assets, net (Continued)




A
breakdown of our intangible assets, net by subsidiaries as of December 31, 2009
is as 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
technologies and SFDA licenses for drug batch numbers is approximately 8
years.




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




Intangible
      Assets as 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 assets with finite lives for each of the years ended
December 31, 2009, 2008 and 2007 was approximately $1,821,000, $274,000 and
$256,000 respectively. Future amortization for the next five years and
thereafter is as follows:




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




F-30




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


14.           Taxes
Payable




Taxes
payable for the years ended December 31, 2009 and 2008 consists of the
following:




December
      31,($ in
      thousands)2009
                        
                        
                        2008Value
      Added Tax, net
                        
                        $
                        1,291
                        
                        
                        $
                        1,179Enterprise
      Income Tax
                        
                        2,452
                        
                        
                        
                        2,107City
      Tax
                        
                        
                        43
                        
                        
                        
                        32Other
      Taxes and additions
                        
                        86
                        
                        
                        
                        45Total
      Taxes Payable
                        
                        $
                        3,873
                        
                        
                        $
                        3,363





15.           Income
Taxes





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




According
to “Enterprise Income Tax and Certain Preferential Policies Notice” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. The following table sets forth the statutory income
tax rate for TDR and its subsidiaries for the years ended December 31, 2009,
2008 and 2007:




As of December 31,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
                    %
                    
                    
                    -







*
              Reflects
      a 25% Tax rate on 8% of Peng Lai’s revenue, regardless of its taxable
      income. As authorized by Peng Lai Municipal Tax Bureau, Peng Lai was not
      required to pay tax on the remaining 92% of revenue regardless of its
      taxable income.




All
the favorable tax rates for TDR, First, Tianlong and Peng Lai will expire by the
end of fiscal year 2010. We are going to seek renewal of these
favorable tax rates in fiscal 2010.




The
Company’s effective tax rate was approximately 25.3% in fiscal 2009. If the
Company’s effective tax rate was 25% in 2009, its net income will be
$31,112,000, basic and diluted earnings per share would be $1.88 and $1.87,
respectively.




The
Company’s effective tax rate was approximately 20.8% in fiscal 2008. If the
Company’s effective tax rate was 25% in 2008, its net income will be
$27,355,000, basic and diluted earnings per share would be $1.81 and $1.77,
respectively.





The
Company’s effective tax rate was approximately 17.6% in fiscal 2007. If the
Company’s effective tax rate was 25% in 2007, its net income will be
$13,989,000, basic and diluted earnings per share would be $1.16 and $1.05,
respectively.




F-31




China
Sky One Medical, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements





15.           Income
Taxes (Continued)





We
recorded a full valuation allowance to reduce our deferred tax assets to the
amount that is more likely than not to be realized. While we have considered
future taxable income and ongoing prudent and feasible tax planning strategies
in assessing the need for the valuation allowance, in the event we were to
determine that we would be able to realize our deferred tax assets in the
future in excess of its net recorded amount, an adjustment to the deferred tax
asset would increase earnings in the period such determination is
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.
Net operating loss (“NOL”) carryforwards only apply to the Company’s U.S.
holding companies because they incurred certain general and administrative
expenses  without generating any revenue and, therefore, incurred
operating losses. In fiscal 2009, the Company’s U.S. holding companies’ expenses
also include an unrealized loss of approximately $4.8 million attributable to
the change in fair value of its derivative warrant liability.  As a
result, Management’s position is that it is more likely than not that any future
tax benefits associated with the U.S. holding companies’ change in fair value of
its derivative warrant liability will not be realized, and, as such, a full
valuation allowance has been recorded as of December 31, 2009. Therefore, the
restatement of the Company’s financial statements due to a correction of an
error in the accounting for its derivative warrant liability held at the U.S.
holding company level had no effect on the Company’s provision for income tax
for the year ended December 31, 2009.




The
Company has established a full valuation allowance for the NOL carryforwards
incurred by the U.S. holding companies.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.





As of
December 31, 2009, the Company has U.S. NOL’s carryforwards of approximately
$10.0 million which will begin to expire in 2029. Accordingly, as mentioned
above, any deferred tax asset that would result from these NOL’s carryforwards
have been fully reserved as of December 31, 2009.




A
reconciliation of the statutory income tax provision to the Company’s
income tax provision for each of the years ended December 31, 2009 (restated),
2008 and 2007 is as follows:





($ in thousands – restated)Year Ended December 31, 2009China
                                        
                                        
                                        U.S.
                                        
                                        
                                        TotalIncome
      (loss) before income taxes
                                        
                                        $
                                        48,300
                                        
                                        
                                        $
                                        (6,800
                                        )
                                        
                                        $
                                        41,500Statutory
      tax rate
                                        
                                        
                                        25
                                        %
                                        
                                        
                                        34
                                        %
                                        
                                        
                                        23.6
                                        %Expected
      statutory income tax expense (benefit)
                                        
                                        
                                        12,100
                                        
                                        
                                        
                                        (2,300
                                        )
                                        
                                        
                                        9,800Change
      in valuation allowance
                                        
                                        
                                        -
                                        
                                        
                                        
                                        2,300
                                        
                                        
                                        
                                        2,300Tax
      rate changes – Special Entity
                                        
                                        
                                        (1,600
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,600
                                        )Income
      tax expense
                                        
                                        $
                                        10,500
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        10,500Effective
      tax rate
                                        
                                        
                                        21.7
                                        %
                                        
                                        
                                        -
                                        
                                        
                                        
                                        25.3
                                        %




F-32




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




15.           Income
Taxes (Continued)





($ in thousands)Year Ended December 31, 2008China
                    
                    
                    U.S.
                    
                    
                    TotalIncome
      (loss) before income taxes
                    
                    $
                    37,900
                    
                    
                    $
                    (1,400
                    )
                    
                    $
                    36,500Statutory
      tax rate
                    
                    
                    25
                    %
                    
                    
                    34
                    %
                    
                    
                    24.7
                    %Expected
      statutory income  tax expense (benefit)
                    
                    
                    9,500
                    
                    
                    
                    (500
                    )
                    
                    
                    9,000Change
      in valuation allowance
                    
                    
                    -
                    
                    
                    
                    500
                    
                    
                    
                    500Tax
      rate changes –Special Entity
                    
                    
                    (1,900
                    )
                    
                    
                    -
                    
                    
                    
                    (1,900
                    )Income
      tax expense
                    
                    $
                    7,600
                    
                    
                    $
                    -
                    
                    
                    $
                    7,600Effective
      tax rate
                    
                    
                    20.1
                    %
                    
                    
                    -
                    
                    
                    
                    20.8
                    %





($ in thousands)Year Ended December 31, 2007China
                                            
                                            
                                            U.S.
                                            
                                            
                                            TotalIncome
      (loss) before income taxes
                                            
                                            $
                                            19,200
                                            
                                            
                                            $
                                            (500
                                            )
                                            
                                            $
                                            18,700Statutory
      tax rate
                                            
                                            
                                            25
                                            %
                                            
                                            
                                            34
                                            %
                                            
                                            
                                            23.6
                                            %Expected
      statutory income tax expense (benefit)
                                            
                                            
                                            4,
      800
                                            
                                            
                                            
                                            (200
                                            )
                                            
                                            
                                            4,600Change
      in valuation allowance
                                            
                                            
                                            -
                                            
                                            
                                            
                                            200
                                            
                                            
                                            
                                            200Tax
      rate changes – Special Entity
                                            
                                            
                                            (1,500
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (1,500
                                            )Income
      tax expense
                                            
                                            $
                                            3,300
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            3,300Effective
      tax rate
                                            
                                            
                                            17.2
                                            %
                                            
                                            
                                            -
                                            
                                            
                                            
                                            17.6
                                            %





Net
deferred tax assets; relate solely to the U.S. holding companies, consist of the
following components as of December 31:





($
      in thousands)2009
                    (restated)
                  
                  
                  2008Deferred
      tax assets:NOL
      carryforwards
                  
                  $
                  1,200
                  
                  
                  $
                  900Share-based
      compensation
                  
                  
                  500
                  
                  
                  
                  100Unrealized
      change in fair value of derivative warrant liability
                  
                  
                  1,600
                  
                  
                  
                  -Total
                  
                  
                  3,300
                  
                  
                  
                  1,000Less
      valuation allowance
                  
                  
                  (3,300
                  )
                  
                  
                  (1,000
                  )Net
      deferred tax asset
                  
                  $
                  -
                  
                  
                  $
                  -





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





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




F-33




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




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




16.           Land
Use Rights and Construction in Progress




The
Company considers the fact that, in the PRC, there is no land ownership but
rather the land use right and it is more appropriate to allocate land use rights
under a separate category and amortize land use rights based on 50 years of the
land use rights, or the term of the lease. The land use rights are
approximately $4,586,000 and $1,945,000 as of December 31, 2009 and 2008,
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 rights for 50 years for the development of a
new biotech engineering project. We spent approximately $9.9 million, $730,000,
and $2.1 million in the years of 2009, 2008, and 2007 respectively 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.




17.           Commitments
and Contingencies




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




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




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




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




F-34




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




18.           Quarterly
Results (Unaudited)




The
following table presents the Company’s selected unaudited quarterly operating
results for the four quarters ended December 31, 2009. The Company believes that
all adjustments of a normal recurring natural have been made to present fairly
the related quarterly results:




$ in thousands, except per share dataFirst
                      Quarter
                    
                    
                    Second
                      Quarter
                    
                    
                    Third
                      Quarter
                    
                    
                    Fourth
                      Quarter
                    
                    
                    TotalYear 2009
                    
                    (restated)
                    
                    
                    (restated)
                    
                    
                    (restated)
                    
                    
                    (restated)
                    
                    
                    (restated)Revenues
                    
                    $
                    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
                    
                    $
                    9,482
                    
                    
                    $
                    8,391
                    
                    
                    $
                    12,591
                    
                    
                    $
                    516
                    
                    
                    $
                    30,980Basic
      EPS
                    
                    $
                    0.58
                    
                    
                    $
                    0.51
                    
                    
                    $
                    0.76
                    
                    
                    $
                    0.02
                    
                    
                    $
                    1.87Diluted
      EPS
                    
                    $
                    0.57
                    
                    
                    $
                    0.51
                    
                    
                    $
                    0.76
                    
                    
                    $
                    0.02
                    
                    
                    $
                    1.86





On
June 22, 2010, the Company’s management determined that the Company’s previously
filed financial statements for the quarterly periods ended March 31, June 30,
September 30 and December 31, 2009, included in the Form 10-K, should no longer
be relied upon due to an error in such financial statements with respect to the
accounting forcertain derivative
instruments (warrants it issued in 2008 discussed below), which were previously
recorded as equity instruments in accordance with generally accepted accounting
principles in effect through December 31, 2008.Management concluded
that the quarterly financial statements in this Form 10-K required restatement
to properly record 750,000 common stock purchase warrants, issued in connection
with its January 31, 2008 private placement (the “Warrants”), as a derivative
liability. The fair value of the Warrants derivative liabilities calculated
using the Monte Carlo valuation model were $6,628,000, $4,389,000, $5,455,000,
$5,323,000 and $11,435,000 for each of the valuation dates on January 1, March
31, June 30, September 30 and December 31 2009, respectively.





The
cumulative effect of the Company’s adoption of ASC 815-40 as of January 1, 2009,
resulted in a reduction of retained earnings and paid-in capital of $4,188,000
and $2,440,000, respectively, and the establishment of a derivative liability of
$6,628,000 as of January 1, 2009.





The
following table sets forth the selected unaudited quarterly results for the four
quarters ended December 31, 2009, as previously recorded:





$ 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
                  
                  
                  $
                  2.08Diluted
      EPS
                  
                  $
                  0.43
                  
                  
                  $
                  0.57
                  
                  
                  $
                  0.74
                  
                  
                  $
                  0.32
                  
                  
                  $
                  2.07




F-35




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




18.           Quarterly
Results (Unaudited) (Continued)





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





$ in thousands, except per share dataYear2008
                  
                  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
                  
                  
                  $
                  1.91Diluted
      EPS
                  
                  $
                  0.25
                  
                  
                  $
                  0.53
                  
                  
                  $
                  0.64
                  
                  
                  $
                  0.45
                  
                  
                  $
                  1.87




F-36




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




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




None.




Item
9A.  Controls and Procedures.




Management’s
Evaluation of Disclosure Controls and Procedures (as revised)




Our
management, with the participation of our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures as of December 31, 2009.  The term “disclosure controls and
procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act, means controls and other procedures of a company that are designed
to ensure that information required to be disclosed by a company in the reports
that it files or submits under the Securities Exchange Act are recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms.  Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits
under the Exchange Act are accumulated and communicated to the company’s
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required disclosure. Our
management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving their
objectives and management necessarily applies its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.  Our
disclosure controls and procedures are designed to provide reasonable assurance
of achieving their objectives as described above.  Based on this
evaluation, our management, including our chief executive officer and chief
financial officer concluded that as of December 31, 2009, our disclosure
controls and procedures were effective at a reasonable assurances
level.




We
received comments from the SEC which led our management to determine that a
restatement was required for our financial statements for the year ended
December 31, 2009 in our Annual Report for the year ended December 31,
2009.  As a result of the foregoing and additional comments received
from the SEC, on June 18, 2010, management determined that a material weakness
existed with respect to our reporting of complex, non-routine
transactions.  This weakness was a result of our incorrect
interpretation of the guidance in ASC 815-40, “Derivative and Hedging–Contracts in an Entity’s own Equity”, and incorrect
conclusion regarding its application, which required the restatement of our
financial statements as of and for the year ended December 31,
2009.




As
result of the material weakness identified with respect to our reporting of
complex non-routine transactions, our chief executive officer and chief
financial officer have re-evaluated our disclosure controls and procedures and,
on June 18, 2010, concluded that our disclosure controls and procedures were not
effective to ensure that the information required to be disclosed by us in the
reports that we file or submit under the Exchange Act was recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms and that such information required to be disclosed is accumulated and
communicated to management, including our chief executive officer and chief
financial officer, to allow timely decisions regarding required
disclosures.




Subsequent
to March 31, 2010, to remediate the weakness in our disclosure controls and
procedures, we hired third party consultants to assist us in identifying and
analyzing complex non-routine transactions and with valuing and determining the
appropriate accounting treatment for any such complex non-routine
transactions.




Management’s
Annual Report on Internal Control over Financial Reporting




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




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




52




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




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




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




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




Our
management revised its assessment of the effectiveness of the Company's internal
control over financial reporting as of December 31, 2009, originally included in
Management's Report on Internal Control Over Financial Reporting in the
Company's annual report on Form 10-K filed on March 16, 2009.  In that
report, management concluded that the Company's internal control over financial
reporting was effective as of December 31, 2009.  Subsequent to filing
its annual report on Form 10-K on March 16, 2009, we identified errors in our
2009 financial statements and have restated those annual financial statements.
Management has concluded that these errors resulted from control deficiencies
that represent material weaknesses in internal control over financial reporting.
As a result, management has revised its assessment of the effectiveness of our
internal control over financial reporting due to material weaknesses in our
reporting of complex, non-routine transactions.




Based
on this assessment and the criteria described below, and the determination that
a material weakness exists with respect to our reporting of non-routine, complex
transactions, our management concluded that, as of December 31, 2009, our
internal control over financial reporting was not effective based on those
criteria due to the material weakness described above.




In
making its assessment and revised assessment, management used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in Internal Control-Integrated Framework.




Our
Independent Registered Public Accounting Firm, MSPC, has audited and issued a
report on management’s revised assessment of the Company's internal control over
financial reporting. The report of MSPC is included in its Report of Independent
Registered Public Accounting Firm on page F-2 of this Form
10-K/A.




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
audit report, which is included as apart of our 2009 Financial Statements filed
as Item 9 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.




Subsequent
to March 31, 2010, to remediate the weakness in our internal controls over
financial reporting, we hired third party consultants to assist us in
identifying and analyzing complex non-routine transactions and with valuing and
determining the appropriate accounting treatment for any such complex
non-routine transactions.




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




53




PART
III




Item
10.   Directors, Executive Officers and Corporate
Governance.




Directors
and Executive Officers




The
following table sets forth certain information regarding our directors and
executive officers during the fiscal year ended December 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, Secretary and DirectorSong
      Chun-fang
              
              70
              
              DirectorWilliam
      Wei Lee
              
              55
              
              DirectorZhao
      Jie
              
              47
              
              DirectorQian
      Xu-feng
              
              42
              
              Director





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




Liu Yan-qing has been our
Chairman, Chief Executive Officer and President since May 2006, a Director of
TDR since September 2000, and General Manager of First since April
2003.  Mr. Liu graduated from Prophylactic Department of Harbin
Medicine University, where he obtained his bachelor’s degree.  In
2005, he studied at Tsing Hua University and earned an Executive Masters of
Business.




Han Xiao-yan has been our Vice
Chairman and Director since May 2006, a General Manager of TDR since September
2004, and Vice Director of First since April 2003.  She also serves as
our senior marketing manager and administrative manager.  Ms. Han
received a master of business administration at Harbin Industrial
University.




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




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




William Wei Lee joined our
board of directors on August 4, 2009.  He has 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.




54




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




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




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 medical industry or
knowledge specific consulting firms or 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 whether directors
and nominees have the experience, qualifications, attributes and skills, taken
as a whole, to enable the Board to satisfy its oversight 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-qing has over 10 years of experience in drug marketing, research and
      development of new drugs and enterprise management in the
      PRC.  His experience in these areas has been instrumental in
      establishing our sales program and sales network covering the PRC, and
      provides us with invaluable insight into our customers’ needs and
      requirements.




·
            Han
      Xiao-yan’s hygiene and medical media experience has been integral in
      developing and marketing TDR’s products and expanding its
      sales.  In addition, she has over 10 years of financial
      management experience.




·
            Stanley
      Hao’s prior experiences as Financial Officer for Sumitomo Group Canadian
      Branch, Marketing Executive and Canadian Market Analyst for MGM Mirage,
      and Chief Executive Offer of SunnyZone 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.




·
            Zhao
      Jie’s experience in the medical field, specifically in the area of tissue
      transplantation, provides us with valuable knowledge with respect to the
      needs of the medical industry.




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




55





Significant
Employees




ZhangWen-chao has been our
Director of Scientific and Technological Development since March
2005.  Mr. Zhang graduated with a PhD in biology pharmaceuticals from
South China University of Technology in 1997.  He has been employed in
various R&D roles since his graduation.  Mr. Zhang completed our
gene recombination medicine independently and has been responsible for
researching and developing various products that have been launched by us since
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 have
seven (7) members serving on our Board of Directors (the
“Board”).  Each Board member is nominated for election at our annual
meeting to serve until the next annual meeting of stockholders and until their
successors are duly elected and qualified.




Board
Committees




The Board
has 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 adopted by the
Board.  Copies of these charters are available on our website at
www.cski.com.cn.




Audit
Committee




The Audit
Committee is responsible for the annual engagement of a firm of independent
accountants and reviews with the independent accountants the scope and results
of audits, our internal accounting controls and audit practices and professional
services rendered to us by our independent accountants. The Audit Committee also
reviews and discusses with management and the board of directors, such matters
as accounting policies, internal accounting controls and procedures for
preparation of financial statements. The Audit Committee is required at all
times to be composed exclusively of directors who, in the opinion of our board
of directors, are free from any relationship that would interfere with the
exercise of independent judgment as a committee member and who posses an
understanding of financial statements and generally accepted accounting
principles. The Audit Committee is comprised of solely independent directors,
Messrs. 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 defined under 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 and benefit
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 results of operations,
financial condition and competitive factors.  The compensation may
include grants of options under our stock option plan to the named executive
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 its
members.  The Compensation Committee may also retain consultants to
assist in the evaluation of directors’, the Chief Executive Officer’s or the
executive officers’ compensation, however the Compensation Committee has not
hired such consultants.  The Compensation Committee is comprised
of  independent directors, Messrs. William Wei Lee and Song Chun-fang
and Ms. Qian Xu-feng.




Nominating
and Governance Committee




The
Nominating and Governance Committee assists the Board of Directors in
identifying qualified individuals to become board members, in determining the
composition of the Board of Directors and in monitoring the process to assess
Board effectiveness.  The Nominating and Governance Committee also
selects director nominees for election at each annual meeting of
stockholders.  The Nominating and Governance Committee of the Board of
Directors comprised of independent directors Zhao Jie, Qian Xu-feng and Song
Chun-fang.




56




Executive
Committee




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 comprised solely 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 its subsidiaries. Qian
Xu-feng, William Wei Lee and Song Chun-fang, independent directors, serve as
members of the Finance Committee.




Director
Independence




Our Board
is composed of seven (7) directors. As required under the Nasdaq Stock Market,
or Nasdaq listing standards, a majority of the members of a listed company’s
board of directors must qualify as “independent,” as affirmatively determined by
the listed company. Our Board consults with our counsel with respect to the
Board’s applications 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 director will only qualify as an “independent
director” if, in the opinion of our Board, that person does not have a
relationship which would interfere with the exercise of independent judgment in
carrying out the responsibilities of a director. Our Board of Directors has
determined that none of Song Chun-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 defined under Rule
5605(a)(2) of the Nasdaq Stock Market, Inc. Marketplace Rules.




Indemnification




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




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




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




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




57




Anti-Takeover
Provisions




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




Director
Fiduciary Duty and Business Judgment Provisions




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




Limitation
on Liability




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




Compliance
with Section 16(a) of the Exchange Act




To our
knowledge, based solely on a review of such materials as are required by the
SEC, none of our officers, directors or beneficial holders of more than 10% of
our issued and outstanding shares of common stock failed to timely file with the
SEC any form or report required to be so filed pursuant to Section 16(a) of the
Exchange Act, during the fiscal year ended December 31, 2009 except
that:  (i) Song Chun Fang filed a 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 filed a 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, (iii) Zhao Jie filed a 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 filed a
late Form 3 on February 3, 2010, as amended on February 11, 2010, to report his
appointment to our Board as of September 24, 2009, and (v) William Wei Lee filed
a late Form 4 on February 3, 2010, as amended on 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.




Code
of Ethics




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




58




·
            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
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.




59




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




Our
Compensation Committee, which is comprised of  independent directors,
Mr. William Wei Lee, Mr. Song Chun-fang and Ms. Qian Xu-feng, is responsible for
reviewing and making recommendations to the Board on matters relating to
employee compensation and benefit plans and determining the compensation of our
Chief Executive Officer.  In addition, the Compensation Committee is
responsible for 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
determinations, the Compensation Committee and the Board give material
consideration to our results of operations, financial condition and competitive
factors.  The Compensation Committee may delegate authority to one or
more subcommittees consisting of one or more of its members.  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 consultants to assist in the evaluation
of compensation for our directors, the Chief Executive Officer or the executive
officers, however the Compensation Committee has not hired such
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.




60




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.




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,
                                                      
                                                      2009
                                                      
                                                      35,083
                                                      
                                                      439,152
                                                      
                                                      —
                                                      
                                                      474,235Chairman,
      Chief Executive Officer
                                                      
                                                      2008
                                                      
                                                      34,320
                                                      
                                                      51,380
                                                      
                                                      —
                                                      
                                                      85,700and
      President
                                                      
                                                      2007
                                                      
                                                      68,512
                                                      
                                                      —
                                                      
                                                      —
                                                      
                                                      68,512Han
      Xiao-Yan,
                                                      
                                                      2009
                                                      
                                                      27,774
                                                      
                                                      336,683
                                                      
                                                      —
                                                      
                                                      364,457Vice
      Chairman and Director
                                                      
                                                      2008
                                                      
                                                      25,680
                                                      
                                                      40,120
                                                      
                                                      —
                                                      
                                                      65,8002007
                                                      
                                                      54,810
                                                      
                                                      —
                                                      
                                                      —
                                                      
                                                      54,810Stanley
      Hao,
                                                      
                                                      2009
                                                      
                                                      17,542
                                                      
                                                      146,384
                                                      
                                                      —
                                                      
                                                      163,926Chief
      Financial Officer, SecretaryAnd
      Director
                                                      
                                                      2008
                                                      
                                                      17,542
                                                      
                                                      11,424
                                                      
                                                      —
                                                      
                                                      28,966





(1)
                In
      fiscal year 2009, we issued an aggregate of 52,844 shares of restricted
      stock to certain executives and directors pursuant to our 2006 Stock
      Incentive Plan. In fiscal 2008, we issued an aggregate of 30,063 shares of
      restricted stock to certain executives, directors an advisors pursuant to
      our 2006 Stock Incentive Plan.




Employment
Agreements and Arrangements




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




Equity Compensation Plan Information




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




61




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




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.




·
            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
                                              
                                              GrantDate
                                              
                                              AllOther
                                                StockAwards:
                                                Numberof
                                                Sharesof
                                                Stockor
                                                Units(#)
                                              
                                              AllOther
                                                Option
                                                Awards:
                                                Numberof
                                                Securities
                                                Underlying
                                                Options(#)
                                              
                                              Exerciseor
                                                BasePrice
                                                ofOption
                                                Awards
                                                ($/share)
                                              
                                              GrantDate
                                                FairValueof
                                                Stockand
                                                Options
                                                Awards
                                              
                                              ClosingPrice
                                                onGrant
                                                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




Outstanding
Equity Awards At Fiscal Year Ended 2009




As of
December 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




62




Potential
Payment Upon Termination or Change in Control




We do not
currently have payment arrangements for our named executive officers upon
termination or change in control.




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 our independent directors.  During
2009, there was no director compensation paid other than the stock
grants.  The common stock is recorded at its fair value based on the
date the stocks were granted.  The following table sets forth certain
information regarding our independent directors’ compensation for the year ended
December 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




63




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




Security
Ownership of Certain Beneficial Owners




The
following table sets forth certain information regarding the beneficial
ownership of our common stock, by (i) each person who, to our knowledge, owns
more than 5% of our common stock, (ii) each of our named executive officers and
directors, and (iii) all of our named executive officers and directors as a
group. Shares of our common stock subject to options, warrants, or other rights
currently exercisable, or exercisable within 60 days of the date hereof, are
deemed to be beneficially owned and outstanding for computing the share
ownership and percentage of the person holding such options, warrants or other
rights, but are not deemed outstanding for computing the percentage of any other
person. As of March 15, 2010, we had 16,790,851 shares of Common Stock issued
and outstanding.




Common Stock Beneficially
                  OwnedName,
      Title and Address (1)
              
              Number
      (2)
              
              
              Percent5%
      StockholdersPope
      Investments II LLC(3)
                5100
      Poplar Avenue, Suite 805
                Memphis,
      TN 38137
              
              
              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
              %Stanley
      Hao
                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
      Named Executive 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 and beneficially.




64




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




(4)  4,560,963
of 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 filed to register for resale shares,
and shares underlying warrants, purchased in the private placement.




(5)  1,371,437
of 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 filed to register for resale shares,
and shares underlying warrants, purchased in 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
Authorized For 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.




65




(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 Director
Independence.




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




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., LLP served as the principal accountant to audit our financial
statements through May 21, 2008, when they were replaced by the firm of MSPC,
Certified Public Accountants and Advisors LLP.




The
following is a summary of the combined fees billed to us by Sherb & Co., LLP
and MSPC, Certified Public Accountants and Advisors LLP for professional
services rendered for the fiscal years ended December 31, 2009, 2008 and
2007:




Aggregate
fees rendered for the fiscal years ended December 2009 and 2008 were as
follows:




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




Audit
Fees.  Consists of fees billed for professional services
rendered for the audit of our consolidated financial statements and review of
the interim consolidated financial statements included in quarterly reports,
services that are normally provided by our independent registered public
accounting firm in connection with statutory and regulatory filings or
engagements. Audit fees in fiscal 2009 included the costs for our internal
control evaluation.




66




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




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




All Other Fees.  No
fees were billed to us by our independent registered public accounting firm for
products and services other than the services reported above.  No such
fees were billed by our independent registered public accounting firm in fiscal
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 provided by the independent
auditor, (ii) all significant non-audit services to be provided by the
independent auditors as permitted by Section 10A of the Securities Exchange Act
of 1934, and (iii) all fees and the terms of engagement with respect to such
services.  All audit and non-audit services performed by Sherb &
Co., LLP and MSPC, Certified Public Accountants and Advisors LLP during fiscal
2009 and 2008 were pre-approved pursuant to the procedures outlined
above.




Item
15.  Exhibits, Financial Statement Schedules




3.1
            Articles
      of Incorporation, as amended (1)




3.2
            Restated
      Articles of Incorporation, as filed with the Secretary of State of Nevada
      on July 11, 2008 (8)




3.3
            Certificate
      of Amendment to Articles of Incorporation
(9)




3.4
            By-Laws
      of the Company (1)




3.3
            Finance
      Committee Charter (2)




3.4
            Audit
      Committee Charter (2)




3.5
            Compensation
      Committee Charter (2)




3.6
            Nominating
      and Governance Committee Charter
(2)




3.7
            Executive
      Committee Charter (2)




4.1
            Form
      of Class A Warrant issued to investors in connection with January 2008
      private offering (3)




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




10.2
            Form
      of Registration Rights Agreement between Company and investors, dated as
      of January 31, 2008 (3)




10.3
            Form
      of Make Good Agreement between Pope Asset Management LLC, as the
      authorized agent of the investors, the Company and Liu Yan-Qin, dated as
      of January 31, 2008 (3)




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




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




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




67




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




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




14.1
            Code
      of Ethics (2)




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




21.1
            Subsidiaries
      of China Sky One Medical, Inc. (10)




31.1
            Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (11)




31.2
            Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (11)




32.1
            Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002 (11)




32.2
            Certification
      of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act
      of 2002 (11)







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




(2)
            Incorporated
      by reference to the Registrant’s Annual Report on Form 10-KSB, for the
      fiscal year ended December 31,
2007.




(3)
            Incorporated
      by reference from exhibits filed with Current Report on Form 8-K, Date of
      Event of January 31, 2008.




(4)
            Incorporated
      by reference to the Registrant’s Form 8-K/A, filed on April 9,
      2008




(5)
            Incorporated
      by reference to the Registrant’s Form 8-K, filed on April 24,
      2008




(6)
            Incorporated
      by reference to the Registrant’s Form 8-K/A, filed on June 10,
      2008




(7)
            Incorporated
      by reference to the Registrant’s Form 8-K, filed on June 11,
      2008




(8)
            Incorporated
      by reference to the Registrant’s Quarterly Report on Form 10-Q, for the
      fiscal quarter ended June 30, 2008




(9)
            Incorporated
      by reference to the Registrant’s Form 8-K, filed on November 21,
      2008




(10)
            Incorporated
      by reference to the Registrant’s Annual Report on Form 10-K, for the
      fiscal year ended December 31,
2009




(11)
            Filed
      herewith




68





SIGNATURES




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




CHINA
      SKY ONE MEDICAL, INC.Dated:
      July 23, 2010
              By:
              /s/ Liu
      Yan-qingLiu
      Yan-qingChairman,
      Chief Executive Officer andPresident
      (Authorized
Representative)




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








Name
            
            Title
            
            Date/s/
      Liu Yan-qing
            
            President,
      Chief Executive Officer
            
            July
      23, 2010Liu
      Yan-qing
            
            and
      Director (Principal Executive Officer)/s/
      Stanley Hao
            
            Chief
      Financial Officer, Secretary,
            
            July
      23, 2010Stanley
      Hao
            
            and
      Director (Principal Financial Officer)/s/
      Han Xiao-yan
            
            Vice
      Chairman and Director
            
            July
      23, 2010Han
      Xiao-yan
            
            (Principal
      Operating Officer)/s/
      Song Chun-fang
            
            Director
            
            July
      23, 2010Song
      Chun-fang/s/
      William Wei Lee
            
            Director
            
            July
      23, 2010William
      Wei Lee/s/
      Zhao Jie
            
            Director
            
            July
      23, 2010Zhao
      Jie/s/
      Qian Xu-feng
            
            Director
            
            July
      23, 2010Qian
      Xu-feng




S-1