UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-K
 
 x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.



For the fiscal year ending June 30, 2011
 
 OR
 
  ̈
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 000-53401
 
 Bohai Pharmaceuticals Group, Inc.
 (Exact name of registrant as specified in its charter)
 
 Nevada

98-0697405(State or other jurisdiction

of incorporation or organization)

(IRS Employer

Identification number)c/o Yantai Bohai Pharmaceuticals Group Co. Ltd.

No. 9 Daxin Road, Zhifu District

Yantai, Shandong Province, China

264000(Address of Principal Executive Offices)

(Zip Code)
 
 +86(535)-685-7928
 (Registrant’s Telephone Number, Including Area Code)
 
 Securities registered pursuant to Section 12(b) of the Act:
 
 None
 (Title of Class)
 
 Name of each exchange on which registered
 
 None
 
 Securities registered pursuant to Section 12(g) of the Act:
 Common Stock, $0.001 par value per share
 
 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ̈    No  x
 
 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes   ̈    No  x.
 
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x No   ̈.
 
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes  ̈   No   ̈.
 
 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.   ̈
 
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large accelerated filer  ̈

Accelerated filer   ̈Non-accelerated filer   ̈

Smaller reporting company x
 
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ̈    No x.
 
 The aggregate market value of the voting and non-voting common stock, other than shares held by persons who may be deemed affiliates of the registrant, computed by reference to the closing sales price for the registrant’s Common Stock on December 31, 2010, as reported on the OTC Bulletin Board, was approximately $13,299,122.
 
 As of September 28, 2011, there were 17,861,085 outstanding shares of common stock of the registrant, par value $.001 per share.
 
 DOCUMENTS INCORPORATED BY REFERENCE
 
 None
  
  Bohai Pharmaceuticals Group, Inc.
 
 Annual Report on Form 10-K for the
 Fiscal Year Ended June 30, 2011
 
 TABLE OF CONTENTS
 
 PageCautionary Note Regarding Forward Looking Statements
-i-PART I

1Item 1.
Business.
1Item 1A.
Risk Factors.
23Item 1B.
Unresolved Staff Comments.
44Item 2.
Description of Properties.
44Item 3.
Legal Proceedings.
44PART II
45Item 5.
Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities Market Information.
45Item 6.
Selected Financial Data.
45Item 7.
Management’s Discussion and Analysis or Plan of Operation.
46Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
58Item 8.
Financial Statements and Supplementary Data.
58Item 9.
Changes In and Disagreements with Accountants On Accounting and Financial Disclosure.
58Item 9A.
Controls and Procedures.
59Item 9B.
Other Information.
61PART III
62Item 10.
Directors, Executive Officers, Promoters and Control Persons; Compliance With  Section 16(A) of the Exchange Act.
62Item 11.
Executive Compensation
65Item 12.
Security Ownership of Certain Beneficial Owners and Management
67Item 13.
Certain Relationships and Related Transactions and Director Independence.
68Item 14.
Principal Accountant Fees and Services.
69Part IV
70Item 15.
Exhibits
70FINANCIAL STATEMENTS
F-1
  
  CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
 
 In addition to historical information, this Annual Report on Form 10-K contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  The forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements.  Factors that might cause such a difference include, but are not limited to those discussed in the sections entitled “Business”, “Risk Factors”, and “Management’s Discussion and Analysis or Plan of Operation.”  Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date thereof.  We undertake no obligation to revise or publicly release the results of any revision of these forward-looking statements.  Readers should carefully review the risk factors described in this Annual Report and in other documents that we file from time to time with the Securities and Exchange Commission.
 
 In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “potential,” “proposed,” “intended,” or “continue” or the negative of these terms or other comparable terminology. You should read statements that contain these words carefully, because they discuss our expectations about our future operating results or our future financial condition or state other “forward-looking” information. There may be events in the future that we are not able to accurately predict or control. You should be aware that the occurrence of any of the events described in our risk factors and other disclosures included in this Annual Report could substantially harm our business, results of operations and financial condition, and that upon the occurrence of any of these events, the trading price of our securities could decline.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, growth rates, and levels of activity, performance or achievements.  Factors that may cause actual results, our performance or achievements, or industry results, to differ materially from those contemplated by such forward-looking statements include, without limitation:
 
 ·
our ability to generate or obtain through financing sufficient working capital to (i) fund the acquisition of Yantai Tianzheng (currently $12 million is due within 12 months, and a total of $29 million is due); (ii) satisfy our obligations under our convertible notes due January 5, 2012 (currently $10.45 million due) or (iii) otherwise to support our business plans;
 
 ·
our ability to integrate the business of Yantai Tianzheng and any future acquisitions into our business;
 
 ·
our ability to expand our product offerings and maintain the quality of our products;
 
 ·
the availability of government granted rights to exclusively manufacture or co-manufacture our products;
 
 ·
the availability of national healthcare reimbursement of our products;
 
 ·
our ability to manage our expanding operations and continue to fill customers’ orders on time;
 
 ·
our ability to maintain adequate control of our expenses allowing us to realize anticipated revenue growth;
 
 ·
our ability to maintain or protect our intellectual property;
 
 ·
our ability to maintain our proprietary technology;
 
 ·
the impact of government regulation in China and elsewhere, including the support provided by the Chinese government to the Traditional Chinese Medicine and healthcare sectors in China;
 
 ·
our ability to implement product development, marketing, sales and acquisition strategies and adapt and modify them as needed;
  -i-
 
 ·
our implementation of required financial, accounting and disclosure controls and procedures and related corporate governance policies; and
 
 ·
our ability to anticipate and adapt to changing conditions in the Traditional Chinese Medicine and healthcare industries resulting from changes in government regulations, mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics.
 
 Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results. The following discussion should be read in conjunction with our financial statements and the related notes that appear elsewhere in this report.
 
 We cannot give any guarantee that these plans, intentions or expectations will be achieved.  All forward-looking statements involve significant risks and uncertainties, and actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including those factors listed above and described in the “Risk Factors” section of this Annual Report.
  -ii-
  PART I
 
 As used throughout this Annual Report, the terms “BOPH,” “Company,” “we,” “us,” or “our” refer to Bohai Pharmaceuticals Group, Inc., a Nevada corporation, together with:
 
 (i)           its wholly owned subsidiary, Chance High International Limited, a British Virgin Islands company (“Chance High”);
 
 (ii)         Chance High’s wholly owned subsidiary, Yantai Shencaojishi Pharmaceuticals Co., Ltd., a PRC company (“WFOE”);
 
 (iii)        Chance High’s wholly owned subsidiary, Yantai Nirui Pharmaceutical Co., Ltd., a PRC company (“WFOE II”);
 
 (iv)         the WFOE’s variable interest entity, Yantai Bohai Pharmaceuticals Group Co., Ltd., a PRC company (“Bohai”), which is our initial operating subsidiary; and
 
 (v)          WFOE II’s wholly owned subsidiary, Yantai Tianzheng Pharmaceutical Co., Ltd., a PRC company (“Yantai Tianzheng”), which we acquired in August 2011 and is our second operating subsidiary.
 
 In this Annual Report, we sometimes refer to BOPH, Chance High, WFOE, WFOE II, Bohai and Yantai Tianzheng collectively as the “Group.”  As used in this Annual Report, “China” or “the PRC” refers to the People’s Republic of China.
 
 Item 1.  Business.
 
 Overview
 
 We are engaged in the production, manufacturing and distribution in China of herbal pharmaceuticals based on traditional Chinese medicine, which we refer to herein as Traditional Chinese Medicine, or TCM.  We are based in the city of Yantai, Shandong Province, China and our operations are exclusively in China.
 
 Our medicines address rheumatoid arthritis, viral infections, gynecological diseases, cardio vascular issues and respiratory diseases.  Our initial operating subsidiary Bohai obtained Drug Approval Numbers (or DANs) for 29 varieties of traditional Chinese herbal medicines in 2004, an additional 14 varieties in December 2010.  Through our acquisition of Yantai Tianzheng in August 2011, we obtained DANs for another 5 varieties in August 2011.  We currently produce 19 varieties of approved traditional Chinese herbal medicines in seven delivery systems: tablets, granules, capsules, formulations, concentrated powder, tincture and medicinal wine.  Of these 19 products, 12 are prescription drugs and 7 are over the counter (or OTC) products.
 
 Three of Bohai’s lead products, Tongbi Capsules and Tablets and Lung Nourishing Syrup, are eligible for reimbursement under China’s National Medical Insurance Program (or NRDL), which we believe significantly increases the marketability of these products.  In addition to these lead products, three of our current products and five of our formulas we acquired in 2010 are eligible for NRDL reimbursement.  In addition, one of our current products and four of our newly acquired formulas are currently included on the Chinese government's Essential Drug List (or EDL).  Inclusion on either the EDL or NRDL allows for up to 100% insurance coverage by the Chinese government.   Yantai Tianzheng owns five prescription products approved by the State Food and Drug Administration of China (which we refer to herein as the SFDA) and currently manufactures four of such products.  Among Yantai Tianzheng’s products, Fangfengtongsheng Granule has an exclusive status and is on the EDL and NDRL. Zhengxintai Capsule is in the process of renewal its protective status and is currently on NDRL.
  1
  The Chinese government has previously awarded us exclusive rights to manufacture our Tongbi Capsules product.  We share manufacturing rights with one or more manufacturers for our Anti-flu Granules product, which rights expire on July 9, 2012.  We held the Certificates of Protected Variety of Traditional Chinese Medicine (Grade Two) (which we refer to herein as the Certificate of Protection) issued by the SFDA for Tongbi Capsules and Shangtongning Tablets, which give us exclusive or near-exclusive rights to manufacture and distribute these two medicines.  The protection periods for both Tongbi Capsules and Shangtongning Tablets expired in September 2009.  We submitted the application to extend such protection period for Tongbi Capsules on March 12, 2009.  The SFDA approved our request and the protection period for Tongbi Capsules has been extended to September 13, 2016.  We have decided to not submit an extension of protection application for Shangtongning Tablets, but will continue to manufacture this product.
 
 Our strategy is to leverage the “protected” status and national insurance coverage for certain of our pharmaceutical products to aggressively increase market penetration throughout China, the world’s most populous nation.  By utilizing our distribution platform, in addition to utilizing mass media and other marketing methods to build awareness of our brand, we have been able to and will continue to seek to significantly grow our revenues and earnings.  In addition, as evidenced by our acquisition of Yantai Tianzheng, we may seek additional acquisition candidates or undertake other strategic transactions to broaden our product offerings and sales, marketing and manufacturing capabilities.
 
 We are focusing a significant portion of our marketing efforts on our Lung Nourishing Syrup and expect to continue this effort over the next several years.  Lung Nourishing Syrup( which we formerly referred to as “Lung Nourishing Cream”), an ingestible liquid product, is one of our most popular products, and its main ingredient, Laiyang Pear, to our knowledge, is not available in other similar pharmaceutical products.  We applied for a patent for Lung Nourishing Syrup with its production method for the treatment of Lung Qi Deficiency Cough and Chronic Bronchitis, which application was approved by the State Intellectual Property Office of the PRC on June 23, 2010.  The patent was awarded for a period of 20 years starting from the day of its application on September 12, 2007.  For these reasons, we believe Lung Nourishing Syrup contains a novel formulation for the treatment of asthma and other common respiratory ailments with an emphasis on the improvement of overall lung function and health.  We believe this represents an exceptional market opportunity.
 
 Our business strategy also seeks to capitalize on new government programs established in early 2009 to extend health insurance coverage to previously uncovered Chinese citizens.  The PRC government’s new health care policies are also designed to encourage the use of TCM and its approach to wellness and treatment of disease.  As a result, the government continues to expand the number of TCMs eligible for reimbursement under national medical insurance programs.  This has resulted in medical professionals working in the state-run medical facilities to increasingly prescribe and recommend TCM products of the type we manufacture and market.  The state-run facilities provide the majority of medical care in China.  Three of our lead products, Lung Nourishing Syrup and Tongbi Capsules and Tablets, are eligible for insurance reimbursement coverage, with others expected to follow.  Currently public health officials in China are developing general consumer awareness of increasing problems and concerns with respiratory and lung health caused by pervasive national air pollution.  This nationwide epidemic is an unfortunate by-product of the robust development of China’s expansive manufacturing and industrial activities.  Increased air pollution is a cause and contributory factor to a range of acute respiratory illnesses including chronic conditions such as asthma.  As a result, we intend to significantly increase our advertising for our Lung Nourishing Syrup.
 
 As of the date of this Annual Report, we have approximately 847 employees operating from 21 offices throughout China.  As we are committed to strong sales efforts, approximately 354 of our employees are sales representatives.
 
 As is not uncommon for Chinese companies listed in the U.S., we control our Chinese operating subsidiary, Bohai, pursuant to a series of variable interest entity contractual agreements (the “VIE Agreements”), under which we assume management of the business activities of Bohai and have the right to appoint all executives and senior management and the members of the board of directors of Bohai.  Under these arrangements, however, we do not, directly or indirectly, own any shares in Bohai, which are owned by Mr. Qu, our Chairman, President and Chief Executive Officer and two unaffiliated parties.  Please see “Contractual Arrangements with Bohai and its Shareholders” below.
 
 We do, however, directly own our Yantai Tianzheng operating subsidiary through WFOE II.
  2
  Background and Key Events
 
 We were incorporated under the laws of the State of Nevada under the name Link Resources Inc. on January 9, 2008.  Our principal office was in Calgary, Alberta, Canada.  Prior to January 5, 2010, we were a public “shell” company in the exploration stage since our formation and had not yet realized any revenues.  We entered into a Mineral Lease Agreement on April 1, 2008 for two mining claims in Pershing County, Nevada, in an area known as the Goldbanks East Prospect.  We terminated the lease on July 7, 2009.
 
 Share Exchange with Chance High
 
 Pursuant to the Share Exchange Agreement entered into on January 5, 2010 (the “Share Exchange Agreement”), and related share exchange (the “Share Exchange”) by and among us, Chance High, and the shareholders of Chance High (the “Chance High Shareholders”), we acquired Chance High and its indirect, controlled subsidiary Bohai, a Chinese company engaged the production, manufacturing and distribution in China of herbal medicines, including capsules and other products, based on Traditional Chinese Medicine.  The closing of the Share Exchange (the “Closing”) took place on January 5, 2010.  As of the Closing, pursuant to the terms of the Share Exchange Agreement, we acquired all of the outstanding equity securities (the “Chance High Shares”) of Chance High from the Chance High Shareholders, and the Chance High Shareholders transferred and contributed all of their Chance High Shares to us.  In exchange, we issued to Chance High Shareholders an aggregate of 13,162,500 newly issued shares of our common stock.
 
 In addition, pursuant to the terms of the Share Exchange Agreement, Anthony Zaradic, our former sole officer and director (“Zaradic”), cancelled a total of 1,500,000 shares of common stock owned by him.  As a further condition of the Share Exchange, effective as of January 5, 2010, Zaradic resigned from all of his positions with our company and Hongwei Qu (“Qu”), the former principal shareholder and Executive Director of Bohai, was appointed as our President, Chief Executive Officer, Interim Chief Financial Officer, Treasurer and Secretary and also, effective January 16, 2010, as our sole director.  In June 2010, Mr. Qu relinquished the positions of Interim Chief Financial Officer, Treasurer and Secretary and we appointed Gene Hsiao as our Chief Financial Officer.  On July 12, 2010, we appointed three independent directors to our board of directors.
 
 January 5, 2010 Private Placement and Related Agreements
 
 Securities Purchase Agreement.  On January 5, 2010, we entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with certain accredited investors (the “Investors”) and Euro Pacific Capital, Inc. (“Euro Pacific”), as representative of the Investors, relating to a private placement by us of 6,000,000 units consisting of Notes and Warrants, which we refer to herein as the private placement.  The consummation of the private placement resulted in gross proceeds to us of $12,000,000 and net proceeds of approximately $9,700,000.  Each unit consisted of a $2.00 principal amount, two year convertible Note and a three year Warrant to purchase one share of our common stock at $2.40 per share, subject to certain conditions.  Euro Pacific acted as the lead placement agent and Chardan Capital Markets, LLC acted as co-placement agent of the private placement.
 
 Registration Rights Agreement.  In connection with the private placement, we entered into Registration Rights Agreement (the “Registration Rights Agreement”) with the Investors which sets forth the rights of the Investors to have the shares of common stock underlying the Notes and Warrants issued in the private placement registered with the Securities and Exchange Commission (“SEC”) for public resale.  We filed such registration statement with the SEC, and registration statement was declared effective by the SEC on August 12, 2010.
 
 Securities Escrow Agreement.  Also in connection with the private placement, we entered into a Securities Escrow Agreement (the “Securities Escrow Agreement”) with Euro Pacific, as representative of the Investors, our principal shareholder, Glory Period Limited, a British Virgin Islands company that we refer to herein as Glory Period and which was the majority shareholder of Chance High prior to the Share Exchange, and Escrow, LLC, as escrow agent (the “Escrow Agent”).  Pursuant to the Securities Escrow Agreement, Glory Period has pledged and deposited a stock certificate representing 1 million shares of our common stock (the “Escrow Shares”) into escrow in order to provide security to the Investors in the event of an occurrence of an event of default under the Notes.  Upon the earlier to occur of the full repayment of all amounts due to the Investors under the Notes or the conversion of fifty percent of the principal face value of Notes into shares of common stock, the Investors’ rights in and to the Escrow Shares shall terminate.  Glory Period is controlled by Qu through certain contractual relationships described elsewhere in this Annual Report.
  3
 
 Closing Escrow Agreement.Pursuant to a Closing Escrow Agreement (the “Closing Escrow Agreement”) that we entered into in connection with the private placement on December 10, 2009, we placed a total of $240,000 of proceeds from the private placement (the “Holdback Amount”) with the Escrow Agent.  The Holdback Amount represents an amount sufficient to satisfy the payment to the Investors of one quarterly interest payment due on the aggregate principal amount of all Notes issued in the private placement.  If, subject to certain conditions and after applicable notice and cure periods, an event of default is declared by Euro Pacific with respect to our failure to make a quarterly interest payment to Investors, the Escrow Agent shall disburse such portion of the Holdback Amount to the Investors, and we shall be obligated to deposit additional amounts equal to the Holdback Amount with Escrow Agent.  At such time as seventy-five percent of the aggregate shares of common stock underlying the Notes have been issued upon conversion of the Notes, all remaining funds of the Holdback Amount shall promptly be disbursed to us.
 
 Corporate Name Change
 
 On January 29, 2010, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which we merged with a newly formed, wholly owned subsidiary called Bohai Pharmaceuticals Group, Inc., a Nevada corporation (“Merger Sub” and such merger transaction, the “Merger”).  Upon the consummation of the Merger, the separate existence of Merger Sub ceased and our shareholders became shareholders of the surviving company named Bohai Pharmaceuticals Group, Inc.  As permitted by Chapter 92A.180 of Nevada Revised Statutes, the sole purpose of the Merger was to effect a change of our corporate name.
 
 Changes of Our Independent Registered Accounting Firms
 
 Effective January 29, 2010, upon the approval of our board of directors, we dismissed John Kinross-Kennedy as our independent registered public accountant and appointed Parker Randall CF (H.K.) CPA Limited (or Parker Randall) as our independent registered public accounting firm.
 
 On June 24, 2011, the audit committee of our board of directors approved the dismissal of Parker Randall as our independent registered public accounting firm, effective as of June 28, 2011, and appointed Marcum Bernstein & Pinchuk LLP as our independent registered public accounting firm as of June 24, 2011.
 
 Intangible Assets Transfer
 
 On December 9, 2010, we entered into an Transfer Agreement of Intangible Assets (the “Transfer Agreement”) with Shandong Daxin Microbiology Pharmaceutical Industry Co., Ltd., a company incorporated in the People’s Republic of China (“Daxin”), pursuant to which Daxin agreed to transfer to us all rights and title in and to 14 Drug Approval Numbers (“DANs”) for 14 traditional Chinese medicines, which DANs were previously issued to Daxin by the Shandong Branch of the SFDA.  The aggregate purchase price is RMB 48 million (approximately US$7,200,000).  As of the date of the execution of the Transfer Agreement, the proposed transfer of the aforementioned 14 DANs has been approved by Shandong SFDA.  Such purchase price has been paid in full.
 
 Acquisition of Yantai Tianzheng
 
 On August 8, 2011, WFOE II entered into a Share Purchase Agreement (the “SPA”) pursuant to which we acquired, from the three individual holders thereof, one hundred percent (100%) of the outstanding shares of Yantai Tianzheng.  Under the terms of the SPA, WFOE II will purchase such shares from Mr. Jiangbo Chi, Ms. Shulian Wang and Mr. Bohai Yu.  The percentage interests owned by Mr. Chi, Ms. Wang and Mr. Yu in Yantai Tianzheng, are 60%, 30% and 10%, respectively.  The SPA also contained customary representations, warranties and covenants of the parties.  Mr. Chi (the majority shareholder of Yantai Tianzheng) also entered into an agreement related to his employment by Yantai Tianzheng, ownership of his future work products and certain confidentiality and non-compete obligations.
  4
 
 The purchase price to be paid for Yantai Tianzheng is $35,000,000 in the aggregate.  Pursuant to the SPA, the purchase price is payable in cash in the following installments:
 
 1.           The first cash payment in the aggregate amount of $ 6,000,000 was paid within 10 calendar days after the execution of the SPA.
 
 2.           The second cash payment in the amount of $12,000,000 will be payable within 6 months after the execution of the SPA, subject to certain conditions (unless otherwise waived), such as the performance of all “transition period” obligations related to renewal or extension of material operational agreements and employment agreements.
 
 3.           The third cash payment of $12,000,000 will be payable within 1 year after the execution of the SPA, subject to certain conditions (unless otherwise waived), such as amendment or obtainment of certain certificates and license necessary for consummation of the transaction.
 
 4.           The fourth cash payment of $5,000,000 will be payable within 18 months after the execution of the SPA, subject to certain conditions.
 
 In addition, each installment requires satisfaction of conditions applicable to its prior payment(s), completion of assignment of certain licenses or certificates, and absence of a material adverse change affecting Yantai Tianzheng during the respective installment periods.  In the event that WFOE II fails to pay any of the installments when due, such outstanding installment will be automatically converted into a two-year term loan owed by WFOE II to the Shareholders of Yantai Tianzheng, with interest accruing on any unpaid portion of such loan from its due date until such installment is paid in full at the rate of six percent (6%) per annum.  As long as such interest payments are made on a timely basis and the outstanding principal of such loan and interest are satisfied in full within 2 years after the applicable installment failure date, WFOE II will not be deemed in breach or default under the SPA and will continue to possess full control and legal ownership over Yantai Tianzheng. Furthermore, even in the event of non-payment by WFOE II of any principal or interest under the loans as described above, or in the event of any other breach or default by WFOE II  of the SPA, the remedies of the former Yantai Tianzheng Shareholders against WFOE II are limited solely to monetary damages, and in all instances such Shareholders will have no right to reclaim ownership of Yantai Tianzheng or demand that WFOE II in any way revert control or legal ownership over the shares of Yantai Tianzheng back to such shareholders.
 
 The acquisition of Yantai Tianzheng marked a major milestone for our company.  The acquisition expanded our product lines and will allow us to leverage our respective sales and distribution channels. Yantai Tianzheng’s current sales network spans over 14 major provinces as well as over 14 Tier 2 and Tier 3 cities, with products sold in over 1,100 hospitals across China.  In addition, Yantai Tianzheng brings additional manufacturing capacity which meets GMP standards and will allow us to further expand our production.  We plan to consolidate and integrate the two companies’ operations, which could provide substantial improvement in the operating efficiency of the combined companies.
 
 Intangible Asset Impairment
 
 During the fourth quarter of our 2011 fiscal year, we determinate that we will no longer manufacture or seek to develop a market for eight of our products due to a change of our business strategy resulting from our acquisition of Yantai Tianzheng.  As a result of this decision, the total cost of these eight products, in the amount of $635,442, was charged to non-cash impairment loss during the 4th quarter of the fiscal year ended June 30, 2011.  Even though we incurred an impairment loss for these eight products, we continue to retain a full ownership of these products and can still manufacture them at any time we deem desirable.
  5
  Corporate Structure and Related Agreements
 
 Our organizational structure as of the date of this Annual Report is summarized below:
  
 
 Chance High owns 100% of the issued and outstanding capital stock of the WFOE.  On December 7, 2009, the WFOE entered into a series of variable interest entity contractual agreements (the “VIE Agreements”) with Bohai and its three shareholders, which include Qu (our Chairman, President and Chief Executive Officer, who owns 90% of Bohai’s shares) and two unaffiliated parties.  Pursuant to the VIE Agreements, WFOE does not directly own the equity of our operating subsidiary, but rather effectively assumed management of the business activities of Bohai and has the right to appoint all executives and senior management and the members of the board of directors of Bohai.  The VIE Agreements are comprised of a series of agreements, including a Consulting Services Agreement, Operating Agreement and Proxy Agreement, through which WFOE has the right to advise, consult, manage and operate Bohai for an annual fee in the amount of Bohai’s yearly net profits after tax.  Additionally, Bohai’s Shareholders have pledged their rights, titles and equity interest in Bohai as security for WFOE to collect consulting and services fees provided to Bohai through an Equity Pledge Agreement.  In order to further reinforce WFOE’s rights to control and operate Bohai, Bohai’s shareholders granted WFOE an exclusive right and option to acquire all of their equity interests in Bohai through an Option Agreement.
 
 In addition, on December 7, 2009, Mr. Qu entered into a call option agreement (the “Call Option Agreement”) with Joshua Tan (“Tan”), the sole shareholder of Glory Period, a British Virgin Islands company, which was the majority shareholder of Chance High prior to the share exchange.  The Call Option Agreement became effective upon the closing of the Share Exchange.  Under the Call Option Agreement, Tan shall transfer up to 100% shares of Glory Period within the next 3 years to Qu for nominal consideration, which would give Qu indirect ownership of a significant percentage of our common stock.  The Call Option Agreement provides that Tan shall not dispose any of the shares of Glory Period without Qu’s prior written consent.
  6
  Executive Offices
 
 Our headquarters are located at No. 9 Daxin Road, Zhifu District, Yantai, Shandong Province, P.R. China 264000. Our telephone number is +86(535)-685-7928.
 
 Overview of Traditional Chinese Medicine
 
 In China, Traditional Chinese Medicine is not an alternative form of therapy but is used in the state-run hospitals alongside modern medicine.  For its practitioners and advocates, TCM is a complete medical system that is used to treat disease in all its forms.  TCM is also believed to promote long term wellness and vigor. Many modern-day drugs have been developed from herbal sources.  These include drugs designed to treat asthma and hay fever such as ephedrine; hepatitis remedies from fruits and licorice roots and a number of anticancer agents from trees and shrubs.
 
 For the Chinese, however, health is more than just the absence of disease.  Chinese herbal medicine is not only intended to cure but to enhance the capacity for enjoyment, fulfillment and happiness.  Accordingly, there are herbal drugs that are used to invigorate, nourish blood, calm tension and regulate menstruation.
 
 The roots of TCM date back thousands of years and include a number of therapeutic approaches.  These include herbal medications, acupuncture, dietary manipulation, massage and others.  Very early works of Chinese medical literature date back as much as 2,500 years while other classics appeared approximately 2,000 years ago during the Han Dynasty.  Medicine in China continued to develop throughout the Middle Ages when emperors commissioned the creation of various scholarly works that compiled and documented hundreds of medicines derived from herbs, animal sources and minerals.  In addition, these works described their therapeutic uses.  In the 1950s, TCM was further modernized and reformed by the PRC government.
 
 The emphasis on wellness and the avoidance of disease is considered by some to be a key distinction between TCM and western medical practice which has been seen as more heavily oriented toward the treatment of disease and less toward prevention.  While TCM has remained a substantial part of medical treatment in China and throughout East Asia, recent decades have seen increasing acceptance throughout the United States, Europe and elsewhere.  This growth is, in part, driven by increasingly educated and empowered consumers of medical care who seek organic, natural and alternative approaches to western medical treatments and prescription drugs.  Medical doctors are also accelerating the process of acceptance, as doctors trained in the western tradition in Europe, the United States and elsewhere are integrating TCM and alternative treatments in their everyday practice.  Additionally, a growing number of physicians specifically trained in TCM, acupuncture and other modalities are opening offices in communities in the U.S. and around the world.
 
 We believe that the sales of TCM in China reflect the central and still growing role these therapies play in medical care in that nation.  According to Helmut Kaiser Consultancy, in 2005, total sales revenue for Chinese herbal medicine manufactured in China was $13.6 billion which accounted for 25.8% of all medicine manufactured in China.  This segment had total profit of $1.76 billion which accounted for 29% of the total profit of the Chinese drug industry.  In 2006, there were approximately 1,400 Chinese herbal medicine manufacturers with an annual growth rate of 15%, much higher than the comparable period GDP growth.  According to Helmut Kaiser Consultancy, as a result of the increasing wealth of China and an aging population, it is estimated that by 2010, China will be the fifth largest market for herbal medicines in the world exceeding more than $24 billion in sales.
 
 According to a published report by PricewaterhouseCoopers, in 2009 China had more than 7,000 distributors supplying pharmaceuticals to hospitals and pharmacies.  According to such report, most Chinese seeking medical care go directly to the hospitals where more than 80% of the medicines used throughout China are prescribed.  Only recently have chain drug stores begun to appear allowing drugs to be obtained in many areas without a visit to a hospital.
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  Our Products
 
 Overview
 
 Through our operating subsidiary Bohai, we obtained Drug Approval Numbers for 29 varieties of traditional Chinese herbal medicines in 2004 and an additional 14 varieties in December 2010 through a product acquisition and currently produce 15 TCM pharmaceutical products.  Through our Yantai Tianzheng operating subsidiary, we hold 5 additional varieties of traditional Chinese herbal medicines, of which we currently produce four.  Of our 19 products in production, 12 are prescription drugs and 7 are OTC products.  All of our products are derived from herbal and organic sources.
 
 The following is a list of the approved pharmaceutical products that we are producing with their intended uses:
 
 Lung NourishingSyrup.  Lung Nourishing Syrup is designed to moisten the lung and relieve coughs and can be used to treat weak lung and chest tightness, poor chronic cough, shortness of spontaneous breath and chronic bronchitis.
 
 Tongbi Capsules.  This product is designed to promote blood circulation and relieve swelling and pain, and can be used to treat cold resistance, liver and kidney deficiency, arthralgia syndrome and rheumatoid arthritis.
 
 Tongbi Tablets.  Tongbi Tablets are designed to regulate and fortify the blood promote blood circulation and relieve swelling pain and can be used to treat alpine resistance, liver and kidney deficiency, including rheumatoid arthritis.
 
 Shangtongning Tablets.  This product is designed to alleviate pain and can be used to treat bruises.
 
 Zhuangyuan shenhailong Medicinal Wine.  This liquid product is designed to promote kidney function and can be used to treat the weakness waist and knee fatigue, insomnia and forgetfulness.
 
 Danqi Tablet.  This product is designed to improve blood circulation and can be used to treat blood stasis, cardio-thoracic pain, dizziness and headache, and menstrual pain.
 
 Fukangning Tablet.This product is designed to improve blood circulation and can be used to treat blood stasis, cardio-thoracic pain, dizziness, headache and menstrual pain.
 
 Bazhen Yimu Cream.  This product is designed for menstruation conditioning and can be used to treat dizziness, palpitation, fatigue, weakness and other menstrual symptoms and can also be used to ease menstrual flow.
 
 Huoxue Shujin Ting.  This product is designed to promote blood circulation and relieve blood congestion, and can be used to treat pain in the waist and leg, numbness in the feet and hands and arthritis.
 
 Anti-flu Granules.  This product is designed to detoxify the body, and can be used to treat cold caused by exogenous wind-heat with symptoms such as fever, headache, stuffy nose, sneezing, pharyngodynia, generalized weakness and soreness.
 
 Compound Manshanhong Syrup.This product is designed to relieve cough due to throat irritation and to prevent asthma symptoms.
 
 Sanqi Shang Tablets.This product is designed to promote blood circulation and relieve blood congestion, numbness, pain or bruises in the body due to arthritis, acute or chronic sprain or neuralgia.
 
 Stomach Nourishing Tablets. This product is designed to relieve heartburn, sour stomach, acid indigestion and stomach upset caused by chronic superficial gastritis.
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 Yangxue Anshen Tablets.This product is designed to improve blood circulation and to treat dizziness, palpitation, fatigue, weakness and other menstrual symptoms.
 
 Shujin Huoxue Tablets.This product is designed to promote blood circulation and relieve blood congestion, and can be used to treat symptoms related to back pain, muscle paralysis, muscle spasm and acute or chronic sprain.
 
 Fangfengtongsheng Granule. This product is used to treat fever, headache, constipation, measles and eczema.
 
 Zhengxintai Capsule.  This product is used to improve kidney function and treat coronary artery disease and angina.
 
 Tongmai Granule.  This product is used to treat ischemic heart and cerebrovascular diseases, arteriosclerosis and cerebral thrombosis
 
 Bezoar Antipyrotic Tablet.  This product is used to heat detoxificationeliminate heat from the body, swelling and pain.
 
 Of our 19 products currently in production, 12 (Tongbi Tablets, Tongbi Capsules, Shangtongning Tablets, Danqi Tablets, Huoxue Shunjin Ting, Compound Manshanhong Syrup, Sanqi Shang Tablets, Shujin Huoxue Tablets, Tongmai Granule, Fangfengtongsheng Granule and Zhengxintai Capsule) are available only through prescription.
 
 In addition to the 19 medicines currently in production, we hold the rights to produce 29 other herb-based pharmaceutical formulations.  We anticipate that we will commence the manufacturing and distribution for these additional products if and when appropriate business conditions develop.
 
 Product Types
 
 Bohai has five production lines for the manufacturing of medicines in five forms, including tablets, granules, capsules, syrup, and medicinal wine.  Our current production capacity is approximately:
 
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1.35 billion tablets and 370 million capsules;
 
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30 million bags granules;
 
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20 million bottles/units of concentrated decoctions;
 
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15 million bottles/units of syrup;
 
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1 million bottles/units of tinctures; and
 
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1 million bottles/units medical wine.
 
 We believe that during the fiscal year ended June 30, 2011, on average, we operated at approximately 50% of our production capacity and we believe we are currently operating at approximately 60% of capacity.  Yantai Tianzheng has annual production capacity of 400 million tablets, 300 million capsules and 250 million bags of granules respectively and operated on average at 35% of its production capacity for the period ended June 30, 2011
 
 One of our pharmaceutical products has been granted “protected” status by the PRC government, a marketplace classification used by the government to regulate both production and distribution of traditional and herbal medicines in addition to the product formula right itself.  These “protected” medicines are not patented in the traditional commercial sense but are essentially proprietary.  The protection refers, in part, to standardizations of formulae which require that medicines of the same name have the same type and proportion of ingredients.  The “protected” designation grants us exclusive manufacturing and distribution rights within China over certain protected products or with up to six manufacturers in other cases.
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 We have the exclusive rights to manufacture Tongbi Capsules and we share manufacturing rights with one or more manufacturers for Shangtongning Tablets and Anti-flu Granules.  The exclusive rights usually have a term of seven years and can be extended for another seven year period after the initial seven year period elapses.  The protection periods for both Tongbi Capsules and Shangtongning Tablets expired in September 2009 and we have filed an application for extending the protection period on March 12, 2009 for Tongbi Capsules. SFDA approved our request to extend the protection period for Tongbi Capsules to September 13, 2016. We have decided not to submit extension application of Shangtongning Tablets, because the SFDA shall not approve Certificate of Protection for Shangtongning Tablets or any other products that are currently produced by more than three manufacturers in China according to applicable Chinese SFDA regulations.  The shared manufacturing rights for Anti-flu Granules expire on July 9, 2012.
 
 During fiscal 2011, we expect to increase marketing and advertising of Tongbi Capsules and Tablets, which are formulated to treat various forms of arthritis.  Sales of our Tongbi medicines are expected to grow in fiscal 2011 due to its protective status and strong demands of drug consumption resulting from health insurance reform in China.  In addition to the Tongbi medicines and the Lung Nourishing Syrup, other substantial contributors to our revenues include its Shangtongning Tablets which are also expected to grow in fiscal 2011 due to strong demands of drug consumption resulting from health insurance reform in China and our marketing efforts.  Sales of our OTC product Bazhen Yimu Cream, used to strengthen the immune system, the enhancement of physical strength and conditioning, are also projected to grow in fiscal 2011 due to strong demands of drug consumption resulting from health insurance reform in China.  As our Tongbi Capsule has been included in the EDL for Shangdong Province, we will focus our marketing efforts in the rural hospitals in Shandong during fiscal 2012.
 
 We will continue to promote four products being sold by Yantai Tianzheng under its current marketing strategy combined with our existing national sales efforts.  In particular, we expect that sales from Yantai Tianzheng’s top two products (Fangfengtongsheng Granule and Zhengxintai Capsule) will continue to grow in 2012 due to their exclusive status and/or NDRL status.
 
 We price our medicines well under government-mandated caps and at a premium to most competitors because we use high quality raw materials and rely on strict quality control and management to produce high quality finished products.  We therefore believe, subject to applicable clinical analysis, that the purity, potency and effectiveness of our ingredients are superior to similar products in the Chinese marketplace.  As Chinese pharmaceutical regulatory authorities continue to tighten drug regulationsto improve Chinese drug quality and safety standards, future entry into the pharmaceutical industry has become an increasing challenge.
 
 Overview of the Chinese Market
 
 The People’s Republic of China is undergoing the world’s most important and powerful economic transformation.  This transformation includes the confluence of its ancient culture with modern trends in business, technology and finance.  As a result, Chinese operating companies are capitalizing on unmatched growth opportunities in this evolving and growing marketplace.  Although average income is approximately one-tenth that of developed western nations, business growth and market reform-driven policies have given the country’s 1.3 billion citizens more purchasing power than ever.
 
 According to a report published in Newsweek, total consumer spending in China reached $1.7 trillion in 2007, compared with $12 trillion in the U.S.  In its China Consumer Survey published in January 2010, Credit Suisse found that household income in China of the bottom 20% of those surveyed rose by 50% since 2004, while the top 10% had grown 255% to around RMB 34,000 per month.  Credit Suisse expects China’s share of global consumption to increase from 5.2% at US$1.72 trillion in 2009 to 23.1% at US$15.94 trillion in 2020, overtaking the U.S. as the largest consumer market in the world.Further, research on Chinese consumers by management consulting firm McKinsey classifies two million households out of a population of 1.3 billion as “wealthy,” based on fairly modest annual earnings of more than $30,000.  An enormous middle class is rising, however, numbering some 70 million urban households, but these still earn $5,000-$10,000 a year.  China’s National Bureau of Statistics, based on a random survey of 65,000 urban households in China, found that the average (annual) disposable income of urban residents in the first half of 2009 was U.S. $1,300, an increase of 9.8% compared to the same period last year.  When price factors are deducted, this is equivalent to a real increase of 11.2%.  The average consumption expenditure amount of urban residents in the first half of 2009 was U.S. $876, an increase of 8.9% compared to the same period last year. When price factors are deducted, this is equal to a real increase of 10.3%.
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  TCM Industry Drivers
 
 We believe that demographic, governmental and related factors in the China will be favorable to growth and expansion of our business.
 
 Growing Prosperity of the Chinese People.  The increased spending power of China’s population continues to be reflected in the increased consumption of health products and medical services between 2007 and 2010.  According to Euromonitor data, spending by Chinese people on these goods and services will increase from $100 billion in 2007 to $145 billion in 2010.  According to the Southern Medicine Economic Institute of the SFDA, sales of TCM increased 20% in 2010 as compared to 2009 in selected hospitals in the cities of Beijing, Guangzhou, Nanjing, Chongqing, Chengdu, Xi'an, Harbin, Shenyang, and Zhengzhou.  Overall sales of TCM in such hospitals increased at an annual rate of more than 20% during the past three years.
 
 Population and Aging
 
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The total population of China was 1.34 billion at the end of 2010, according to official government estimates.
 
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Due to improved healthcare, the elderly population of China is growing.
 
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The health/medical costs associated with care for elderly in China are approximately five (5x) times that of younger people.
 
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China had 170 million elderly people in 2007 but will have an expected 230 million elderly by 2015 according to “Consumer Lifestyles in China: Consumer Trends, China’s Grey Population,” by Euromonitor, 2009.
 
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The proportion of the China’s population aged 65 and over will rise from just 10% of the overall population in 1995 to 22% by 2030, according to the World Bank.
 
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From 1995 to 2030 it is estimated that the ratio of working-age people to pensioners will decrease from 9.7:1 to 4.2:1.  China’s national estimates vary slightly from World Bank figures, but still show in increase in the proportion of the population over 65 years from 7% in 2000 to 9.4% in 2007, according to China Country Profile 2009, The Economist Intelligence Unit Ltd.
 
 Government Policies in Health Care and TCM.  In April of 2009 the PRC government implemented a new national medical and health plan.  Among other features, this new plan extended national medical insurance coverage to China’s rural areas, where the bulk of the population resides.  This expanded coverage will eventually encompass virtually all of China’s 1.3 billion citizens, greatly expanding the market for TCM pharmaceuticals, as well as other health care products and services.   This has led to massive potential for increased sales growth for Bohai and other providers of TCM pharmaceutical products.
 
 According to Espicom Business Intelligence, by 2011, the PRC government’s health care investment will rise to $125 billion, compared with $96 billion for 2008.  Direct health care subsidies of urban and rural residents will amount to $57 billion.  China’s health care investment is expected to witness a growth of 19.7% and the overall growth rate will reach more than 25%.
 
 Government Support of Traditional Chinese Medicine.  Among its public health initiatives, the Chinese government officially supports use of TCM to enhance wellness and to treat chronic and acute diseases. The government has also commenced a program to evaluate TCM and herbal-based pharmaceuticals for coverage and reimbursement under national medical insurance.  In 2002, TCM was declared a “national strategic industry” in the government’s “Development Outline of Traditional Chinese Medicine Modernization (2002 – 2010).”
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  Decreased Competition.  According to the Information Office of the State Council of the PRC, prior to 2009, there were approximately 6,000 Chinese pharmaceutical manufacturers.  That number is being significantly reduced through both marketplace attrition and direct government involvement, decreasing competition and increasing potential sales opportunities for the surviving companies.  Other companies are expected to fail through lack of size and innovative and aggressive management.  According to a 2009 report published by KMPG, of the approximately 4,500 pharmaceutical companies in China, the majority are small players with limited local market reach, and rapid consolidation between medium and large players in the sector is anticipated since the Chinese government has been encouraging industry consolidation with an effort to improve the Good Manufacturing Practice (GMP) standard, enforce GMP certification and to better control the pricing of drugs..
 
 Growth Strategy
 
 Our strategic initiatives for the foreseeable future are designed to aggressively capitalize on the health and wellness needs of increasingly wealthy and empowered consumer class in China.  In particular, we are seeking to capitalize on the government policies that extended medical insurance in 2009 to hundreds of millions of Chinese citizens living in rural areas, representing a vast untapped market of potential consumers who previously lacked access to national medical insurance.  As part of its reforms to expand and improve public health and medical care, the PRC government is promoting the use of herbal-based TCM and expanding insurance coverage to 100% of an increasing number of medicines.
 
 Our strategic initiatives include the following:
 
 Grow Hospital Presence.  We have targeted over 600 hospitals in 100 locations throughout China for direct marketing of Bohai products.  As part of this initiative, our sales team will expand its marketing activities to educate hospital personnel about our product lines and train hospital employees in the preventative and curative qualities of these products.  The initial focus will capitalize on the best known and most popular of our products, such as Tongbi capsules and Shangtongning tablets, using these as door-openers for our other medicines
 
 The average marketing cost to “open” each hospital to our products is $1,500.  For our base Bohai business, we are currently targeting the following provinces and the number of hospitals in such provinces indicted below:
 
 Cities

Number of HospitalsZhejiang

50Jiangsu

40Anhui

30Shandong

300Sichuan

50Hunan

40Henan

40Yunnan

20Fujian

40Shanghai

40Hubei

30
 
 Build Awareness of the Lung NourishingSyrup.  We allocated a significant portion of the proceeds from our January 2010 private placement for brand-building and continue to dedicate resources to these efforts.  We will primarily target consumers through television and print advertising to expand awareness of the uses and effectiveness of our Lung Nourishing Syrup.  The advertising will incorporate targeting smokers and workers with occupational diseases as well as city dwellers exposed to smog.  It is expected that the consumer television advertising program will initially be focused in the following areas:
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 TV Station LocationShandongAnhuiHubeiSichuanChongqingShanxiJiangsuLiaoning
 
 We spent approximately $15 million in advertising and promotion expense in fiscal year 2011 as compared to approximately $13 million in advertising and promotion expense in fiscal year 2010. As a result of our efforts in fiscal year 2011, sales from Lung Nourishing Syrup increased by 33% compared to last fiscal year. By the end of our fiscal 2011, we added more than 200 level 2 hospitals and more than 10 new drug store chains to our national network of retail locations in China currently selling our Lung Nourishing Syrup.  As a result, we now sell Lung Nourishing Syrup in more than 1,600 level 2 hospitals and more than 36 drug store chains across China.
 
 Expand to Rural Areas.  We expect to execute a comprehensive marketing campaign targeting 100 rural counties as a result of the national government’s emphasis on expansion of healthcare and health insurance into the country’s rural areas.  We plan on starting its rural marketing in Shandong, Anhui, Liaoning and Hubei.  Our sales team will market its products to pharmacies, hospitals, physicians, herbal medicine experts, media outlets and other opinion leaders in these rural areas.  The main purpose is to be listed in the New Rural Cooperative Medical Directory which is farmer-friendly and assists these rural dwellers with reimbursement of medical expenses.
 
 Generally, the marketing cost of this professional relationship-building with each rural county is $3,000. Total estimated marketing costs in the New Rural Cooperative Medical Directory could be in excess of $1,000,000. We plan to continue our efforts in hiring additional sale people under our current strategy as national health reform continue to focus in the rural areas especially in Shandong province.  All of these sales and marketing initiatives will involve both OTC and prescribed products.
 
 Develop Our Product Lines and Product Awareness.  Brand awareness marketing will include the promotion and introduction to new markets of the current popular Bohai products such as Tongbi Tablets, Lung Nourishing Syrup, Fangfengtongsheng Granule, and  Zhengxintai Capsule.  As part of our increase in sales and marketing staff, we plan to have special trainers and presenters who can conduct promotional events and seminars to increase awareness of our products.
 
 Seek Acquisitions of Complimentary Companies or Assets.  We believe that there may be TCM companies (such as Yantai Tianzheng) or assets in China that would be complimentary with our current product offerings and which could fit well with our sales and marketing platform.  We may seek to acquire such assets or other companies as a means to grow our revenue and profitability.
 
 Competitive Advantages
 
 We believe there are several key factors that will continue to differentiate us from our competition in the PRC:
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“Protected” Status of Key Bohai Product.  One of our lead products (Tongbi Capsules) currently enjoys exclusive protected status by the PRC government.  We have submitted an application for extending the protection period for this product.  This status regulates competition, granting us exclusive or near-exclusive rights to manufacture and sell the protected products. SFDA approved our request to extend the protection period for Tongbi Capsules to September 13, 2016. We submitted to the SFDA our request for renewal of the protected status for Zhengxintai Capsule on February 26, 2010, and such request is currently being reviewed.  We are in the process of applying for protected status for Fangfengtongsheng Granule, and such application was received by SFDA on June 30, 2010.
 
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Patent Granted for Lead Product.  We have received a patent in the PRC for our Lung Nourishing Syrup with its production method for the treatment of Lung Qi Deficiency Cough and Chronic Bronchitis.  The patent was awarded for a period of 20 years starting from the day of its application on September 12, 2007.  For these reasons, we believe Lung Nourishing Syrup contains a novel formulation for the treatment of asthma and other common respiratory ailments with an emphasis on the improvement of overall lung function and health.  We believe this represents an exceptional market opportunity.
 
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Insurance Coverage for Lead Bohai Products.  Five  of our lead products, Lung Nourishing Syrup,  Tongbi Capsules and Tablets, Fangfengtongsheng Granule and Zhengxintai Capsule, are listed in the Catalogue Eligible for Medicine Reimbursement as of November 30, 2009.  This means that these medicines are eligible for reimbursement under the national health insurance.  We will seek to have additional (approximately 2-3) products listed in the catalogue.
 
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Low Development Costs.  We enjoy relatively low research and development (including acquisition) costs for our TCM products compared with western pharmaceuticals as our products are derived from recognized formulas.
 
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Effective Sales Force.  We maintain a highly trained sales force of approximately 354 people as of the date of this Annual Report.
 
 The principal raw materials used for the production of our distributed products are honey, laiyang pear paste, Sichuan fritillaria, pangolin, and Chinese angelica.  Raw materials, as well as packaging materials, are sourced from various independent suppliers in the PRC.  We have no long term agreements with our suppliers, and purchase raw materials on a purchase order basis.  We try to maintain relationships with at least two vendors for each major raw material in order to ensure a reliable supply of raw materials at reasonable prices.  We believe there is ample supply in the market for the foreseeable future of the ingredients for our products.
 
 Our principal suppliers include Anhui Dechang Pharmaceutical Tablet Co., Ltd., Shandong Yantai Medicine Purchasing and Supply Station, Zibo Taibao Forgery-proof Product Co., Ltd., and Zhejiang Yuhuan Kangning Medicine Packaging CO., Ltd.  In the fiscal year ended June 30, 2011, one supplier accounted for over 10% of our purchases of raw materials, although currently no single supplier accounts for over15 % of our purchases of raw materials. Approximately 34% of the raw material is purchased from Anhui Dechang Pharmaceutical Tablet Co., Ltd., Shandong Yantai Medicine Purchasing and Supply Station and Shandong Cangli Medicine Co., Ltd.
 
 Yantai Tianzheng’s major suppliers are Anhui Dechange Pharmaceutical Tablet Co., Ltd., Shandong Yantai Medical Materials Purchasing and Supply Station and Anguo Jinkangdi Medicine Co., Ltd.Approximately 35% of the raw material used by Yantai Tianzheng was purchased from Anhui Dechang Pharmaceutical.
 
 Research and Development
 
 We currently have limited resources to devote to and limited capabilities to conduct the development of new products and as such research and development activities are not presently material to our business.  We have only one full-time employee who is engaged in research and development, so we are mainly dependent on a third-party, Yantai Tianzheng Medicine Research and Development Co., Ltd., to perform research and development for us.  We currently have two products, namely Forsythia Capsule and Fern Injection, under research and development in association with Yantai Tianzheng Medicine Research and Development Co., Ltd.
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 We, like other TCM manufacturers, enjoy relatively low research and development expenses as most TCM medicines are based on standardized formulas.  In 2008, SFDA promulgated a notice of registration of Chinese traditional medicine providing that TCM composed of classic prescriptions will be exempted from pharmacological and toxicological tests and studies.  The notice defined classic prescription and classic TCM formulas as those herbal remedies recorded in ancient Chinese medicine books from Qing Dynasty or earlier which are currently widely used.  According to such notice, the production and manufacturing of TCM products are subject to non-clinical safety studies only and exempted from pharmacological and toxicological tests and studies.  Thus, TCM products are entitled to obtain faster SFDA approval.  As such, we enjoy relatively low research and development expenses because most of our products are based on classic TCM formulas that are covered by this notice.
 
 The research and development process includes toxicological tests, pharmalogical and qualitative research, preparation for production and other miscellaneous costs.  We intend to introduce one new product by 2014 which is currently identified as a Shujin Pain Relief soft capsule.  The total cost to develop this product is not expected to exceed $1,500,000.  We may also seek to acquire new products through acquisitions of other TCM companies in the future.
 
 We received a two-year government research grant totaling $144,000 (RMB 950,000) to fund the research and development of Menstrual Relief Tablet, a traditional Chinese medicine (TCM) for dysmenorrhea, or menstrual pain, currently in early-stage clinical development. The grant includes $91,000 (RMB 600,000) from the Ministry of Science and Technology of the People's Republic of China and $53,000 (RMB 350,000) from the Yantai local government.  The grants are being given to companies to encourage the modernization of TCM drug-development in a manner more aligned with the typical development pathway of Western medicines.
 
 Manufacturing
 
 Although TCM is thousands of years old, we believe that our product manufacturing and procedures are the most modern and up-to-date available.  We employ rigorous standards for product quality control and safety.  The manufacturing facility owned by us is conducted in the city of Yantai in Shandong Province in a state-of-the-art 18,000 square-meter facility that meets or exceeds the latest Good Manufacturing and Quality Management Practice standards (referred to in China as “GMP”).
 
 Yantai Tianzheng owns a manufacturing facility with a total area of 10,908.83 square meters (approximately 117,000 square feet) that also meets or exceeds the latest GMP.
 
 GMP standards are the government’s benchmark for pharmaceutical manufacturers in China and must be met for the manufacturer to be eligible to market domestically or enter world markets.  On March 31, 2009, we completed a GMP review which included examination of 225 items including development technology, production, quality assurance, quality control, material handling and engineering.  As a result of that review, we were been re-certified for a new five-year period.
 
 Through stringent application of GMP standards, the PRC government has reduced the number of marginal medicine manufacturers by one-third, from 6,000 to 4,000.  The new GMP standards established in 2011 could potentially eliminated additional 500 medicine manufacturers.  It is expected that TCM and pharmaceutical companies such as ours that have received full GMP approval by the government will enjoy the competitive benefits of their strict adherence to quality control, safety, health and manufacturing standards.
 
 Our advanced and mechanized facilities utilize controlled, clean-room procedures with sophisticated water filtration and materials processing systems.  The manufacturing staff consists of approximately 343 production employees and approximately 25 quality control inspectors as of June 30, 2011.  We believe that we operated at approximately 60% of our manufacturing capacity during as of June 30, 2011.
 
 In February 2010, we acquired land use right for a parcel of land totaling 333,335 square meters in Yantai City which we may use to expand our manufacturing capability.
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  Marketing, Sales and Distribution
 
 Bohai’s products are sold either by prescription through hospitals or Over the Counter (OTC) through hospitals, local pharmacies and retail drug store chains. Sales and distribution are managed and executed by approximately 354 sales representatives located in 21 offices throughout China as of June 30, 2011.  These employees are trained in all details of each product and are encouraged to develop strong ties with physicians, hospitals and pharmacies in their local areas.
 
 Our distribution and marketing initiatives for the next several years will be focused on achieving the following goals:
  Expand hospital presence.  We intend to further develop business in over 600 hospitals in provinces we already serve including Shandong, Zhejiang, Jiangsu, Anhui, Sichuan, Hubei and other provinces.  We believe that we will generate additional revenue from the newly developed hospitals in those provinces.  During the fiscal year ended June 30, 2011, we added more than 200 level 2 hospitals and more than 10 new drug store chains to its national network of retail locations in China currently selling our Lung Nourishing Syrup. As a result, we now sells Lung Nourishing Syrup in approximately 1,600 level 2 hospitals and 36 drug store chains across China.Currently, wesell our products to more than 1,680 hospitals and medical centers in more than 20 provinces and special districts in China.
  Expand distribution to the rural market.  We believe that the Chinese government’s expansion in 2009 of national medical insurance reimbursement coverage to the rural population provides us with new and largely untapped markets.  Some of our products, namely Lung Nourishing Syrup, Tongbi Capsules and Tongbi Tablets, have been listed in government’s New National Medical Insurance Catalogue in Shandong and Anhui Province as of November 30, 2009, and we expect to gain a competitive advantage in these newly accessible rural markets.  With the addition of more than 200 level 2 hospitals and 10 drug store chains to our national distribution network during the fiscal year ended June 30, 2011, we expect considerable growth in our sales in the rural market.
 
 Expand prescription medicine sales organization.  A key element of our growth strategy is increased outreach to physicians.  These outreach programs will focus on the eight current pharmaceutical products of ours that are available by prescription only and will typically take place at state-run hospitals where virtually all Chinese citizens obtain their medical care.  Our educational training programs will be designed to inform doctors of the range of our pharmaceutical products including diseases or health/wellness concerns targeted and proper usage of the medicines.
 
 Expand OTC team to drive market share.  Our management intends to accelerate and expand sales of our OTC medicines through promotion and advertising targeting consumers.  The marketing programs will principally utilize television, print advertising and news releases.
 
 Acquisition of Yantai Tianzheng. Part of our ongoing marketing strategy is to consolidate Yantai Tianzheng’s sales team and distribution network with our own.  Together, we sell 19 products to more than 2,700 hospitals and medical centers in China by working with more than 100 distributors and 300 plus sale people.  We believe that the consolidation process for the two companies will take approximately 1 to 2 years to complete.
 
 Competition
 
 China’s domestic pharmaceutical industry is highly competitive, with hundreds of companies vying to reach consumers through more than 100,000 pharmacies.  In some categories in which we compete there are many other companies offering the same competitive products.  The market continues to attract new entrants because the per capita medicine consumption in China is still low, compared to developed countries, and that shows promise for substantial growth.
 
 Competitive factors primarily include price and quality. We believe that we are able to effectively compete in our market segment in China based upon the quality of our product, given our new GMP certified manufacturing facility and our reputation in the market place.
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  Many of our current and potential competitors have significantly longer operating histories and significantly greater managerial, financial, marketing, technical and other competitive resources, as well as greater name recognition, than we do. 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 or adopt more aggressive pricing policies. We cannot assure you 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.
 
 Intellectual Property
 
 We market our products under the trademark “Xian Ge” which is registered with the PRC Trademark Bureau under the State Administration for Industry and Commerce.  Currently, another company is licensed to utilize our registered trademark “Xian Ge”.  We have also received a patent in the PRC for our Lung Nourishing Syrup with its production method for the treatment of Lung Qi Deficiency Cough and Chronic Bronchitis.
 
 Government Regulation
 
 We are subject to many general regulations governing business entities and their behavior in China and in any other jurisdiction in which we have operations. 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.
 
 Our only sales market is presently in China.  We are subject to the Pharmaceutical Administrative Law, which governs the licensing, manufacturing, marketing and distribution of pharmaceutical products in China and sets penalties for violations of the law.  We are also subject to the Food Sanitation Law, which provides for the food sanitation standards to be followed.
 
 Under SFDA guidelines for licensing of pharmaceutical products, all pharmaceutical manufacturers must obtain and maintain GMP Certificate.  We hold a GMP Certificate (No. Lu K0587), which was issued by Shandong Branch of SFDA on June 18, 2009 and a GMP Certificate (No. Lu L0763), which was issued by Shandong Branch of SFDA on November 15, 2010 for Yantai Tianzheng.  Because our manufacturing facility has obtained the National GMP Certificate, we are authorized to produce products in seven modes which are tablets, capsules, granules, syrup, concentrated decoctions, tincture and medical wine.  Such certificate expires on June 14, 2014 for us and on November 14, 2014 for Yantai Tianzheng  and we will seek to renew the certificate before its expiration date.
 
 We hold a Permit for the Production of Medicine (Lu Zb20050330) issued by Shandong Branch of SFDA on January 1, 2006 which allows us to engage in the production of tablets, capsules, granules, syrup, concentrated decoctions, tincture (for oral use) and medical wine.  Such permit expires on December 31, 2010 and was renewed through December 31, 2015.  Yantai Tianzheng  holds a Permit for the Production of Medicine (Lu 20100140) issued by Shandong Branch of SFDA on January 1, 2011 which allows Tianzheng  to engage in the production of tablets, capsules, and granules.  Such permit expires on December 31, 2015.
 
 The Permit for the Production of Medicine and GMP certificates are each valid for a term of five years and must be renewed before their expiration.
 
 We obtained a Drug Approval Number for each of our products in 2004. The first five year valid terms of such Drug Approval Numbers have expired.  We submitted the applications for re-registration on June 29, 2007 which were accepted by SFDA.  We have been advised that the approval processes for these drugs have been recently commenced by the Shandong Branch of SFDA.  During the renewal period, we are permitted to continue manufacturing these drugs as if the renewals had been approved.
  17
 
 The governmental approval process in China’s newly developed health product is as follows: a product sample is sent to a clinical testing agent designated by the Ministry of Health, which conducts extensive clinical testing and examinations to verify if the product has the specified functions as stated by the company producing the product.  A report will be issued by the clinical testing agent confirming or negating such functions. It generally takes approximately six months to one year for the report to be issued.  This report then has to be submitted to a provincial Health Management Commission for approval. A letter of approval issued by such commission will then be submitted to the Ministry of Health for the issuance of a certificate that authorizes the sales and marketing of the product in China. The whole process generally takes one and a half to two years.
 
 Because our subsidiaries WFOE I  and WFOE II are wholly foreign owned enterprises, we are subject to the law on foreign investment enterprises in China, and the foreign company provisions of the Company Law of China, which governs the conduct of our operating subsidiary and its officers and directors. Additionally, we are also subject to varying degrees of regulations and permit system by the Chinese government.
 
 Currently we have not developed a market in U.S. so we believe we are not subject to any of regulations by the U.S. Food and Drug Administration.
 
 Environment Regulation
 
 As of the date of Annual Report, we believe we are in compliance with the Environmental Protection Law of the PRC, as well as applicable local regulations (including the City of Yantai, where both Bohai and Yantai Tianzheng are located).  In addition to compliance with PRC laws 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.
 
 Properties
 
 Our corporate headquarters is located at No. 9 Daxin Road, Zhifu District, Yantai, Shandong Province, China. Under the current PRC laws, land is owned by the state, and parcels of land in rural areas which is known as collective land is owned by the rural collective economic organization. “Land use rights” are granted to an individual or entity after payment of a land use right fee is made to the applicable state or rural collective economic organization. Land use rights allow the holder of the right to use the land for a specified long-term period. We have a land use right, expiring in 2047, for a total of approximately 30,637 square meters of land, on which we maintain our manufacturing facility. We currently have not obtained a land use right certificate for a piece of land located in Xingfu Twelve Village of Zhifu District with the area of 11,222 square meters, on which we maintain our corporate headquarters. In the process of the planning of Yantai City, the usage of the aforesaid land use right has been changed from “industrial use” to “commercial use” and therefore, the approval process for the land use right certificates on five relevant parcels of land including the land occupied by us is suspended until the completion of the planning. We cannot assure you that we will eventually obtain the land use right certificate for this land. If we are asked by the local government to relocate our facility, we believe costs associate with relocation and other related expenses will be reimbursed by the local government.
 
 On February 22, 2010, we entered into a land-use right purchase agreement with Shandong Yantai Bureau of Land and Resources, pursuant to which we acquired the land use right for a parcel of land totaling 333,335 square meters for RMB 97,500,000 (approximately $14,480,284).  As of March 31, 2011, this purchase price was paid in full.
 
 Yantai Tianzheng owns land use right for a total area of 32,884 square meters at its current headquarters located at 9 Tengen Road, Laishan District, Yantai, China 264003. Its manufacturing facility has a total area of 10,908.83 square meters (approximately 117,422 square feet) that also meets or exceeds the latest GMP.
  Employees
 
 Substantially all of our employees are located in China.  As of the date of this Annual Report, we have approximately 847 employees, including approximately 354 sales representatives, operating from 21 offices throughout China.  There are no collective bargaining contracts covering any of our employees.  We believe our relationship with our employees is satisfactory.
  18
 
 We are required to contribute a portion of our employees’ total salaries to the Chinese government’s social insurance funds, including medical insurance, unemployment insurance and job injuries insurance, and a housing assistance fund, in accordance with relevant regulations.  In the last three years, we contributed approximately $85,024, $82,586 and $113,575 for the fiscal years ended June 30, 2009, 2010 and 2011, respectively.  We expect the amount of contribution to the government’s social insurance funds to increase in the future as we expand our workforce and operations.
 
 January 2010 Share Exchange and Private Placement Transaction
 
 We were originally incorporated under the laws of the State of Nevada under the name Link Resources Inc. on January 9, 2008.  Our principal office was in Calgary, Alberta, Canada.  Prior to January 5, 2010, we were a public “shell” company in the exploration stage since our formation and had not yet realized any revenues.  We entered into a Mineral Lease Agreement on April 1, 2008 for two mining claims in Pershing County, Nevada, in an area known as the Goldbanks East Prospect.  We terminated the lease on July 7, 2009.
 
 Share Exchange with Chance High
 
 Pursuant to the Share Exchange Agreement entered into on January 5, 2010, we acquired Chance High and its indirect controlled subsidiary, Bohai, a Chinese company engaged the production, manufacturing and distribution in China of herbal medicines, including capsules and other products, based on Traditional Chinese Medicine.  On January 5, 2010, pursuant to the terms of the Share Exchange Agreement, we acquired all of the Chance High Shares of Chance High from the Chance High Shareholders, and the Chance High Shareholders transferred and contributed all of their Chance High Shares to us.  In exchange, we issued to Chance High Shareholders an aggregate of 13,162,500 newly issued shares of our common stock.
 
 In addition, pursuant to the terms of the Share Exchange Agreement, Zaradic, our former sole officer and director, cancelled a total of 1,500,000 shares of common stock owned by him.  As a further condition of the Share Exchange, effective as of January 5, 2010, Zaradic resigned from all of his positions with our company and Qu, the former principal shareholder and Executive Director of Bohai, was appointed as our President, Chief Executive Officer, Interim Chief Financial Officer, Treasurer and Secretary and also, effective January 16, 2010, as our sole director.  In June 2010, Mr. Qu relinquished the positions of Interim Chief Financial Officer, Treasurer and Secretary and we appointed Gene Hsiao as our Chief Financial Officer.  On July 12, 2010, we appointed three independent directors to our board of directors.
 
 Private Placement and Related Agreements
 
 Securities Purchase Agreement.  On January 5, 2010, we entered into the Securities Purchase with the Investors and Euro Pacific, as representative of the Investors, relating to a private placement by us of 6,000,000 units consisting of Notes and Warrants.  The consummation of the private placement resulted in gross proceeds to us of $12,000,000 and net proceeds of approximately $9,700,000.  Each unit consisted of a $2.00 principal amount, two year convertible Note and a three year Warrant to purchase one share of our common stock at $2.40 per share, subject to certain conditions.  Euro Pacific acted as the lead placement agent and Chardan Capital Markets, LLC acted as co-placement agent of the private placement.
 
 Pursuant to the Securities Purchase Agreement, we have agreed that we shall:
  (a)           Within six (6) months of the closing of the private placement, appoint individuals constituting a majority of “independent” directors (as defined under the Nasdaq Marketplace rules) to the our board of directors, with one such director being designated by Euro Pacific, and with at least two of such directors being fluent in English.  As of the date of this Annual Report, we have fulfilled this agreement.
  19
 
 (b)           Within six (6) months of the closing of the private placement, enter into a 24 month agreement with a new Chief Financial Officer who is reasonably satisfactory to Euro Pacific and who is proficient in: (i) U.S. generally accepted accounting principals; (ii) transactions similar to the ones contemplated by Securities Purchase Agreement; and (iii) U.S. public company listings and the related filing and compliance requirements.  As of the date of this Annual Report, we have fulfilled this agreement.
 
 (c)           Within three (3) months of the closing of the private placement, enter into a 12 month agreement with an investor and public relations firm, the Trilogy Capital Group, and that is reasonably satisfactory to Euro Pacific.  As of the date of this Annual Report, we have fulfilled this agreement when we entered into a one year agreement with Triolgy Capital Partner (which agreement expired at the end of 2010).
 
 Registration Rights Agreement.  In connection with the private placement, we entered into the Registration Rights Agreement with the Investors which set forth the rights of the Investors to have the shares of common stock underlying the Notes and Warrants issued in the private placement registered with the SEC for public resale.  We filed such registration statement with the SEC, and such registration statement was declared effective by the SEC on August 12, 2010.
 
 Pursuant to the Registration Rights Agreement, we agreed to file a registration statement on Form S-1 (“Registration Statement”) by March 5, 2010 (which agreement was fulfilled) and use our commercially reasonable best efforts to have the Registration Statement declared effective by the SEC within 160 days after the required filing deadline to register 100% of the common stock underlying: (i) the Notes, (ii) the Warrants and the Private Placement Warrants, and (iii) any capital stock of the Company issued or issuable, with respect to the registered shares of common stock as a result of any stock split, stock dividend, recapitalization, exchange or similar event or otherwise, without regard to any limitations on exercises of the Warrants.
 
 The Registration Rights Agreement provides that if we fail to file, obtain and maintain effectiveness of Registration Statement due to “filing failure” or “maintenance failure” (each as defined in the Registration Rights Agreement), we shall pay to Investors, distributed pro rata, equal to one percent (1%) of the aggregate purchase price paid for the Notes and Warrants (the “Registration Delay Payments”), provided that in no event shall the aggregate amount of Registration Delay Payments exceed, in the aggregate, six percent (6%) of such aggregate purchase price, or $720,000.
 
 Securities Escrow Agreement.  Also in connection with the private placement, we entered into the Securities Escrow Agreement with Euro Pacific, as representative of the Investors, our principal shareholder, Glory Period, and the Escrow Agent.  Pursuant to the Securities Escrow Agreement, Glory Period has pledged and deposited a stock certificate representing 1 million shares of our common stock (the “Escrow Shares”) into escrow in order to provide security to the Investors in the event of an occurrence of an event of default under the Notes.  Upon the earlier to occur of the full repayment of all amounts due to the Investors under the Notes or the conversion of fifty percent of the principal face value of Notes into shares of common stock, the Investors’ rights in and to the Escrow Shares shall terminate.  Glory Period is controlled by Qu through certain contractual relationships described elsewhere in this Annual Report.
 
 Closing Escrow Agreement.Pursuant to the Closing Escrow Agreement that we entered into in connection with the private placement on December 10, 2009, we placed a total of $240,000 of proceeds from the private placement (the “Holdback Amount”) with the Escrow Agent.  The Holdback Amount represents an amount sufficient to satisfy the payment to the Investors of one quarterly interest payment due on the aggregate principal amount of all Notes issued in the private placement.  If, subject to certain conditions and after applicable notice and cure periods, an event of default is declared by Euro Pacific with respect to our failure to make a quarterly interest payment to Investors, the Escrow Agent shall disburse such portion of the Holdback Amount to the Investors, and we shall be obligated to deposit additional amounts equal to the Holdback Amount with Escrow Agent.  At such time as seventy-five percent of the aggregate shares of common stock underlying the Notes have been issued upon conversion of the Notes, all remaining funds of the Holdback Amount shall promptly be disbursed to us.
  20
 
 Certain Rights of Euro Pacific.  From and after the closing of the private placement, we have agreed with Euro Pacific that if we decide to engage any placement agent, underwriter or investment bank on a fee basis in connection with any private placement of our securities or our affiliates and executive officers (a “Subsequent Offering”) for a period of twelve (12) months from the date of the closing of the private placement, we shall give prompt written notice of such an event to Euro Pacific, and Euro Pacific shall be entitled to a 5 day right of first refusal, beginning on the day Euro Pacific receives such written notice from us of such Subsequent Offering, to act as agent or manager for such private placement.  In addition, Euro Pacific shall be entitled 10.0% of the gross proceeds received by us with respect to any equity or equity-linked financing transactions consummated within twelve (12) months from the closing of the private placement with any investor introduced to is by Euro Pacific.
  21
  Contractual Arrangements with Bohai and its Shareholders
  On January 9, 2008, our company was incorporated under the laws of the State of Nevada under the name Link Resources Inc. On July 2, 2009, we established our wholly owned subsidiary, Chance High International Limited., in Hong Kong. Other than the Company equity interest in Chance High, the Company does not own any assets or conduct any operations. On November 23, 2009, Chance High established one wholly owned subsidiary, Yantai Shencaojishi Pharmaceuticals Co., Ltd. (“WFOE” or “Shencaojishi”) in Yantai, Shandong Province of PRC. Other than Shencaojishi, Chance High does not own any assets or conduct any operations. Shencaojishi was formed to operate Yantai Bohai Pharmaceuticals Group, Inc. (the “Domestic Company” or “Yantai Bohai”) by contract.
  On December 7, 2009, the WFOE entered into a series of variable interest entity contractual agreements (the “VIE Agreements”) with Bohai and its three shareholders, including Mr. Hongwei Qu, Jianwei Wang and Lu Liang (the “Bohai Shareholders”).  Pursuant to the VIE Agreements, WFOE effectively assumed management of the business activities of Bohai and has the right to appoint all executives and senior management and the members of the board of directors of Bohai.  The VIE Agreements are comprised of a series of agreements, including a Consulting Services Agreement, Operating Agreement and Proxy Agreement, through which WFOE has the right to advise, consult, manage and operate Bohai for an annual fee in the amount of Bohai’s yearly net profits after tax.  Additionally, Bohai’s Shareholders have pledged their rights, titles and equity interest in Bohai as security for WFOE to collect consulting and services fees provided to Bohai through an Equity Pledge Agreement.  In order to further reinforce WFOE’s rights to control and operate Bohai, Bohai’s Shareholders granted WFOE an exclusive right and option to acquire all of their equity interests in Bohai through an Option Agreement.  Accordingly, we have consolidated Bohai’s historical financial results in our financial statements as a variable interest entity pursuant to U.S. GAAP following the date of the agreements and combined such results prior to the date of the agreements.
 
 We have been advised by PRC legal counsel AllBright Law Offices, in an opinion dated December 31, 2009, that: (1) our inner-PRC shareholding structure complies with PRC laws and regulations; (2) the contractual arrangements between the WFOE, Chance High, Bohai and Bohai’s Shareholders are valid and binding on all parties to these arrangements and do not violate relevant PRC laws or regulations; (3) the each of the WFOE and Bohai has the requisite corporate power to own, lease and operate its properties, to enter into contracts and to conduct its business and (4) each of the WFOE and Bohai is qualified to do business in the respective jurisdiction of its establishment.
 
 Equity Interest Pledge Agreement.The WFOE and Bohai Shareholders have entered into Equity Interest Pledge Agreements, pursuant to which each Bohai Shareholder has pledged all of his shares of Bohai to the WFOE in order to guarantee cash-flow payments under the applicable Consulting Services Agreement. The Equity Pledge Agreement further entitles the WFOE to collect dividends from Bohai during the term of the pledge.
 
 Consulting Service Agreement.Bohai and the WFOE has entered into a Consulting Services Agreement, which provides that the WFOE will be the exclusive provider of technology services to Bohai and Bohai will pay all of its net income based on the quarterly financial statements to the WFOE for such services.  Any such payment from the WFOE to the Company would need to comply with applicable Chinese laws affecting payments from Chinese companies to non-Chinese companies.  See “Risk Factors – Risks Associated With Doing Business in China.”
 
 Operating Agreement. Pursuant to the operating agreement among the WFOE, Bohai and each of Bohai Shareholder, the WFOE provides guidance and instructions on Bohai’s daily operations and financial affairs. The Bohai Shareholders must designate the candidates recommended by the WFOE as their representatives on their respective boards of directors. The WFOE has the right to appoint senior executives of Bohai. In addition, the WFOE agrees to guarantee Bohai’s performance under any agreements or arrangements relating to Bohai’s business arrangements with any third party. Bohai, in return, agrees to pledge its accounts receivable and all of its assets to the WFOE. Moreover, Bohai agrees that without the prior consent of the WFOE, Bohai will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of its assets or intellectual property rights in favor of a third party or transfer of any agreements relating to its business operation to any third party.
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 Item 1A. Risk Factors.
 
 RISK FACTORS
 
 You should carefully consider the risks described below as well as other information provided to you in this Annual Report, including information in the section of this document entitled “Cautionary Note Regarding Forward Looking Statements.”  Our business, operations and financial condition are subject to various significant risks.  Some of these risks are described below and you should take these risks into account in making a decision to invest in our securities.  If any of the following risks actually occurs, we may not be able to conduct our business as currently planned and our business, financial condition or results of operations could be seriously harmed.  In that case, the market price of our common stock could decline and you could lose all or part of your investment in our securities.
  Risks Related to Our Business
  Our limited operating history may not serve as an adequate basis to judge our future prospects and results of operations.
 
 Our limited operating history in the traditional Chinese herbal medicines industry may not provide a meaningful basis for evaluating our business.  Bohai entered into its current line of business in September 2004.Although Bohai’s revenues have grown rapidly since its inception, we cannot guarantee that we will maintain revenue growth or profitability or that we will not incur net losses in the future.  We will continue to encounter risks and difficulties that companies at a similar stage of development frequently experience, including the potential failure to:
 
 ·
obtain sufficient working capital to support our expansion;
 
 ·
maintain or protect our intellectual property;
 
 ·
maintain our proprietary technology;
 
 ·
expand our product offerings and maintain the quality of our products;
 
 ·
manage our expanding operations and continue to fill customers’ orders on time;
 
 ·
maintain adequate control of our expenses allowing us to realize anticipated revenue growth;
 
 ·
implement our product development, marketing, sales and acquisition strategies and adapt and modify them as needed;
 
 ·
integrate any future acquisitions; and
 
 ·
anticipate and adapt to changing conditions in the Chinese herbal medicines industry resulting from changes in government regulations, mergers and acquisitions involving our competitors, technological developments and other significant competitive and market dynamics.
 
 If we are unable to address any or all of the foregoing risks, our business may be materially and adversely affected.
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  We will likely need to raise additional funds in the future to pay or debts and grow our business, which funds may not be available on acceptable terms or at all, and, without additional funds, we may not be able to repay our convertible notes due in January 2012, fund our remaining obligations under our Yantai Tianzheng acquisition, or maintain or expand our business.
 
 We believe that our cash on hand, together with cash generated from our operations, will be sufficient to fund our projected operations for at least the next 12 months.  It is likely however that in the future we will require substantial funds in order to:
 
 ·
pay down the principal and interest on our convertible notes, which are due January 5, 2012, the principal amount of which is $10,450,000 as of the date of this Annual Report;
 
 ·
fund our remaining obligations under our Yantai Tianzheng acquisition, which amounts to $29,000,000 as of the date of this Annual Report;
 
 ·
fund ongoing operating expenses;
 
 ·
fund our plans to continue the development of our  manufacturing, marketing and sales capabilities; and
 
 ·
consider and fund strategic acquisitions in the fragmented TCM market in China; and
 
 ·
cover public company costs.
 
 Without enough funds, we may not be able to meet these goals.  We may seek additional funding through public or private financing or through collaborative arrangements with strategic partners.
 
 You should also be aware that in the future:
 
 ·
We cannot be certain that additional capital will be available on favorable terms, if at all;
 
 ·
Any available additional financing may not be adequate to meet our goals; and
 
 ·
Any equity financing would result in dilution to our shareholders.
 
 If we cannot raise additional funds when needed, or on acceptable terms, we may not be able to effectively execute our growth strategy, take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements.  In addition, we may be required to scale back or discontinue our production and development program, or obtain funds through strategic alliances that may require us to relinquish certain rights.
 
 We have significant short-term debt obligations, which mature in less than one year.  Our inability to extend the maturities of, or to refinance, this debt could result in defaults, and in certain instances, foreclosures on our assets.  Moreover, we may be unable to obtain financing to fund ongoing operations and future growth.
 
 We currently depend on short-term bank loans and net revenues to meet our short-term cash requirements.  As of June 30, 2011, our total bank debt outstanding was $920,554 which carries a maturity period of one year, while the short-term and revolving nature of these credit facilities is common in China.  The majority of this debt is guaranteed by third-parties, and a portion is secured by fixed assets.  In China, short-term bank loans generally mature in one year or less and contain no specific renewal terms.  However, it is customary practice for banks and borrowers to negotiate roll-overs or renewals of short-term borrowings on an on-going basis shortly before they mature.  Although we have renewed our short-term borrowings in the past, we cannot assure you that we will be able to renew these loans in the future as they mature.  If we are unable to obtain renewals of these loans or sufficient alternative funding on reasonable terms from banks or other parties, we will have to repay these borrowings with the cash on our balance sheet or cash generated by our future operations, if any.
  24
 
 Moreover, we cannot assure you that our business will generate sufficient cash flow from operations to repay these borrowings.  Failure to obtain extensions of the maturity dates of, or to refinance, these obligations or to obtain additional equity financing to meet these debt obligations would result in an event of default with respect to such obligations and could result in the foreclosure on the collateral.  The sale of such collateral at foreclosure would significantly disrupt our ability to produce products for our customers in the quantities required by customer orders or deliver products in a timely fashion, which could significantly lower our revenues and profitability.
 
 In addition, we may be exposed to changes in interest rates.  If interest rates increase substantially, our results of operations could be adversely affected.
 
 We have significant payments that we are required to make in connection with our acquisition of Yantai Tianzheng.
 
 On August 8, 2011, through WFOE II, our wholly owned subsidiary and a company formed under the laws of China, we entered into a Share Purchase Agreement (the “SPA”) pursuant to which WFOE II acquired, from the three individual holders thereof, one hundred percent (100%) of the outstanding equity interests (the “Shares”) in Yantai Tianzheng.
 
 Pursuant to the SPA, the purchase price to be paid by WFOE II for the Shares is $35,000,000 in the aggregate.  Pursuant to the SPA, the purchase price is payable in cash in four installments within 18 months after the execution of the SPA.  As of the date of this Annual Report, we have paid the initial installment of $6,000,000.  The remaining three installments will be due within 6 months, 12 months, and 18 months after the execution of the SPA in the amount of $12 million, $12 million, and $5 million, respectively. In the event that Yantan Nirui fails to pay any of the installments when due (such date, the “Conversion Date”), such outstanding installment will be automatically converted into a two-year term loan owed by WFOE II to the Shareholders (a “Conversion Loan”), with interest accruing on any unpaid portion of such Conversion Loan from its due date until such installment is paid in full at the rate of six percent (6%) per annum.  As long as such interest payments are made on a timely basis and the outstanding principal of such Conversion Loan and interest are satisfied in full within 2 years after the Conversion Date, WFOE II will not be deemed in breach or default under the SPA and will continue to possess full control and legal ownership over the Shares.  Furthermore, in the event of non-payment by WFOE II of any principal or interest under the loans as described above, or in the event of any other breach or default by WFOE II of the SPA, the Tianzheng Shareholders remedies against Yantai Nurui are limited solely to monetary damages, and in all instances the Shareholders will have no right to reclaim ownership of the Shares or demand that WFOE II in any way revert control or legal ownership over the Shares back to the Shareholders.
 
 We currently believe that we will generate sufficient cash flow from operations and have access to the capital funding (either through debt or equity issuances) necessary to meet our payment requirements under the SPA.  However, there is a significant risk that we may not generate sufficient cash flow from operations or otherwise have access to financing on favorable terms, or at all.  Failure to make the installment payments and, subsequently, the resulting Conversion Loan payments when due would result in an event of default with respect to such obligations and could result in substantial monetary damages and would likely materially disrupt our Yantai Tianzheng business, which could cause a material deterioration in our financial condition or operating results.
 
 We have not yet developed comprehensive independent corporate governance.
 
 Although we have formed audit, compensation, or nominating committees of our board of directors, we are inexperienced in formal U.S. corporate governance procedures.  A lack of functioning independent controls over our corporate affairs may result in potential or actual conflicts of interest between Mr. Qu and our shareholders.  We presently have no policy to resolve such conflicts.  The absence of customary standards of corporate governance may leave our shareholders without protections against interested director transactions, conflicts of interest, if any, and similar matters and any potential investors may be reluctant to provide us with funds necessary to expand our operations.
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  We have been heavily dependent on sales of certain key products.
 
 Four of our products, namely Tongbi Capsules, Tongbi Tablets, Lung Nourishing Syrup and Shangtongning Tablets represented approximately 27.41%, 14.37%, 26.23%, and 8.66%, respectively, of total sales as of June 30, 2011. We expect that a significant portion of our future revenue will continue to be derived from sales of these four products.  If one or more of these products were to become subject to a problem such as loss of Certificates of Protected Variety of Traditional Chinese Medicine, unexpected side effects, regulatory proceedings, publicity adversely affecting user confidence or pressure from competing products, or if a new, more effective treatment should be introduced, the negative impact on our revenues could be significant.  We held the Certificates of Protected Variety of Traditional Chinese Medicine (Grade Two) issued by State Food and Drug Administration of China (“SFDA”) for Tongbi Capsules and Shangtongning Tablets which gave exclusive or near-exclusive rights to manufacture and distribute these two medicines.  These certificates expired in September 2009, and the SFDA approved our request to extend the protection period for Tongbi Capsules to September 13, 2016. Fangfengtongsheng granule is in the process of applying protection status and its application for protected status was received by SFDA on June 30, 2010.  Zhengxintai capsule is in the processing of renewal the protected status and its renewal application was received by SFDA on February 26, 2010. We cannot assure you that we will be granted or will be able to renew the Certificate of Protected Variety of Traditional Chinese Medicine in the future and our failure to obtain such protection, or the loss of such protection, will have a material adverse effect on our revenues.  If we are unable to obtain or maintain such approvals, these products can be manufactured and sold by other pharmaceutical manufacturers in China once the relevant protection periods lapse, which would increase our competition and potentially have an adverse effect on our sales.
  We may not be able to adequately protect our intellectual property, which could cause us to be less competitive and negatively impact our business.
  We regard our trademarks, trade secrets, patents and similar intellectual property as critical to our success.  We hold the trademark “Xian Ge” registered with the PRC Trademark Bureau under the State Administration for Industry and Commerce with a valid term effective through February 23, 2013.  We have received a patent in the PRC for Lung Nourishing Syrup with its production method for the treatment of Lung-qi Deficiency Cough and Chronic Bronchitis.  If we are unable to obtain or maintain registered intellectual property protections for our proprietary products or methods, these products or methods could be infringed upon, which could materially adversely affect our business.
 
 We rely on trademark, patent and trade secret law, as well as confidentiality agreement with certain of our employees to protect our proprietary rights.  For senior managers, we include a standard confidentiality clause into the employment agreement to prevent them from disclosing the formula or processing procedure to outside parties. No assurance can be given that our intellectual property will not be challenged, invalidated, infringed or circumvented, or that our intellectual property rights will provide competitive advantages to us.  Any material impairment of our intellectual property rights could have a material adverse effect on our business.
 
 The availability of counterfeit versions of our products could adversely affect our sales volume, revenue and profitability and brand value.
 
 The availability of sales of counterfeits of our products in China could adversely impact our sales and potentially damage the value and reputation of our brands.  For example, we discovered evidence of a counterfeit Tongbi Capsule sold in China which we believe infringes on our intellectual property rights in 2010. We have addressed this situation with applicable PRC authorities and do not believe it will adversely affect our company, but similar situations may arise in the future which could adversely impact our sales, profitability and brand value.  We are in the process of applying a patent for Tongbi Capsule, but no assurances can be given that such patent will be granted.  Additionally, consumers who mistake counterfeit Tongbi Capsules or counterfeits of our other products for our products may attribute quality and efficacy deficiencies in the counterfeit product to our brands and discontinue purchasing our brands, which would have an adverse effect on our sales and profitability.
  26
  We face competition in the pharmaceutical market in the PRC and such competition could cause our sales revenue and profits to decline.
 
 According to SFDA in China, there were approximately 5,071 pharmaceutical manufacturing companies in the PRC as of the end of June 2004, of which approximately 3,237 manufacturers obtained certificates of Good Manufacturing Practices Certification (“GMP”).  After GMP certification became a mandatory requirement on July 1, 2004, approximately 1,834 pharmaceutical manufacturers were forced to cease production.  Only the 3,237 pharmaceutical manufacturers with GMP certifications may continue their manufacturing operations.  As of the end of 2010, there were 7,166 enterprises manufacturing medicines and formulation in China.  The certificates, permits, and licenses required for pharmaceutical operation in the PRC create a potentially significant barrier for new competitors seeking entrance into the market.  Despite these obstacles, we face competitors that will attempt to create, or are already marketing, products in the PRC that are similar to ours.  Many of our current and potential competitors have significantly longer operating histories and significantly greater managerial, financial, marketing, technical and other competitive resources, as well as greater name recognition, than we do.  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 or adopt more aggressive pricing policies.  We cannot assure you 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.
 
 Our business depends and will depend substantially on the continuing efforts of our present and future executive officers, and our business may be severely disrupted if we lose, are unable to obtain or unable to replace their services.
 
 Our future prospects depend substantially on the continued services of our President, Chief Executive Officer and Chairman of the Board, Mr. Qu.  We have no employment agreement with Mr. Qu and do not maintain key man life insurance on Mr. Qu’s life.  We also have other corporate officers and key employees, and if Mr. Qu or one or more of our future executive officers or key employees are unable or unwilling to continue in their positions, we may not be able to replace them readily, if at all.  Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain new officers.  In addition, if any of our executives joins a competitor or forms a competing company, we may lose some of our customers.
 
 Our business and growth will suffer if we are unable to hire and retain key personnel that are in high demand.
  Our future performance depends on our ability to attract and retain highly skilled chemists, pharmaceutical engineers, technical, marketing and sales personnel, especially qualified personnel for our operations in China.  Qualified individuals are in high demand in China, and there are insufficient experienced personnel to fill the demand.  Therefore, we may not be able to attract or retain the personnel we need to succeed.  Our business development would be hindered if we lost the services of some key personnel.
  Our business is highly dependent on continually developing or acquiring new and advanced products, technologies, and processes and failure to do so may cause us to lose our competitiveness in the pharmaceutical industry and may cause our profits to decline.
 
 To remain competitive in the pharmaceutical industry, it is important to continually develop new and advanced products, technologies and processes.  There is no assurance that our competitors’ new products, technologies and processes will not render our company’s existing products obsolete or non-competitive.  Our company’s competitiveness in the pharmaceutical market therefore relies upon our ability to enhance our current products, introduce new products, and develop and implement new technologies and processes.  Our company’s failure to technologically evolve and/or develop new or enhanced products may cause us to lose our competitiveness in the pharmaceutical industry and may cause our profits to decline.  It is likely that our efforts to grow our products lines will be focused on acquisitions of such products from third parties.  There are many risks attendant to the acquisition of assets or companies, including availability, pricing, competition and, if acquisitions are consummate, integration.  If we are unable to so acquire and integrate new products, our revenue and profitability may suffer.
  27
  Our research and development may be costly and/or untimely, and there are no assurances that our research and development will either be successful or completed within the anticipated timeframe, if ever at all.
 
 We do not presently rely on research and development activities as our business is focused on expanding sales of our existing products.  However, in the future, the research and development of new products may play an important role for our company.  Development of new products requires significant research, development and clinical testing efforts, and we currently have limited resources to devote to and limited capabilities to conduct the development of new products.  We have only one full-time employee who is engaged in research and development, so we mainly dependent on a third-party, Yantai Tianzheng Medicine Research and Development Co., Ltd., to perform the limited amount of research and development that we undertake.  If research and development activities become more important for us, and if we or third parties that we retain are unable to perform research and development successfully, our business and results of operations could be negatively impacted.
 
 As of the date of this Annual Report, we have two products, namely Forsythia Capsule and Fern Injection, under research and development.  The research and development of new products is costly and time consuming, and there are no assurances that our research and development of new products will either be successful or completed within the anticipated time frame, if ever at all.  There are also no assurances that if the product is developed, that it will lead to actual commercialization and sales.
 
 The commercial performance of our products depends upon the degree of market acceptance among the medical community and failure to attain market acceptance among the medical community may have an adverse impact on our operations and profitability.
 
 The commercial performance of our products depends upon the degree of market acceptance among the medical community, such as hospitals and physicians.  Even if our products are approved by SFDA, and even if our products are eligible for reimbursement under Chinese national medical insurance programs, there is no assurance that physicians will prescribe or recommend our products to patients.  Furthermore, a product’s prevalence and use at hospitals may be contingent upon our relationship with the medical community.  The acceptance of our products among the medical community may depend upon several factors, including but not limited to, the product’s acceptance by physicians and patients as a safe and effective treatment, cost effectiveness, potential advantages over alternative treatments, and the prevalence and severity of side effects.  Failure to attain market acceptance among the medical community may have an adverse impact on our operations and profitability.
 
 We may not be able to obtain the regulatory approvals or clearances that are necessary to commercialize our products.
 
 The PRC and other countries impose significant statutory and regulatory obligations upon the manufacture and sale of pharmaceutical products.  Each regulatory authority typically has a lengthy approval process in which it examines pre-clinical and clinical data and the facilities in which the product is manufactured.  Regulatory submissions must meet complex criteria to demonstrate the safety and efficacy of the ultimate products. Addressing these criteria requires considerable data collection, verification and analysis. We may spend time and money preparing regulatory submissions or applications without assurances as to whether they will be approved on a timely basis or at all.
 
 Our product candidates, some of which are currently in the early stages of development, will require significant additional development and pre-clinical and clinical testing prior to their commercialization. These steps and the process of obtaining required approvals and clearances can be costly and time-consuming. If our potential products are not successfully developed, cannot be proven to be safe and effective through clinical trials, or do not receive applicable regulatory approvals and clearances, or if there are delays in the process:
 
 ·
the commercialization of our products could be adversely affected;
 
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any competitive advantages of the products could be diminished; and
 
 ·
revenue or collaborative milestones from the products could be reduced or delayed.
  28
 
 Governmental and regulatory authorities may approve a product candidate for fewer indications or narrower circumstances than requested or may condition approval on the performance of post-marketing studies for a product candidate. Even if a product receives regulatory approval and clearance, it may later exhibit adverse side effects that limit or prevent its widespread use or that would force us to withdraw the product from the market.
 
 Any marketed product and its manufacturer will continue to be subject to strict regulation after approval. Results of post-marketing programs may limit or expand the further marketing of products. Unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including its withdrawal from the market and possible civil actions.
 
 In manufacturing our products we will be required to comply with applicable good manufacturing practices regulations, which include requirements relating to quality control and quality assurance, as well as the maintenance of records and documentation. If we cannot comply with regulatory requirements, including applicable good manufacturing practice requirements, we may not be allowed to develop or market the product candidates. If we or our manufacturers fail to comply with applicable regulatory requirements at any stage during the regulatory process, we may be subject to sanctions, including fines, product recalls or seizures, injunctions, refusal of regulatory agencies to review pending market approval applications or supplements to approve applications, total or partial suspension of production, civil penalties, withdrawals of previously approved marketing applications and criminal prosecution.
 
 Our current and future products may have inadvertent and/or harmful side effects which would expose us to the risks of litigation and a loss of revenue.
 
 All medicines have certain side effects.  Although all of our medicines sold on market have passed proper testing and are approved by SFDA, the products may still inadvertently adverse effects on the health of the consumers. If such side effect is identified after marketing and sale of the products, the products may be required to be withdrawn from the market, or have a change in labeling. If a product liability claim is brought against us, it may, regardless of merit or eventual outcome, result in damage to our reputation, breach of contracts with consumers, decreased demand for our products, costly litigation and loss of revenue.
 
 Natural disasters, weather conditions and other environmental factors affect our raw material supply, and a reduction in the quality or quantity of our herb supplies may have material adverse consequences on our financial results.
 
 Our business may be adversely affected by weather and environmental factors beyond our control, such as natural disasters and adverse weather conditions.  The production of our products depends on the availability of raw materials, a significant portion of which are herbs.  These herbs tend to be very sensitive crops, which can be readily damaged by harsh weather, by disease, and by pests.  If our suppliers’ crops are destroyed by drought, flood, storm, blight, or the other woes of farming, we will not be able to meet the demands of our customers, which will have a material adverse effect on our business and financial condition and results.
 
 Our certificates, permits, and license are subject to governmental control and renewal, and the failure to obtain renewal would cause all or part of our operation to be suspended and have a material adverse effect on our financial condition.
 
 We are subject to various PRC laws and regulations pertaining to the pharmaceutical industry.  We have obtained certain certificates, permits, and licenses required for the operation of a pharmaceutical enterprise and the manufacturing and distribution of pharmaceutical products in the PRC.  Some of the permits and license have expired or are about to expire.  We hold a Permit for the Production of Medicine (Lu Zb20050330) issued by Shandong Branch of SFDA on January 1, 2006 which allows us to engage in the production of tablets, capsules, granules, syrup, concentrated decoctions, tincture (for oral use) and medical wine.  Such permit, as renewed, expires on December 31, 2015.  We also hold a GMP Certificate (No. Lu K0587) issued by Shandong Branch of SFDA on June 18, 2009, the scope of inspection of which is tablets, capsules, granules, syrup, concentrated decoctions, tincture and medical wine.  Such certificate expires on June, 17, 2014.  The Permit for the Production of Medicine and GMP certificates are each valid for a term of five years and must be renewed before their expiration.  We hold a Drug Approval Number (“DAN”) for each of our products.  Our license to produce medical wine, as renewed, has a term valid through December 31, 2015.
  29
 
 During the application or renewal process for our licenses and permits, we will be evaluated and re-evaluated by the appropriate governmental authorities and must comply with the prevailing standards and regulations, which may change from time to time.  In the event that we are not able to obtain or renew the certificates, permits and licenses, all or part of our operations may be suspended by the government, which would have a material adverse effect on our business and financial condition.  Furthermore, if escalating compliance costs associated with governmental standards and regulations restrict or prohibit any part of our operations, it may adversely affect our results of operations and profitability.
 
 We held the Certificates of Protected Variety of Traditional Chinese Medicine (Grade Two) (the “Certificate of Protection”) issued by SFDA for two of our products, Tongbi Capsules and Shangtongning Tablets. The protection periods for both Tongbi Capsules and Shangtongning Tablets expired in September 2009.  We submitted application to extend the protection period for Tongbi Capsules to extend such protection period on March 12, 2009 and such protection period was extended till September 13, 2016.  We have decided not to submit extension application of Shangtongning Tablets, because the SFDA will not approve a Certificate of Protection for Shangtongning Tablets or any other products that are currently produced by more than three manufacturers in China according to applicable Chinese SFDA regulations.  Fangfengtongsheng granule is in the process of applying protection status and its application for protected status was received by SFDA on June 30, 2010. Zhengxintai capsule is in the processing of renewal the protected status and its renewal application was received by SFDA on February 26, 2010.  The loss of the Certificate of Protection for our product Shangttongning Tablets, may grant other manufactures the right to produce similar products, which would result in the loss of competitive advantage and could adversely impact our sales results.
 
 Our failure to fully comply with PRC labor laws, including laws relating to social insurance, may expose us to potential liability and increased costs.
 
 Companies operating in China must comply with a variety of labor laws, including certain pension, health insurance, unemployment insurance and other welfare-oriented payment obligations.  Our failure to comply with these laws could have a material adverse effect on our business.  For example, we are currently paying social insurance for our 206 full-time employees.  We also currently have approximately 354 sales representatives that we believe we are not required to pay social insurance for as these sales representatives are not legally employees of ours, but are rather independent contractors. We have not paid social insurance for 287 of our full-time employees whose personal identification files cannot be transferred to us since they are not registered residents in Yantai, Shandong Province, and as an alternative we have paid these employees compensation included in their monthly salary with an amount equals to the amount of monthly social insurance that we are required to pay and the employees could pay the social insurance by themselves.  We believe these employees have been covered by social insurance and we are not required to make any contributions to the government in addition to the amount we have paid to these employees.  However, our interpretation of these requirements may be wrong, and the PRC regulatory authorities may not take the same view as we do on this subject.  If the PRC regulatory authorities take the view that we are required to pay social insurance for our independent contractors or other employees, our failure to make previous payments may be in violation of applicable PRC labor laws and we cannot assure you that PRC governmental authorities will not impose penalties on us for failure to comply.  In addition, in the event that any current or former employee files a complaint with the PRC government, we may be subject to making up the social insurance payment obligations as well as paying administrative fines.  The total cost of these payments and any related fines or penalties could be very significant and could have a material adverse effect on our working capital.
 
 In addition, the new PRC Labor Contract Law took effect January 1, 2008 and governs standard terms and conditions for employment, including termination and lay-off rights, contract requirements, compensation levels and consultation with labor unions, among other topics.  In addition, the law limits non-competition agreements with senior management and other employees who have access to confidential information to two years and imposes restrictions or geographical limits.  This new labor contract law will increase our labor costs, which could adversely impact our results of operations.
  30
 
 We are subject to PRC government price control of drugs which may limit our profitability and even cause us to stop manufacturing certain products.
 
 The State Development and Reform Commission of the PRC (“SDRC”) and the price administration bureaus of the relevant provinces of the PRC in which the pharmaceutical products are manufactured are responsible for the retail price control over our pharmaceutical products.  The SDRC sets the price ceilings for certain pharmaceutical products in the PRC. All of our products except those under the protection periods are subject to such price controls as of the date of this Memorandum and we prices our medicines well under government-mandated caps. There is no assurance that whether our other products will remain unaffected by the price control.  Where our products are subject to a price ceiling, we will need to adjust the product price to meet the requirement and to accommodate for the pricing of competitors in the competition for market shares.  The price ceilings set by the SDRC may limit our profitability, and in some instances, such as where the price ceiling is below production costs, may cause us to stop manufacturing certain products which may adversely affect our results of operations.
 
 Because we may not be able to obtain business insurance in the PRC, we may not be protected from risks that are customarily covered by insurance in the United States.
 
 Business insurance is not readily available in the PRC.  To the extent that we suffer a loss of a type which would normally be covered by insurance in the United States, such as product liability and general liability insurance, we would incur significant expenses in both defending any action and in paying any claims that result from a settlement or judgment.  We have not obtained fire, casualty and theft insurance, and there is no insurance coverage for our raw materials, goods and merchandise, furniture and buildings in China.  Any losses incurred by us will have to be borne by us without any assistance, and we may not have sufficient capital to cover material damage to, or the loss of, our production facility due to fire, severe weather, flood or other cause, and such damage or loss would have a material adverse effect on our financial condition, business and prospects.
 
 We may be subject to product liability claims, for which we have no insurance.
 
 We may produce products which inadvertently have an adverse pharmaceutical effect on the health of individuals.  Existing laws and regulations in China do not require us to maintain third party liability insurance to cover product liability claims.  However, if a product liability claim is brought against us, it may, regardless of merit or eventual outcome, result in damage to our reputation, breach of contracts with our customers, decreased demand for our products, costly litigations, product recalls, loss of revenue, and our inability to commercialize some products.
 
 Our indemnification obligations could adversely affect our business, financial condition and results of operations.
 
 Our governing documents require us to indemnify our current and former directors, officers, employees and agents against most actions of a civil, criminal, administrative or investigative nature.  Generally, we are required to advance indemnification expenses prior to any final adjudication of an individual’s culpability.  The expense of indemnifying our current and former directors, officers and employees and agents in their defense or related expenses as a result of any actions related to the internal investigation and financial restatement may be significant and in excess of any insurance coverage we may have.  As such, there is a risk that our indemnification obligations could divert needed financial resources and may adversely affect our business, financial condition and results of operations.
  31
 
 Potential environmental liability could have a material adverse effect on our operations and financial condition.
 
 As a manufacturer, we are subject to various Chinese environmental laws and regulations on air emission, waste water discharge, solid wastes and noise.  We are in the process of applying for Pollution Discharge Permit, other than that we believe that our operations are in substantial compliance with current environmental laws and regulations. We cannot assure you that we may not be able to comply with these regulations at all times as the Chinese environmental legal regime is evolving and becoming more stringent.  Therefore, if the Chinese government imposes more stringent regulations in future, we may have to incur additional and potentially substantial costs and expenses in order to comply with new regulations, which may negatively affect our results of operations.  Furthermore, no assurance can be given that all potential environmental liabilities have been identified or properly quantified or that any prior owner, operator, or tenant has not created an environmental condition unknown to us.  If we fail to comply with any of the present or future environmental regulations in any material aspects, we may suffer from negative publicity and be subject to claims for damages that may require us to pay substantial fines or have our operations suspended or even be forced to cease operations.
 
 Risks Relating to the Our Corporate Structure
 
 Our corporate structure, in particular the VIE Agreements, are subject to significant risks, as set forth in the following risk factors.
 
 The PRC government may determine that the VIE Agreements which we utilize to control our operating subsidiary Bohai are not in compliance with applicable PRC laws, rules and regulations and that they are therefore unenforceable.
 
 In the PRC it is widely understood that foreign invested enterprises are forbidden or restricted to engage in certain businesses or industries which are sensitive to the economy.  As we intend to centralize our management and operation in the PRC without being restricted to conduct certain business activities which are important for our current or future business but are restricted or might be restricted in the future, we believe our VIE Agreements will be essential for our business operation.  In order for WFOE to manage and operate our business through Bohai in the PRC, the VIE Agreements were entered into under which almost all the business activities of Bohai are managed and operated by WFOE and almost all economic benefits and risks arising from the business of Bohai are transferred to WFOE.
 
 There are risks involved with the operation of Bohai under the VIE Agreements.  We have been advised by PRC legal counsel that if the PRC government determines the VIE Agreement used to control the operating company to be unenforceable as they circumvent the PRC restrictions relating to foreign investment restrictions, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:
 
 ·
imposing economic penalties;
 
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discontinuing or restricting the operations of WFOE or Bohai;
 
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imposing conditions or requirements in respect of the VIE Agreements with which WFOE may not be able to comply;
 
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requiring us to restructure the relevant ownership structure or operations;
 
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taking other regulatory or enforcement actions that could adversely affect our business; and
 
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revoking the business license and/or the licenses or certificates of WFOE, and/or voiding the VIE Agreements.
 
 Any of these actions could have a material adverse impact on our business, financial condition and results of operations.
 
 We depend upon the VIE Agreements in conducting our production, manufacturing and distribution of traditional Chinese herbal medicines in the PRC, which may not be as effective as direct ownership.
 
 We conduct our production, manufacturing and distribution of traditional Chinese herbal medicines in the PRC and generate the revenues from our Bohai business through the VIE Agreements.  The VIE Agreements may not be as effective in providing us with control over Bohai as direct ownership.  The VIE Agreements are governed by PRC laws and provide for the resolution of disputes through arbitration proceedings pursuant to PRC laws.  Accordingly, the VIE Agreements will be interpreted in accordance with PRC laws.  If Bohai or its Shareholders fail to perform the obligations under the VIE Agreements, we may have to rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, and there is a risk that we may be unable to obtain these remedies.  The legal environment in China is not as developed as in other jurisdictions.  As a result, uncertainties in the PRC legal system could limit our ability to enforce the VIE Agreements.
  32
 
 The pricing arrangement under the VIE Agreements may be challenged by the PRC tax authorities.
 
 We could face adverse tax consequences if the PRC tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations.  If the PRC tax authorities determine that the VIE Agreements were not entered into on an arm’s length basis, they may adjust the income and expenses of our company for PRC tax purposes which could result in higher tax liability.
 
 We rely on the approval certificates and business license held by Bohai and any deterioration of the relationship between WFOE and Bohai could materially and adversely affect the overall business operation of our company.
 
 Pursuant to the VIE Agreements, our production, manufacturing and distribution of traditional Chinese herbal medicines in China is undertaken on the basis of the approvals, certificates and business license as well as other requisite licenses held by Bohai.  There is no assurance that Bohai will be able to renew its licenses or certificates when their terms expire with substantially similar terms as the ones they currently hold.
 
 Further, our relationship with Bohai is governed by the VIE Agreements, which are intended to provide us, through our indirect ownership of WFOE, with effective control over the business operations of Bohai.  However, the VIE Agreements may not be effective in providing control over the applications for and maintenance of the licenses required for our business operations.  Bohai could violate the VIE Agreements, go bankrupt, suffer from difficulties in its business or otherwise become unable to perform its obligations under the VIE Agreements and, as a result, our operations, reputation, business and stock price could be severely harmed.
 
 If WFOE exercises the purchase options over Bohai’s equity pursuant to the VIE Agreements, the payment of purchase prices could materially and adversely affect the financial position of our company.
 
 Under the VIE Agreements, WFOE holds an option to purchase all or a portion of the equity of Bohai at a price, pro rata in case of not all, based on the capital paid in by the Bohai Shareholders (namely, $2.94 million or RMB 20 million ).  In the case that applicable PRC laws and regulations require an appraisal of the equity interest or provide other restriction on the purchase price, the purchase price shall be the lowest price permitted under the applicable PRC laws and regulations. As Bohai is already a contractually controlled affiliate to our company, WFOE’s purchase of Bohai’s equity would not bring immediate benefits to our company and the exercise of the option and payment of the purchase prices could adversely affect the financial position of our company.
 
 Risks Associated With Doing Business in China
 
 There are substantial risks associated with doing business in China, some of which are addressed in the following risk factors.
 
 The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
 
 We are dependent on our relationship with the local government in the province in which we operate our business.  The Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership.  Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to the “protected” status of our products, the coverage of national health insurance for our products, taxation, environmental regulations, land use rights, property and other matters.  The central or local governments of in the PRC jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.  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.
  33
 
 Future inflation in China may inhibit our ability to conduct business in China. In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation.  Rapid economic growth can lead to growth in the money supply and rising inflation.  If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may have an adverse effect on profitability.  These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation.  High inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.
 
 Our operations and assets in China are subject to significant political and economic uncertainties and we may lose all of our assets and operations if the Chinese government alters its policies to further restrict foreign participation in business operating in the PRC.
 
 Changes in PRC laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition.  Under its current leadership, the Chinese government has been pursuing economic reform policies that encourage private economic activities and greater economic decentralization.  There is no assurance, however, that the Chinese government will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.  We may lose all of our assets and operations if the Chinese government alters its policies to further restrict foreign participation in business operating in the PRC.
 
 We derive all of our sales in China and a slowdown or other adverse developments in the PRC economy may materially and adversely affect our customers, demand for our products and our business.
 
 All of our sales are generated in China.  We anticipate that sales of our products in China will continue to represent all of our total sales in the near future.  Although the PRC economy has grown significantly in recent years, we cannot assure you that such growth will continue.  The industry which we are involved in the PRC is relatively new and growing, but 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.  In addition, the Chinese government also exercises significant control over Chinese 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.  Efforts by the Chinese government to slow the pace of growth of the Chinese economy could result in reduced 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.
 
 Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert Chinese Renminbi into foreign currencies and, if Chinese Renminbi were to decline in value, reducing our revenue in U.S. dollar terms.
 
 Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies.  Substantially all of our revenue and expenses are in the Chinese currency, the Renminbi.  We are subject to the effects of exchange rate fluctuations with respect to any of these currencies.  For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market.  Since 1994, the official exchange rate for the conversion of the Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar.  In July 2005, the Chinese government changed its policy of pegging the value of the Renminbi to the U.S. dollar.  Under this policy, which was halted in 2008 due to the worldwide financial crisis, the Renminbi was permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies.  In June 2010, the Chinese government announced its intention to again allow the Renminbi to fluctuate within the 2005 parameters.  It is possible that the Chinese government could adopt an even more flexible currency policy, which could result in more significant fluctuation of Renminbi against the U.S. dollar, or it could adopt a more restrictive policy.  We can offer no assurance that the Renminbi will be stable against the U.S. dollar or any other foreign currency.
  34




Our financial statements are translated into U.S. dollars at the average exchange rates in each applicable period.  To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations.  Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations.  We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign consolidated subsidiaries into U.S. dollars in consolidation.  If there is a change in foreign currency exchange rates, the conversion of the foreign consolidated subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income.  In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency.  Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss.  We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future.  The availability and effectiveness of any hedging transaction may be limited and we may not be able to hedge our exchange rate risks.





The State Administration of Foreign Exchange (“SAFE”) restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively and to pay dividends, and the restrictions may cause a delay in payment of interest on the Notes.





All of our sales revenue and expenses are denominated in the Chinese currency, Renminbi.  Under PRC law, the Renminbi is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans.  Currently, our PRC operating subsidiary, Bohai, may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of SAFE, by complying with certain procedural requirements.  However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future.  Since a significant amount of our future revenue will be denominated in Renminbi, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in Renminbi to fund our business activities outside China that are denominated in foreign currencies.





All of our income is derived from the consulting fees we receive from Bohai through the VIE Agreements.  SAFE restrictions may delay the payment of dividends, since we have to comply with certain procedural requirement and we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from the profits of WFOE, and it thus may delay our payment of interest to the Notes holders.





Foreign exchange transactions by PRC operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE.  In particular, if Bohai, our PRC operating subsidiary, borrows foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance Bohai by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or their respective local counterparts.  These limitations could affect Bohai’s ability to obtain foreign exchange through debt or equity financing.





The PRC government also may at its discretion restrict access in the future to foreign currencies for current account transactions.  If the foreign exchange control system prevents us from obtaining foreign currency, we may be unable to pay the interest and principal on the Notes, pay dividends or meet obligations that may be incurred in the future that require payment in foreign currency.


35


The PRC State Administration of Foreign Exchange restrictions on the use of offshore holding companies in mergers and acquisitions in China may create regulatory uncertainties that could restrict or limit our ability to operate.





In November 2005, SAFE issued a public notice, known as Circular 75, concerning foreign exchange registrations that are required in order to use of offshore holding companies in mergers and acquisitions in China.  The public notice provides that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to registration with the relevant foreign exchange authorities.  The public notice also suggested that registration with the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of shares in an offshore holding company that owns an onshore company.  PRC residents must each submit a registration form to the local SAFE branch with respect to their ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transactions or use of assets in China to guarantee offshore obligations.





Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), expanded the reach of Circular 75 by: (i) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (ii) adding requirements relating to the source of the PRC resident’s funds used to establish or acquire the offshore entity; (iii) covering the use of existing offshore entities for offshore financings; (iv) purporting to cover situations in which an offshore special purpose vehicle, or SPV, establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (v) making the domestic affiliate of the SPV responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds.  Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore SPV jointly responsible for these filings.  In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions.  Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.





The PRC regulatory authorities may take the view that our acquisition of indirect ownership and controlling interest in Bohai through VIE arrangements shall be subject to SAFE approval and registration. Any adverse action taken against us by PRC regulatory authorities could significantly and negatively impact our operations and the trading market for our common stock.





PRC regulations and potential registration requirements relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate.  Similarly, our failure to obtain the prior approval of PRC authorities for our January 2010 private placement and the listing and trading of our common stock could have a material adverse effect on our business, operating results, reputation and trading price of our common stock.





On August 8, 2006, the PRC Ministry of Commerce (“MOC”), joined by the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission (“CSRC”) and SAFE, released a substantially amended version of the Provisions for Foreign Investors to Merge with or Acquire Domestic Enterprises (the “Revised M&A Regulations”), which took effect September 8, 2006.  These new rules significantly revised China’s regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions of domestic enterprises.  These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOC as a key regulator for issues related to mergers and acquisitions in China and requiring MOC approval of a broad range of merger, acquisition and investment transactions.  Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign control transactions in key industries.


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Among other things, the revised M&A Regulations include new provisions that purport to require that an offshore SPV, formed for listing purposes and controlled directly or indirectly by PRC companies or individuals must obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange.  On September 21, 2006, the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings.  However, the application of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement.





Our principal shareholder, Glory Period, is 100% owned by Joshua Tan, a Singapore citizen.  As of the date of this Annual Report, Glory Period holds approximately 50% of our outstanding common stock.  Mr. Tan and Mr. Qu (the principal founder of Bohai and our Chairman, President and Chief Executive Officer) entered into the Call Option Agreement on December 7, 2009 by which Mr. Qu has an option to acquire all the issued and outstanding shares of Glory Period within three years for nominal consideration.  Chance High, as the wholly owned subsidiary of our company, formed WFOE on November 23, 2009 and WFOE obtained effective and substantial control over Bohai further through executing the VIE Agreements on December 7, 2009 by and among WFOE, Bohai and the three Shareholders of Bohai (including Mr. Qu).  The PRC regulatory authorities may take the view that entry into the VIE Agreements by WFOE and Bohai resulting in Mr. Qu, a PRC resident becoming the majority owner and effective controlling party of our company which acquired 100% indirect ownership of Bohai.  The PRC regulatory authorities may also take the view that the relevant parties should fully disclose to SAFE or MOC of the overall restructuring arrangements, the existence of the Share Exchange and related VIE Agreements.  If the PRC regulatory authorities take the view that the Share Exchange and VIE arrangement constitutes a reverse ,merger or round-trip investment under the M&A Regulations, we cannot assure you we may be able to obtain the approval required from the national offices of MOC.





If the PRC regulatory authorities take the view that the Share Exchange and the VIE Agreements constitutes a reverse merger acquisition or round-trip investment without the approval of the national offices of MOC, they could invalidate the Share Exchange and VIE Agreements.  Additionally, the PRC regulatory authorities may take the view that any public offering plan of us will require the prior approval of CSRC.  If we cannot obtain MOC or CSRC approval in case we are required to do so, our business and financial performance will be materially adversely affected.  We may also face regulatory actions or other sanctions from the MOC or other PRC regulatory agencies.  These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from the Private Placement into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our common stock.





Also, if later the CSRC requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our common stock.  Furthermore, published news reports in China recently indicated that the CSRC may have curtailed or suspended overseas listings for Chinese private companies. These news reports have created further uncertainty regarding the approach that the CSRC and other PRC regulators may take with respect to transactions that we have engaged in our may in the future engage in.  Any adverse action taken against us by PRC regulatory authorities could significantly and negatively impact our operations and the trading market for our common stock.





Because our assets are located outside of the United States and half of our directors, including our Chairman, and the majority of our officers reside outside of the United States, it may be difficult for you to enforce your rights based on the United States federal securities laws against us and these persons in the United States or to enforce judgments of United States courts against us or him in the PRC.





Our Chairman of the Board and principal executive officer, Mr. Qu, resides outside of the United States in China.  In addition, another of our directors and a majority of our officers are also located in China.  Furthermore, our operating subsidiary is located in the PRC and all of its assets are located outside of the United States.  China does not have a treaty with United States providing for the reciprocal recognition and enforcement of judgments of courts.  It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the United States federal securities laws against us in the courts of either the United States or the PRC and, even if civil judgments are obtained in courts of the United States, to enforce such judgments in the PRC courts.  Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties, under the United States federal securities laws or otherwise.




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We may have limited legal recourse under PRC laws if disputes arise under our contracts with third parties.





The Chinese government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade.  However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable.  If our new business ventures are unsuccessful, or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business operations of these acquired companies.  The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an injunction under PRC laws, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring.  The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.  Although legislation in China over the past 30 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you.  The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital and could have a material adverse impact on our operations.





We must comply with the Foreign Corrupt Practices Act.





We are required to comply with the United States Foreign Corrupt Practices Act, which 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 of our competitors, are not subject to these prohibitions.  Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China.  If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage.  We have not established formal policies or procedures for prohibiting or monitoring this conduct, and we can not assure you 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.





If we make equity compensation grants to persons who are PRC citizens, they may be required to register with SAFE.  We may also face regulatory uncertainties that could restrict our ability to adopt equity compensation plans for our directors and employees and other parties under PRC laws.





On April 6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company, also known as “Circular 78.”  It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company, such as our company, after April 6, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan.  In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company’s covered equity compensation plan prior to April 6, 2007.  We believe that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming.


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In the future, we may adopt an equity incentive plan and make numerous stock option grants under the plan to our officers, directors and employees, some of whom are PRC citizens and may be required to register with SAFE.  If it is determined that any of our equity compensation plans are subject to Circular 78, failure to comply with such provisions may subject us and participants of our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our ability to compensate our employees and directors through equity compensation would be hindered and our business operations may be adversely affected.





Due to various restrictions under PRC laws on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our shareholders.





The Wholly-Foreign Owned Enterprise Law (1986), as amended and the Wholly-Foreign Owned Enterprise Law Implementing Rules (1990), as amended and the Company Law of the PRC (2006) contain the principal regulations governing dividend distributions by wholly foreign owned enterprises. Under these regulations, wholly foreign owned enterprises, such as WFOE, may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, WFOE is required to set aside a certain amount of their accumulated profits each year, if any, to fund certain reserve funds.  These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes.





Furthermore, if our consolidated subsidiaries in China incur debt on their own in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments. If we or our consolidated subsidiaries are unable to receive all of the revenues from our operations due to these contractual or dividend arrangements, we may be unable to pay dividends on our common stock.





We may have difficulty establishing adequate management, governance, legal and financial controls in the PRC.





The PRC historically has been deficient in western style management, governance and financial reporting concepts and practices, as well as in modern banking, and other control systems.  Our current management has little experience with western style management, governance and financial reporting concepts and practices, and we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC.  As a result of these factors, and especially given that we expect to be a publicly listed company in U.S. and subject to regulation as such, we may experience difficulty in establishing management, governance legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet western standards.  We may have difficulty establishing adequate management, governance, legal and financial controls in the PRC.  Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002 and other applicable laws, rules and regulations.  This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002.  Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business and the public announcement of such deficiencies could adversely impact our stock price.





It may be difficult to protect and enforce our intellectual property rights under PRC laws.





Intellectual property rights in China are still developing, and there are uncertainties involved in the protection and the enforcement of such rights.  We will need to pay special attention to protecting our intellectual property and trade secrets.  Failure to do so could lead to the loss of a competitive advantage that could not be compensated by our damages award.




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If our land use rights are revoked, we would have no operational capabilities.





Under Chinese law land is owned by the state or rural collective economic organizations. The state issues to tenants the rights to use property.  Use rights can be revoked and the tenants forced to vacate at any time when redevelopment of the land is in the public interest.  The public interest rationale is interpreted quite broadly and the process of land appropriation may be less than transparent.  Through our operating subsidiary Bohai, we rely on these land use rights as the cornerstone of our operations for both our manufacturing facility and our corporate headquarters.  The loss of such rights would have a material adverse effect on our company as we would be required to relocate our facilities and obtain new land use rights, and there is a risk that we would not be able to accomplish such a relocation with reasonable cost or at all.





In addition, we currently do not maintain a land use right certificate for a piece of land located in Xingfu Twelve Village of Zhifu District with the area of 11,222 square meters, on which we have built our corporate headquarters.  In the process of the planning of Yantai City, the usage of this land use right has been changed from “industrial use” to “commercial use” and therefore, the process for the land use right certificate on five relevant parcels of land including the land occupied by Bohai is suspended until the completion of the planning. We can not assure you that we will eventually obtain the land use right certificate for this land with reasonable cost.




Risks Related to Our Common Stock




The registration statement covering the shares of common stock underlying the Notes and Warrants may not remain effective, which could impact the liquidity of our common stock.




Under the terms of our January 2010 Registration Rights Agreement, we are obligated to include the shares of common stock underlying the Notes and Warrants in an effective registration statement.  From time to time, including following the filing of this Annual Report, it will be necessary for us to file post-effective amendments to the registration statement when subsequent events so require.  We intend to use our best efforts to keep the registration statement current, but we may not be able to do so.  If the registration statement is not current in the future, we will incur penalties and investors’ ability to sell the shares of common stock underlying the Notes and Warrants will be limited, which would have a material adverse effect on the liquidity of our common stock.




There is currently an extremely limited trading market for our common stock, and the limited public trading market that may develop in the future may cause extreme volatility in our stock price.





Although our common stock is listed for quotation on the OTCBB and the OTCQB, there has been only limited trading in our stock.  Trading in our common stock may not fully evolve for a variety of reasons, and even if a market for our stock develops, it may continue to be limited.  Even if a market for our common stock does develop, there is a risk that a meaningful, consistent and liquid trading market may not develop.  Moreover, stocks with limited trading markets have historically experienced extreme price and volume fluctuations and have particularly affected the market prices of many smaller companies like us.  Our common stock is thus expected to be subject to significant volatility when and if meaningful trading commences.  In addition, sales of substantial amounts of our common stock, or the perception that such sales might occur, could adversely affect prevailing market prices of our common stock.





All of the foregoing risks are particularly true of our company as we are based in China and recently US-listed Chinese companies (especially those that obtained a US listing via a “reverse merger” transaction as we did) have come under significant scrutiny by US regulators and investors.  This scrutiny and related disfavor for companies like ours has had and may in the future a negative impact on our public stock price





An active and visible trading market for our common stock may not develop.





We cannot predict whether an active market for our common stock will develop in the future.  In the absence of an active trading market:





·
Investors may have difficulty buying and selling or obtaining market quotations;


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·
Market visibility for our common stock may be limited; and





·
A lack of visibility for our common stock may have a depressive effect on the market price for our common stock.





The OTCBB and the OTCQB are unorganized, inter-dealers, over-the-counter markets that provides significantly less liquidity than NASDAQ or the NYSE AMEX.  No assurances can be given that we will ever obtain a listing for our securities on a senior exchange.  The trading price of our common stock is therefore expected to be subject to significant fluctuations in response to variations in quarterly operating results, changes in analysts’ earnings estimates, announcements of innovations by us or our competitors, general conditions in the industry in which we operate and other factors.  These fluctuations, as well as general economic and market conditions, may have a material or adverse effect on the market price of our common stock.





The market price for our stock may be volatile.





The market price for our stock may be volatile and subject to wide fluctuations due to factors such as:





·
the perception of US investors and regulators of US-listed Chinese companies;





·
actual or anticipated fluctuations in our quarterly operating results;





·
changes in financial estimates by securities research analysts;





·
conditions in pharmaceutical markets;





·
changes in the economic performance or market valuations of other pharmaceutical companies;





·
announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;





·
addition or departure of key personnel;





·
fluctuations of exchange rates between RMB and the U.S. dollar;





·
intellectual property or other litigation; and





·
general economic or political conditions in China.





In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies.  These market fluctuations may also materially and adversely affect the market price of our stock.





The accounting treatment for our convertible securities is complex and subject to judgments concerning the valuation of embedded derivative rights within the applicable securities.  Fluctuations in the valuation of these rights could cause us to take charges to our earnings and make our financial results unpredictable.





Our Notes and Warrants issued in January 2010 contain, or may be deemed to contain from time to time, embedded derivative rights in accordance with GAAP.  These derivative rights, or similar rights in convertible securities we may issue in the future, need to be, or may need to be, separately valued as of the end of each accounting period in accordance with GAAP.  Changes in the valuations of these rights, the valuation methodology or the assumptions on which the valuations are based could cause us to take charges to our earnings, which would adversely impact our results of operations.  Moreover, the methodologies, assumptions and related interpretations of accounting or regulatory authorities associated with these embedded derivatives are complex and in some cases uncertain, which could cause our accounting for these derivatives, and as a result, our financial results, to fluctuate.  There is a risk that questions could arise from investors or regulatory authorities concerning the appropriate accounting treatment of these instruments, which could require us to restate previous financial statements, which in turn could adversely impact our results of operations, our reputation and our public stock price.


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Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of outstanding stock in the public marketplace could reduce the price of our common stock.





Pursuant to the terms of the Registration Rights Agreement and Securities Purchase Agreement, we agreed to file a registration statement with the SEC to register the common stock underlying the Notes, Warrants and Placement Agent Warrants for public resale.  All of such shares may be freely sold and transferred following conversion or exercise of the Notes and Warrants if such registration statement remains effective.  Additionally, concurrently with the closing of the Private Placement, we engaged in a Share Exchange, and following the Share Exchange, the former shareholders of Chance High (other than Glory Period) may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to such registration statement or SEC Rule 144, subject to certain limitations.  In general, pursuant to Rule 144, a shareholder (or shareholders whose shares are aggregated) who has satisfied an one-year holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale.  As of the date of this registration statement, shares of common stock underlying the Notes and Warrants issued in our January 2010 private placement, 1% of our issued and outstanding shares of common stock equals approximately 178,210 shares.  .  Rule 144 also permits, under certain circumstances, the sale of securities, without any limitations, by a non-affiliate that has satisfied a one-year holding period.  Any substantial sale of common stock pursuant to any resale prospectus or Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply.





Our controlling shareholder may exercise significant influence over us.





Our controlling shareholder, Glory Period Limited, owns approximately 50% of our outstanding common stock as of the closing of the Share Exchange.  Tan is the sole shareholder of Glory Period and Qu is the sole director of Glory Period.  Either Tan or Qu has a controlling influence in determining the outcome of any corporate transaction or other matters submitted to our shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors, and other significant corporate actions.  Tan and Qu may also have the power to prevent or cause a change in control.  In addition, without the consent of Tan and Qu, we could be prevented from entering into transactions that could be beneficial to us.  As Qu serves as our principal executive officer and Tan has provided consulting services to Bohai in the past, the interests of Tan and Qu may differ from the interests of our other shareholders, which could create conflicts of interest and the potential for approval of actions which may not be in the best interests of all of our shareholders.





Compliance with complex and changing regulation of corporate governance and public disclosure, and our management’s inexperience with such regulations, will result in additional expenses and creates a risk of non-compliance.





Changing laws, regulations and standards relating to corporate governance and public legal and accounting disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC regulations, have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the public markets and public reporting.  Our management team will need to invest significant management time and financial resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.  In addition, our management located in the PRC has little experience with compliance with U.S. laws (including securities laws).  This inexperience may cause us to fall out of compliance with applicable regulatory requirements, which could lead to restatements of our financial statements, breaches of covenants in our investor agreements, regulatory enforcement actions against us and a negative impact on our stock price and our business generally.


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The challenges we have with properly complying with applicable disclosure and accounting regulations were evidenced when we were required to restate our financial statements for the period ended March 31, 2010 to account for the embedded derivative liabilities associated with Notes and Warrants.  There is a risk that we will face similar challenges in the future.





If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.





We are subject to reporting obligations under the U.S. securities laws.  The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of our internal controls over financial reporting.  In addition, we may be required to have an independent registered public accounting firm attest to and report on management’s assessment of the effectiveness of our internal controls over financial reporting.  Our management may conclude that our internal controls over our financial reporting are not effective.  Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may still decline to attest to our management’s assessment or may issue a report that is qualified if it is not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us.  Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future.  Effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to prevent fraud.  As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our stock.  Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.





Our common stock may be considered a “penny stock,” and thereby be subject to additional sale and trading regulations that may make it more difficult to sell.





Our common stock, which is currently and will be quoted for trading on OTCBB and OTCQB, may be considered to be a “penny stock” if it does not qualify for one of the exemptions from the definition of “penny stock” under Section 3a51-1 of the Exchange Act, as amended.  Our common stock may be a “penny stock” if it meets one or more of the following conditions: (i) the stock trades at a price less than $5 per share; (ii) it is NOT traded on a “recognized” national exchange; (iii) it is not quoted on the Nasdaq Capital Market, or even if so, has a price less than $5 per share; or (iv) is issued by a company that has been in business less than three years with net tangible assets less than $5 million.  The principal result or effect of being designated a “penny stock” is that securities broker-dealers participating in sales of our common stock will be subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9 promulgated under the Exchange Act.  For example, Rule 15g-2 requires broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document at least two business days before effecting any transaction in a penny stock for the investor’s account.  Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor.  This procedure requires the broker-dealer to: (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives.  Compliance with these requirements may make it more difficult and time consuming for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.


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We do not foresee paying cash dividends in the foreseeable future and, as a result, our investors’ sole source of gain, if any, will depend on capital appreciation, if any.





We do not plan to declare or pay any cash dividends on our shares of common stock in the foreseeable future and currently intend to retain any future earnings for funding growth. As a result, investors should not rely on an investment in our securities if they require the investment to produce dividend income. Capital appreciation, if any, of our shares may be investors’ sole source of gain for the foreseeable future. Moreover, investors may not be able to resell their common stock at or above the price they paid for them.





Item 1B.  Unresolved Staff Comments.





None.





Item 2.Description of Properties.





Our corporate headquarters is located at No. 9 Daxin Road, Zhifu District, Yantai, Shandong Province, China.  Under the current PRC laws, land is owned by the state, and parcels of land in rural areas which is known as collective land is owned by the rural collective economic organization.  “Land use rights” are granted to an individual or entity after payment of a land use right fee is made to the applicable state or rural collective economic organization. Land use rights allow the holder of the right to use the land for a specified long-term period.  We have a land use right, expiring in 2047, for a total of approximately 30,637 square meters of land, on which we maintain our manufacturing facility.  We currently have not obtained a land use right certificate for a piece of land located in Xingfu Twelve Village of Zhifu District with the area of 11,222 square meters, on which we maintain our corporate headquarters.  In the process of the planning of Yantai City, the usage of the aforesaid land use right has been changed from “industrial use” to “commercial use” and therefore, the approval process for the land use right certificate on the land for our corporate headquarters has been suspended until the completion of the planning.  We can not assure you that we will eventually obtain the land use right certificate for this land.





On February 22, 2010, we entered into a land-use right purchase agreement with Shandong Yantai Bureau of Land and Resources, pursuant to which we acquired the land use right for a parcel of land totaling 333,335 square meters for RMB 97,500,000 (approximately $14,320,100).  As of March 31, 2011, this purchase price was paid in full.





On August 8, 2011, we acquired Yantai Tianzheng, pursuant to which we acquired the land use right for a parcel of land totaling 32,883.6 including a manufacture facility of 10,908.83 square meters (approximately 117,421.668 square feet).





Item 3.Legal Proceedings.





We are not a party to any current or pending legal proceedings that, if decided adversely to us, would have a material adverse effect upon our business, results of operations, or financial condition, and we are not aware of any threatened or contemplated proceeding by any governmental authority against us.  To our knowledge, we are not a party to any threatened civil or criminal action or investigation.




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PART II





Item 5.   Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities Market Information.





Our common stock is listed for quotation on the OTCBB and the OTCQB under the symbol “BOPH.” From January 9, 2008 until February 8, 2010, our common stock was listed for quotation on the OTCBB under the symbol “LINK”.  The following tables set forth, for the calendar quarter indicated, the quarterly high and low sales price for our common stock as reported on the OTC Bulletin Board.  Trading in the common stock in the over-the-counter market has been limited and sporadic and the quotations set forth below are not necessarily indicative of actual market conditions.  Further, the quotations merely reflect the prices at which transactions were proposed, and do not necessarily represent actual transactions.





High


Low2011 by QuarterJuly 1, 2010 - September 30, 2010

$
2.40


$
1.26October 1, 2010 - December 31, 2010

$
2.30


$
1.70January, 2011 - March 31, 2011

$
2.20


$
1.65April 1, 2011 – June 30, 2011

$
1.70


$
0.952010 by QuarterJuly 1, 2009 - September 30, 2009

$
-


$
-October 1, 2009 - December 31, 2009

$
-


$
-January, 2010 - March 31, 2010

$
2.10


$
2.10April 1, 2010 – June 30, 2010

$
2.22


$
2.10





Holders





As of September 28, 2011, there were 17,861,085 shares of our common stock outstanding held by approximately 65 shareholders of record.  The number of our shareholders of record excludes any estimate by us of the number of beneficial owners of shares held in street name, the accuracy of which cannot be guaranteed.





Dividend Policy





We have not paid any cash dividends on our common stock to date, and we have no intention of paying cash dividends in the foreseeable future. Whether we will declare and pay dividends in the future will be determined by our board of directors at their discretion, subject to certain limitations imposed under Delaware corporate law. In addition, our ability to pay dividends may be affected by the foreign exchange controls in China. The timing, amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our board of directors.





Recent Sales of Unregistered Securities





None.





Item 6.  Selected Financial Data.





We are a “smaller reporting company” as defined by Regulation S-K and as such, are not required to provide the information contained in this item pursuant to Regulation S-K.


45


Item 7.  Management’s Discussion and Analysis or Plan of Operation.





The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in our audited condensed financial statements for the twelve months ended June 30, 2011, and should be read in conjunction with such financial statements and related notes included in this Annual Report.  Those statements in the following discussion that are not historical in nature should be considered to be forward looking statements that are inherently uncertain.  Actual results and the timing of the events may differ materially from those contained in these forward looking statements due to a number of factors, including those discussed in the “Cautionary Note on Forward Looking Statements” set forth elsewhere in this Annual Report.





Overview





We were incorporated under the laws of the State of Nevada on January 9, 2008.  Since January 5, 2010, our business consists of the production, manufacturing and distribution of herbal pharmaceuticals in the PRC which is based on Traditional Chinese Medicine, or TCM.  We are based in the city of Yantai, Shandong Province, China.





Prior to January 5, 2010, we were a public “shell” company operating under the name “Link Resources, Inc.”  On January 5, 2010, we consummated a share exchange transaction pursuant to which we acquired Chance High, the indirect parent company of Bohai, our initial operating subsidiary, which is a Chinese variable interest entity that we (through a Chinese wholly-owned foreign enterprise subsidiary) control through certain contractual arrangements.





Our medicines address rheumatoid arthritis, viral infections, gynecological diseases, cardio vascular issues and respiratory diseases.  Bohai obtained Drug Approval Numbers for 29 varieties of traditional Chinese herbal medicines in 2004 and for an additional 14 medicines in December 2010.  Through our acquisition of Yantai Tianzheng in August 2011, we obtained Drug Approval Numbers for another 5 varieties in August 2011.  We currently produce 19 varieties of approved traditional Chinese herbal medicines in seven delivery systems: tablets, granules, capsules, formulations, concentrated powder, tincture and medicinal wine.  Of these 19 products, 12 are prescription drugs and 7 are over the counter (or OTC) products.





Use of Non-GAAP Financial Measures





We make reference to Non-GAAP financial measures in portions of this “Management’s Discussion of Financial Condition and Results of Operations”.  Management believes that investors may find it useful to review our financial results that exclude certain non-cash income and expense, namely changes in the fair value of our warrants, amortized beneficial conversion features on convertible notes, option and stock-based compensation, and deferred tax liabilities and impairment losses shown in the chart below, of $2,234,879 and $493,843 income for the twelve months ended June 30, 2011 and 2010, respectively, due to the adoption of the Financial Accounting Standards Board’s (“FASB”) ASC 815, ASC 350 and ASC 360 accounting standards as discussed in the accompanying audited financial statements.





Management believes that these Non-GAAP financial measures are useful to investors in that they provide supplemental information to possibly better understand the underlying business trends and operating performance of our company.  We use these Non-GAAP financial measures to evaluate operating performance.  However, Non-GAAP financial measures should not be considered as an alternative to net income or any other performance measures derived in accordance with GAAP.





The following is a summary of reconciliations of such Non-GAAP financial measures to the most directly comparable GAAP financial measures for the fiscal years ended June 30, 2011 and 2010:


46




Twelve Months EndedJune 30,2011


2010


Increase(Decrease)Net income available to common shareholders -GAAP

$
14,004,875


$
9,056,972


$
4,947,903Add back (subtract):Change in fair value of warrants


(4,544,061
)(a)


(925,063
)(a)


(3,618,998
)Accretion of beneficial conversion features on convertible notes


1,029,487
(a)


-
(a)


1,029,487Share based payments


209,527
(b)


-
(b)


209,527Deferred tax expenses and impairment losses - indefinite intangible assets


1,070,168
(c)


431,220
(c)


638,948Adjusted net income available to common Shareholders -non-GAAP

$
11,769,996


$
8,563,129


$
3,206,867Net income margins -non-GAAP


14.5
%


14.5
%


-Basic earnings per share – GAAP

$
0.81


$
0.62


$
0.19Add back (Subtract):Change in fair value of warrants


(0.26
)(a)


(0.06
)(a)


(0.20
)Accretion of beneficial conversion features on convertible notes


0.06
(a)


0.00
(a)


0.06Share based payments


0.01
(b)


0.00
(b)


0.01Deferred tax expenses and impairment losses - indefinite intangible assets


0.06
(c)


0.03
(c)


0.03Adjusted basic earnings per share non-GAAP

$
0.68


$
0.59


$
0.09Diluted earnings per share-GAAP

$
0.75


$
0.55


$
0.20Add back (Subtract):Change in fair value of warrants


(0.20
)(a)


(0.05
)(a)


(0.15
)Accretion of beneficial conversion features on convertible notes


0.05
(a)


0.00
(a)


0.05Share based payments


0.01
(b)


0.00
(b)


0.01Deferred tax expenses and impairment losses - indefinite intangible assets


0.05
(c)


0.02
(c)


0.03Adjusted diluted earning per share non-GAAP

$
0.66


$
0.52


$
0.14Weighted average number of sharesBasic


17,198,917



14,722,055Diluted


22,423,917



17,569,315





(a)
We adopted the provisions of FASB accounting standard, ASC 815, which provides standards with respect to determine whether an instrument (or embedded feature) is indexed to an entity’s own stock (See note 12).  As a result of these measurements, we recognized non-cash credits of $4,544,061 and $925,063 for the twelve months ended June 30, 2011 and 2010, respectively, from changes in fair value for investor and agent warrants and non-cash charges of $1,029,487 and $0 for the twelve months ended, 2011 and 2010, respectively, for unamortized beneficial conversion features on convertible notes converted.


47





(b)
We adopted stock-based compensation expense pursuant to FASB’s accounting standard regarding stock compensation which requires us to measure compensation cost for consultants and stock-based employee compensation plans at fair value at the grant date and recognize the expense over the employee's requisite service period. Under ASC Topic 718, our expected volatility assumption is based on the historical volatility of Company’s stock or the expected volatility of similar entities. The expected life assumption is primarily based on historical exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. For the twelve months ended June 30, 2011 and 2010, we recognized $182,500 and $0 of restricted stock as compensation expense. For the twelve months ended June 30, 2011 and 2010, we recognized $27,027 and $0, respectably as compensation expenses for its stock option plan.





(c)
We adopted the provisions of FASB accounting standard, ASC 350, which provides standards with respect to the deferred tax liability for indefinite intangible assets and FASB accounting standard, ASC 360, which provides standards with respect to accounting for the impairment or disposal of long-lived assets.  As a result of these measurements, we recognized net non-cash deferred tax charges of $434,726 and $431,220 for the twelve months ended June 30, 2011 and 2010, respectively, from deferred tax expenses and impairment losses of $635,442 and $0 for the twelve months ended June 30, 2011 and 2010, respectively.





Principal Factors Affecting Our Financial Performance





We believe that the following factors will continue to affect our financial performance:





Sales of Key Products





Our top selling products as a percentage of total net revenue consist of the following:





For the twelve month ended June 30,2011


2010Tongbi Capsules


27.4
%


25.7
%Lung Nourishing Syrup


26.2
%


26.2
%Tongbi Tablets


14.4
%


14.6
%Shangtongning Tablets


8.7
%


13.0
%Other Products


23.3
%


20.5
%Total Sales


100.0
%


100.0
%





We expect that a significant portion of our future revenue will continue to be derived from sales of our top three products.





We held the Certificates of Protected Variety of Traditional Chinese Medicine (Grade Two) issued by the SFDA for Tongbi Capsules and Anti-flu Granuleswhich gave exclusive or near-exclusive rights to manufacture and distribute these two medicines.  Tongbi Capsules’ certificates expired in September 2009. We filed an application for extending the protection period on March 12, 2009 and received certification extension until September 13, 2016. Lung Nourishing Syrup received a patent with duration of 20 years from the State Intellectual Property Office of the PRC and the patent will expire on September 12, 2027. We have decided to not submit an extension application for Shangtongning Tablets, because the SFDA will not approve a Certificate of Protection for Shangtongning Tablets or any other products that are currently produced by more than three manufacturers in China.





Experienced Management





Management’s marketing strategies and business relationships gives us the ability to expand our product market areas, which provides us with leverage to acquire less sophisticated operators, increase production volumes, and implement quality standards. Our future prospects depend substantially on the continued services of our senior management team, especially our President, Chief Executive Officer and Chairman of the Board, Mr. Qu.




48


Price Control of Drugs by PRC Government





The State Development and Reform Commission of the PRC (“SDRC”) and the price administration bureaus of the relevant provinces of the PRC in which the pharmaceutical products are manufactured are responsible for the retail price control over our pharmaceutical products.  The SDRC sets the price ceilings for certain pharmaceutical products in the PRC. All of our products except those under the protection periods are subject to such price controls and could affect our future revenue growth. However, due to the direct support of TCM by the Chinese government, China’s immense market, and our protected drugs, we are optimistic regarding our continuous growth potential for TCM in China.





Financial Highlights





·
Net revenues for the twelve months ended June 30, 2011 increased 37% to $81.3 million compared to the same period in 2010.





o
Profit margin for the five new products introduced in April 2010 increased to 34% this fiscal year compared to 22% in last fiscal year.





o
Sales were mostly derived from our lead products, Lung Nourishing Syrup, Tongbi Capsules, Tongbi Tablets and Shangtongning Tablets, which together represented over 76% of our total net revenues for the twelve months ended June 30, 2011.





o
61% of net revenue was derived from sales of prescription products and 39% was from Over-the-Counter products for the twelve months ended June 30, 2011.





·
Non-GAAP Net income for the twelve months ended June 30, 2011 increased 37.4% to $11.8 million compared to the same period in 2010. GAAP Net income for the twelve months ended June 30, 2011 increased 54.6% to $14.0 million compared to the same period in 2010 (See above Use of Non-GAAP Financial Measures).





o
Income from operations increased 42.1% to $18.3 million this fiscal year compared to last fiscal year.





o
Net income margin increased from 15.3% for the year ended June 30, 2010 to 17.2% this fiscal year. The increase was mainly due to the net increase in certain non-cash gains such as the fair value of our warrants this fiscal year and to increase in selling related expenses, which could potentially increase our revenues in the near future.





o
Included in the net income this fiscal year was a non-cash credit of $4.5 million and $0.9 million for changes in fair value of warrants and non-cash charges for approximately $0.4 million and $0.4 million for deferred tax expenses as well as $1.0 million related to the unamortized beneficial conversion for convertible notes this fiscal year compared to last fiscal year.





·
Basic earnings per share increased to $0.81 and diluted earnings per share increased to $0.75 for the twelve months ended June 30, 2011.





o
Non-GAAP Diluted earnings per share increased 26.5% to $0.66 for the twelve months ended June 30, 2011 compared to the same period in 2010.





o
Non-GAAP Basic earnings per share increased 16.0% to $0.68 for the twelve months ended June 30, 2011 compared to the same period in 2010.





·
Including restricted cash, our total cash balance was $13.3 million as of June 30, 2011 and cash flow from operating activities was $11.0 million for the twelve months ended June 30, 2011.





o
Total cash and cash equivalents decreased by $3.8 million for twelve months ended June 30, 2011 compared to June 30, 2010.




49





o
Major cash payments activities for the twelve months ended June 30, 2011 included $7.2 million for deposits on the purchase of prepaid land use rights from the Shandong provincial government for future factory expansion, $7.2 million for purchase of DANs, and repayment of short term bank loan of $4.5 million to China Construction Bank.





Operating Results





Comparison of the twelve months ended June 30, 2011 and 2010





The following table sets forth key components of our results of operations for the twelve months ended June 30, 2011 and 2010, in US dollars:





For The Twelve Months EndedJune 30,Percentage2011


2010


Difference


IncreaseNet revenues

$
81,328,555


$
59,264,724


$
22,063,831



37.2
%Cost of revenue


(17,293,680
)


(10,164,853
)


(7,128,827
)


70.1
%Gross profit


64,034,875



49,099,871



14,935,004



30.4
%Selling, general, and administrative expenses


(45,779,010
)


(36,253,075
)


(9,525,935
)


26.3
%Income from operations


18,255,865



12,846,796



5,409,069



42.1
%Total other income (expenses)


514,028



(385,315
)


899,343



233.4
%Income before provision for income taxes


18,769,893



12,461,481



6,308,412



50.6
%Provision for income taxes


(4,765,018
)


(3,404,509
)


(1,360,509
)


40.0
%Net income

$
14,004,875


$
9,056,972


$
4,947,903



54.6
%





The following table sets forth key components as a percentage of net revenue for the twelve months ended June 30, 2011 and 2010:





For The Twelve Months EndedJune 30,2011


2010Net revenues


100.0
%


100.0
%Cost of sales


(21.3
)%


(17.2
)%Gross profit


78.7
%


82.8
%Selling, general, and administrative expenses


(56.3
)%


(61.2
)%Income from operations


22.4



21.7Total other income(expenses)


0.6
%


(0.7
)%Income before provision for income taxes


23.1
%


21.0
%Provision for income taxes


(5.9
)%


(5.7
)%Net income


17.2
%


15.3
%




50





Net Revenues





Net revenues are comprised of sales of 15 traditional Chinese medicines in China during the fiscal year ended June 30, 2011 (we currently sell 19 medicines following our acquisition of Yantai Tianzheng on August 8, 2011).  Net revenues for the twelve months ended June 30, 2011 increased by $22,063,831, or 37.2%, to $81,328,555 as compared to $59,264,724 for the twelve months ended June 30, 2010.  This increase was primarily due to a net increase of 28.3% in revenues from our four lead products, Lung Nourishing Syrup, Tongbi Capsules,  Tongbi Tablets, and Shantongning Tablets, which together accounted for over 76.0% of our total net revenues.  All of our lead products are listed for coverage and reimbursement under national medical insurance program starting in December 2009.  The increase was also due to sales from five new products for approximately $4.9 million, or 6.0% of total net revenue for the twelve months ended June 30, 2011.  We started selling these five products in April and May of 2010.  The sale of our prescription drug products for the twelve months ended June 30, 2011 represented 60.7% of total net revenue compared to 60.0% for the same period in last year.   The increase in prescription sales was primary due to increases in sales volume from our two prescription drugs, Tongbi Capsules and Tongbi Tablets.





We anticipate our overall net revenues will continue to increase due to a national medical and health plan initiated by the Chinese government in 2009, which will eventually cover individual health insurance for over 90% of China’s population by 2011 and includes traditional Chinese medicines for coverage and reimbursement from hospitals and medical centers all over China.  We also believe that our acquisition of Yantai Tianzheng will result in revenue growth for our company.





Cost of Revenues





Cost of revenues is comprised of raw material costs, labor cost, overhead costs associated with the manufacturing processes and related expenses which are directly attributable to our revenues.  Our cost of revenues for the twelve months ended June 30, 2011 was $17,293,680 as compared to $10,164,853 for the twelve months ended June 30, 2010, representing an increase of $7,128,827, or 70.1%. The increase in cost of revenues was mainly attributable to an increase in total cost of raw material, labor, and overhead as a result of an increase in overall sales and five new products we introduced in May last year as well as an increase in unit costs of raw material for two other products, Danqi Tablet and Anti-Flu Granules, for the twelve months ended June 30, 2011 compared to the same periods in last year.





Gross Profit





Gross profit represents the difference between net revenues and cost of revenues.  We achieved gross profit of $64,034,875 for the twelve months ended June 30, 2011, compared to $49,099,871 for the same periods in 2010, representing an increase of $14,935,004, or 30.4%, over the same periods of fiscal year 2010.  Our overall gross profit margins as a percentage of net revenues decreased by approximately 4.0% this fiscal year to date compared to the same periods last year.  The decrease of gross profit margin was principally due to lower gross profit margins from our five products introduced in May last year resulting from higher manufacturing costs and lower unit sales prices when introducing the 5 new products into the market.  The decrease of gross margin was also due to increase in unit costs of raw material for two of our products, Danqi Tablet s and Anti-Flu Granules. If we excluded gross profit for the five new products from the total gross profit for the twelve months ended June 30, 2010, the gross profit margin would be 81.9%, which was in line with gross profit margin of 82.8% for the twelve months ended June 30, 2010.


51





Selling, General and Administrative Expenses





Our selling, general and administrative expenses increased by $9,525,935 to $45,779,010, for the twelve months ended June 30, 2011 compared to $36,253,075 for the same fiscal periods end in 2010.  This increase was mainly attributable to an increase in advertising and promotion expenses of approximately $1.6 million, conferences for $1.7 million and travel and accommodation expenses for $2.9 million in the fiscal year ended June 30, 2011 compared to last fiscal year as we continued to expand sales of both prescriptions and over the counter products to existing and new market areas all over China.  The overall increase in selling, general, and administrative expenses was related to services supporting an overall increase in sales activities and new product promotions.  The percentage of selling, general, and administrative expenses to net revenues was 56.3% and 61.2% for the twelve months ended June 30, 2011 and 2010, respectively, representing a decrease of 4.9% as a percentage of net revenues as we continue to improve operating margins by leveraging fixed cost infrastructure and increasing capacity utilization. The overall increase in sales activities year to date, including the addition of 200 level 2 hospitals and10 new drug store chains to our national network of retail locations in China during the year, will eventually expand our sales volumes for the year to come.





Total Other Income (Expenses)





Total other income (expenses) are comprised of interest income (expenses), changes in fair value of derivative instruments, other income (expenses), and amortization of deferred financing fees.  Total other income was $514,028 for the twelve months ended June 30, 2011 compared to total other expenses of $385,315 for the period ended June 30, 2010, a decrease of total other expenses of $899,343.  The decrease in total other expenses were principally due to an increase in amortization of deferred financing fees of approximately $460,287, an increase of non-cash unamortized beneficial conversion features on convertible notes converted offset by an increase in non-cash gain in fair value of warrants for $3,618,998 for convertible notes in connection with our private placement on January 5, 2010.  The effective interest expense for convertible note is calculated using a constant effective interest rate, applied to the carrying value of the notes each month.  As the carrying value increases, so does the interest expense. We anticipate the non-cash effective interest charge will increase by approximately $9 million by December 31, 2011. If the convertible note holders did not convert their notes by their maturity date (January 5, 2012), we will need to redeem those convertible notes at $2.0 per each note plus accrued interest, if any.  Number of outstanding convertible notes was 5,225,000 as of June 30, 2011 (See Note 12).





Provision for Income Tax





Our provisions for income taxes for the twelve months ended June 30, 2011 and 2010 were $4,765,018 and $3,404,509, an increase of $1,360,509, or 40.0%, from this fiscal year to date over the same period in last year. The increase in income tax was principally due to an increase in taxable income under the PRC law (see Note 18).





Net Income





We had a net income of $14,004,875 for the twelve months ended June 30, 2011, as compared to net income of $9,056,972 for the twelve months ended June 30, 2010, an increase in net income of $4,947,903, or 54.6%. This translates into basic net income per common share of $0.81 and $0.62, and diluted net income per common share of $0.70 and $0.55, for the twelve months ended June 30, 2011 and 2010, respectively. The increase in net income was primarily attributable to an increase in total gross profit of $14,935,004 offset by an increase in selling, general and administrative expenses of $9,525,935 and an increase in the tax provision of $1,360,509 this fiscal year to date compared to the same period in prior year.





Net income margin was 17.2% for the twelve months ended June 30, 2011 compared to 15.3% for the same period last year, an increase of 1.9%. The increase in net income margin for the twelve months ended June 30, 2011 over the period in the previous fiscal year was principally due to an increase in net gains on non-cash related activities such as changes in fair value of our warrants, unamortized beneficial conversion features on convertible notes converted, non-cash impairment loss, and option and stock-based compensation for a total of $2,234,879. If we excluded such net gains, the net income margin would be 14.5% this fiscal year to date compared to 14.4% for the same period in last year.


52





We had Non-GAAP net income of $11,769,996 for the twelve months ended June 30, 2011, as compared to Non-GAAP net income of $8,563,129 for the twelve months ended June 30, 2010, an increase in Non-GAAP net income of $3,206,867, or 37.4 %. This translates into basic Non-GAAP net income per common share of $0.68 and $0.59, and Non-GAAP diluted net income per common share of $0.66 and $0.52, for the twelve months ended June 30, 2011 and 2010, respectively (See Use of Non-GAAP Financial Measures above).





Total other income included a non-cash gain for change in fair value of investor and placement agent warrants of $4,544,061 for the twelve months ended June 30, 2011 compared to $925,063 for the same period in 2010.





Total other income for the twelve months ended June 30, 2011 also comprised of non-cash interest expenses for the unamortized discount of the convertible notes converted in connection with our private placement on January 5, 2010 and non-cash charges for deferred tax expense of $434,726.





Liquidity and Capital Resources





Liquidity is the ability of a company to generate adequate amounts of cash to meet its needs for cash. As of June 30, 2011, we had cash and cash equivalents of $13,344,426 and restricted cash of $11,043, substantially almost all of which is located in financial institutions in China. The following table provides detailed information about our net cash flow for financial statement periods presented in this report:





Summary of Cash Flow StatementsFor the twelve months endedJune 302011


2010Net cash provided by operating activities

$
10,958,943


$
11,751,920Net cash (used in)  investing activities


(14,492,630
)


(7,360,781
)Net cash (used in) provided by financing activities


(1,131,618
)


10,218,759Effect of foreign currency translation on cash and cash equivalents


860,649



45,018Net (decrease) increase in cash and cash equivalent

$
(3,804,656
)

$
14,654,916





On January 5, 2010, pursuant to a Securities Purchase Agreement with 128 accredited investors, we sold 6,000,000 units for aggregate gross proceeds of $12,000,000, each unit consisting of an 8% senior convertible promissory note in the principal amount of $2.0, or the Notes, and one common stock purchase warrant, or the Warrants.   The Notes bear interest at 8% per annum, payable quarterly in arrears on the last day of each of our fiscal quarter s. No principal payments are required until maturity of the Notes on January 5, 2012. Each Note, plus all accrued but unpaid interest thereon, is convertible, in whole but not in part, at any time at the option of the holder, into shares of the Company’s common stock, par value $0.001 per share, at a conversion price of $2.00 per share, subject to adjustment as set forth in the Note. If the convertible note holders did not convert their notes by their maturity date (January 5, 2012), we will need to redeem those convertible notes at $2.0 per each note. Number of outstanding convertible notes was 5,225,000 as of June 30, 2011.  See Note 12 to the accompanying audited financial statements.




53


Effective as of June 30, 2010, we entered into an Amendment and Agreement (the “A&A”) with the representative of the investors pursuant to which we agreed to make certain amendments to the Notes and the Warrants.  Pursuant to the A&A, the anti-dilution protection provisions in the Notes and the Warrants were eliminated and a provision specifically precluding net cash settlement by the Company of the Notes and the Warrants was added.  In return, and subject to certain non-financing exceptions, we agreed not to issue any new equity securities at a price per share below $2.20 until the earlier of (i) January 5, 2013 or (ii) the date on which, collectively with any prior conversions or exercises of Notes and Warrants, 75% of the principal face value of the Notes in the aggregate has been converted into shares of Common Stock and Warrants representing, in the aggregate, 75% of the aggregate shares of Common Stock underlying the Warrants have been exercised. On March 30, 2011, we entered into a Termination Agreement pursuant to which we and the representative of the investors agreed to terminate the A&A because, after further study, we concluded that the original purpose of the A&A (to mitigate the impact of certain non-cash embedded derivative liabilities associated with the Notes, Warrants and certain placement agent warrants) would not be achieved. Therefore, we determined and agreed with the representative of the investors to terminate the A&A and to thereby restore the Notes, Warrants and such placement agent warrants to their original terms.





Comparison of Twelve Months Ended June 30, 2011 and 2010





Net Cash Provided by Operating Activities





Net cash provided by operating activities totaled $10,958,943 for the twelve months ended June 30, 2011 as compared to net cash provided by operating activities of $11,751,920 for the twelve months ended June 30, 2010. The increase in net cash provided by operating activities was primarily due to increases in net income and other payable balances offset by increases in accounts receivable and change in fair value of warrants. We expect our cash flow from operating activities to maintain at positive flow due to strong support of TCM products from the Chinese government in that a national medical and health plan initiated by the Chinese government in 2009, which will eventually cover individual health insurance over 90% of China’s population by 2011 and includes traditional Chinese medicines for coverage and reimbursement from hospitals and medical centers all over China.





Net Cash Used In Investing Activities





Net cash used in investing activities was $14,492,630for the twelve months ended June 30, 2011 and $7,360,781 for the twelve months ended June 30, 2010.  The increase in cash used in investing activities was due to a cash payment of $7,242,222 for the purchase of 14 State approved TCM formulas.





Net Cash Used in (Provided by) Financing Activities





Net cash used by financing activities totaled $1,131,618 for the twelve months ended June 30, 2011 as compared to net cash provided by financing activities of $10,218,759 for the same period in 2010. The reason for the decrease in cash provided by financing activities was due to net cash received of $10.4 million from convertible notes issued in connection with our private placement on January 5, 2010.





Cash Position





As of June 30, 2011, we had cash of $13,344,426 as compared to $17,149,082 as of June 30, 2010, a decrease of $3,804,656. This decrease was due primarily to increase in cash from operating activities of approximately $11.0 million and cash receipt of approximately $1.9 million from restricted shares issued to Chinese investors offset by cash payment of approximately $7.2 million for the purchase of leased land use rights from the Shandong provincial government, cash payment of $7.2 million for 14 State approved TCM formulas and cash payment of $4.5 million for short term bank loan.





We believe that we can meet our liquidity and capital requirements for our ongoing operations from our currently available working capital and maintain our operations at our current levels.





However, during the current fiscal year and thereafter, we will be required to fund two significant obligations (as well as others described under Obligations of Material Contracts below):





(i)
the completion of the acquisition of Yantai Tianzheng (currently $12 million is due within 12 months, and a total of $29 million is due); and





(ii)
the repayment our convertible promissory notes due January 5, 2012 (currently $10.45 million due).


54




As such, we will be required to raise substantial additional capital to fund these obligations, either through the issuance of debt or equity securities, bank loans or other methods.  Readers are cautioned that additional funding, capital or loans may be unavailable to us on favorable terms, if at all.  If adequate funds are not available, we would likely have to renegotiate the terms of these obligations, which we may be unable to do on favorable terms.  We may thus be required to agree to unfavorable terms which could have a material adverse effect on us, our financial condition and our results of operations in 2011 and beyond.  Moreover, to the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in ownership and potentially economic dilution to existing shareholders.




In addition, if we are faced with worldwide financial and credit crises as occurred in 2008 and 2009 and very recently in 2011, it may make the future cost of raising funds through the debt or equity markets more expensive or make financial markets unavailable to us at times when we require additional financing.





Critical Accounting Policies and Estimates





Recently Adopted Accounting Pronouncements





In January 2010, FASB issued ASU No. 2010-05, Compensation - Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. This update codifies Emerging Issues Task Force D-110. The adoption of this standard did not have a material impact to the Company’s consolidated financial statements.




In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. This standard is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this standard did not have a material impact to the Company’s consolidated financial statements.





Recent Accounting Pronouncements Not Yet Adopted





In April 2010, the FASB issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades - a consensus of the FASB Emerging Issues Task Force.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  Earlier application is permitted.  We do not expect the provisions of ASU 2010-13 to have a material effect on our consolidated financial statements.





In December 2010, FASB issued ASU No. 2010-28, Intangibles - Goodwill and Other(ASC Topic 350). Under Topic 350 on goodwill and other intangible assets, testing for goodwill impairment is a two-step test. When a goodwill impairment test is performed (either on an annual or interim basis), an entity must assess whether the carrying amount of a reporting unit exceeds its fair value (Step 1). I f it does, an entity must perform an additional test to determine whether goodwill has been impaired and to calculate the amount of that impairment (Step 2).  The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist.  The qualitative factors require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted.  The Company is assessing the impact of adopting this on our consolidated financial statements


55





In December 2010, FASB issued Accounting Standards Update (ASU) No. 2010-29, Business Combinations(ASC Topic 805). The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination(s). The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is permitted. The Company is currently assessing the impact on our financial statement disclosures.





In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about the fair value measurements. The amendments include the following:





·
Those that clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements.





·
Those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.





The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  Early application by public entities is not permitted.





The Company is currently evaluating the impact, and does not expect the adoption of this amendment have a material impact on the Company’s consolidated financial statements.





In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The presentation option under current GAAP to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity has been eliminated.





The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted because compliance with amendments is already permitted. The Company already complies with this presentation.





Obligations under Material Contracts





The following table summarizes our contractual obligations as of June 30, 2011, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.


56





Payments Due by PeriodTotal


Less than 1 year


1-3 Years


4-5 years


5 Years+Contractual Obligations:Bank loans (RMB 5,950,000)

$
920,554


$
920,554


$
-


$
-


$
-Research and development (RMB 6,700,000)


1,036,590



1,036,590



-



-



-Convertible notes


10,450,000



10,450,000



-



-Raw material purchase obligations * (RMB 10,147,095)


1,569,907



1,569,907



-



-



-Tianzheng acquisition **


35,000,000



18,000,000



17,000,000



-



-Total Contractual Obligations:

$
48,977,051


$
31,977,051


$
17,000,000


$
-


$
-





* Various raw material purchase contracts, contractual obligation fulfilled in July 2011.


** Incurred after June 30, 2011 $6 million of this amount has been paid as of the date of this Annual Report.





Other than discussed above, there are no other foreseeable material commitments or contingencies as of June 30, 2011.





Off-Balance Sheet Arrangements





We did not engage in any “off-balance sheet arrangements” (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) during the twelve months ended June 30, 2011. We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our condensed consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to   an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.





Currency Exchange Risk





Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies.  Substantially all of our revenue and expenses are in the Chinese currency, the Renminbi.  We are subject to the effects of exchange rate fluctuations with respect to any of these currencies.  For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market.  Since 1994, the official exchange rate for the conversion of the Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar.  In July 2005, the Chinese government changed its policy of pegging the value of the Renminbi to the U.S. dollar.  Under this policy, which was halted in 2008 due to the worldwide financial crisis, the Renminbi was permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies.  In June 2010, the Chinese government announced its intention to again allow the Renminbi to fluctuate within the 2005 parameters.  It is possible that the Chinese government could adopt an even more flexible currency policy, which could result in more significant fluctuation of Renminbi against the U.S. dollar, or it could adopt a more restrictive policy.  We can offer no assurance that the Renminbi will be stable against the U.S. dollar or any other foreign currency.




57


Our consolidated financial statements are translated into U.S. dollars at the average exchange rates in each applicable period.  To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations.  Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations.  We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign consolidated subsidiaries into U.S. dollars in consolidation.  If there is a change in foreign currency exchange rates, the conversion of the foreign consolidated subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income.  In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency.  Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss.  We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future.  The availability and effectiveness of any hedging transaction may be limited and we may not be able to hedge our exchange rate risks. Most of our transactions are settled in Renminbi and U.S. dollars.  We are not exposed to significant foreign currency risk.





Credit risk





Our potential credit risk is mainly attributable to its debtors and bank balances.  In respect of debtors, we have policies in place to ensure that it will only accept customers from countries which are politically stable and customers with an appropriate credit history.  In addition, all the bank balances were made with financial institutions with high-credit quality.  Thus, we are not considered to be subject to significant credit risk.





Interest rate risk





Our interest rate risk is primarily attributable to its short-term borrowings, loan to a third party and loan to equity holders.  Our borrowings carry interest at fixed rate.  Our management has not used any interest rate swaps to hedge its exposure to interest rate risk.





Inflation





In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as -2.2%. These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.





Item 7A.  Quantitative and Qualitative Disclosures about Market Risk.





We are a “smaller reporting company” as defined by Regulation S-K and as such, are not required to provide the information contained in this item pursuant to Regulation S-K.





Item 8.  Financial Statements and Supplementary Data.





Our Consolidated Financial Statements and Notes thereto and the report of Marcum Bernstein Pinchuk LLP, our independent registered public accounting firm, are set forth on pages F-1 through F-36 of this Annual Report.





Item 9.  Changes In and Disagreements with Accountants On Accounting and Financial Disclosure.





Effective January 29, 2010, upon the approval of our board of directors, we dismissed John Kinross-Kennedy as our independent registered public accountant.





During the prior fiscal years ended May 31, 2009 and 2008, John Kinross-Kennedy’s reports on the financial statements of our company contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principle.





During the fiscal years ended May 31, 2009 and 2008 and subsequent period through January 29, 2010, there were no disagreements (as defined in Item 304(a)(1)(iv) of Regulation S-K) between us and John Kinross-Kennedy on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of John Kinross-Kennedy, would have caused him to make reference thereto in his report on financial statements for such years.


58





During the fiscal years ended May 31, 2009 and 2008 and subsequent period through January 29, 2010, there were no reportable events as defined in Regulation S-K Item 304(a)(1)(v).





On January 29, 2010, upon the approval of our board of directors, Parker Randall CF (H.K.) CPA Limited (the “Parker Randall”) was appointed as our independent registered public accounting firm.  During our prior fiscal years ended May 31, 2009 and 2008 and subsequent period through January 31,2010, we did not consult with Parker Randall regarding any of the matters or events set forth in Item 304(a)(2)(i) and Item 304(a)(2)(ii) of Regulation S-K.





On June 24, 2011, the audit committee of our board of directors (the “Audit Committee”) approved the dismissal of Parker Randall as the Company’s independent registered public accounting firm, effective as of June 28, 2011.





During the Company’s fiscal years ended June 30, 2009 and June 30, 2010, Parker Randall’s audit reports on the Company’s consolidated financial statements did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles.





During the Company’s fiscal years ended June 30, 2009 and June 30, 2010 and the subsequent period through June 28, 2011: (i) there were no disagreements between the Company and Parker Randall on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedures which, if not resolved to Parker Randall’s satisfaction, would have caused Parker Randall to make reference in connection with Parker Randall’s opinion to the subject matter of the disagreement; and (ii) there were no reportable events as the term described in Item 304(a)(1)(iv) of Regulation S-K.





Concurrently with the decision to dismissParker Randall as the Company’s independent auditor, the Audit Committee appointed Marcum Bernstein & Pinchuk LLP (“Marcum”) as the Company’s independent registered public accounting firm as of June 24, 2011.





Item 9A.  Controls and Procedures.





Evaluation of Disclosure Controls and Procedures





As of the end of the period covered by this Annual Report, our President and Chief Executive Officer and our Chief Financial Officer (the “Certifying Officers”), conducted evaluations of our disclosure controls and procedures.  As defined under Sections 13a–15(e) and 15d–15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is 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 an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the Certifying Officers, to allow timely decisions regarding required disclosures.





Based on this evaluation, the Certifying Officers have concluded that our disclosure controls and procedures were, due to certain factors, not effective to ensure that material information is recorded, processed, summarized and reported by our management on a timely basis in order to comply with our disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder.





During our fourth fiscal quarter ended June 30, 2011, we restated our consolidated financial statements and related Management’s Discussion and Analysis of Financial Conditions of Operations for the fiscal year ended June 30, 2010 and for the interim periods ended, September 30, 2010, December 31, 2010, and March 31, 2011 which restatements are more fully described in our Current Report on Form 8-K, filed with the SEC on September 14, 2011.


59





In light of such restatements, the Certifying Officers and our board of directors are assessing the effect of such restatements on our internal control over financial reporting and its disclosure controls and procedures.





A material weakness (within the meaning of PCAOB Auditing Standard No. 5) 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 our annual or interim financial statements will not be prevented or detected on a timely basis.  A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness: yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.





The Certifying Officers assessed the effectiveness of our internal control over financial reporting as of June 30, 2011.  Management identified a significant deficiency related to the following:





1.           Lack of internal audit functions–We do not have sufficient documentation with our existing financial processes, risk assessment and internal controls.  Although we maintain certain internal audit functions, the scope and effectiveness goals of internal audit function have not been identified.  Due to this weakness, we may be ineffective in timely prevention or detection of errors in the recording of accounting transactions, which may have a material impact on our financial statements.





The Certifying Officers assessed the effectiveness of our internal control over financial reporting as of June 30, 2011.  Management identified a material weakness related to the following:





1.           Intangible assets–There was a material weakness in the accounting process related to evaluating differences in calculating the deferred tax liability for our traditional Chinese medicine between US GAAP and Chinese GAAP, which resulted in financial restatements for the fiscal year ended June 30, 2010 and for the interim periods quarter ended September 30, 2010, December 31, 2010, and  March 31, 2011.





In order to correct the foregoing deficiencies, we have taken the following remediation measures:





1.           We plan to work closely with our audit committee and external financial advisors to provide US GAAP training to our accounting and auditing staff, which we hope will remedy matters such as the material weakness described above.





2.           We plan to work more closely with our audit committee and external financial advisors to document the existing financial processes, risk assessment and internal controls systematically.





We believe that the foregoing steps will remediate the significant deficiency and material weakness identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.





Changes in Internal Control over Financial Reporting





Subject to the foregoing disclosure, there were no changes in our internal control over financial reporting during our fiscal year ended June 30, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.





Limitations on the Effectiveness of Internal Controls





Readers are cautioned that our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any control design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.


60





Item 9B.  Other Information.





None.




61


PART III





Item 10.   Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(A) of the Exchange Act.





The following table sets forth the name, age, and position of our directors, our executive officers and key employees as of the date of this Annual Report.  Executive officers are elected annually by our board of directors.  Each executive officer or key employee holds his office until he resigns, is removed by the board of directors, or his successor is elected and qualified, subject to applicable employment agreements.  We have a classified board of directors under which each of our directors is designated as a part of one of three separate classes, with the directors in one class being elected annually by our shareholders at our annual meeting of shareholders for a term of three years.  Each director holds his office until his successor is elected and qualified or his earlier resignation or removal.  As used below, the term “Bohai” means Yantai Bohai Pharmaceuticals Group Co., Ltd., a PRC company and our operating subsidiary.





Name

Age

Position/Director ClassHongwei Qu

36

President, Chief Executive Officer and Chairman of the Board of Directors (Class 1)Gene Hsiao

48

Chief Financial Officer, Director (Class 3)Ning Tang

51

Vice President – OperationsHongbin Shan

42

Vice President – Sales and MarketingChunhong Jiang

46

Secretary and TreasurerChengde Wang

63

Director (Class 1)Adam Wasserman

47

Director (Class 3)Thomas Tan

49

Director (Class 2)





Hongwei Qu.  Mr. Qu became our President, Chief Executive Officer, Interim Chief Financial Officer, Treasurer and Secretary as of January 5, 2010, and, became the sole director and Chairman of the our board of directors effective as of January 16, 2010 upon filing of Schedule 14(f) with the SEC on January 6, 2010 in compliance with Section 14(f) of the Exchange Act.  Mr. Qu relinquished the positions of Interim Chief Financial Officer, Secretary and Treasurer in June 2010.  From 2001 to May 2007, Mr. Qu was the founder and principal officer of Yantai Hangwei Medical Trading Co., a PRC company engaged in the wholesale of drugs and medical products and retail of medical devices. In May 2007, Mr. Qu took principal responsibilities for the acquisition of Bohai.  From May 2007 until present, Mr. Qu has served as the General Manger and Executive Director of Boha. . Mr. Qu has significant experience in the medical and pharmaceutical sectors in China.  Mr. Qu graduated from Shandong Economic University with a bachelor degree.





Gene Hsiao became a director of the Company on February 2, 2011. Mr. Hsiao has served as the Company’s Chief Financial Officer since June 2010.  Mr. Hsiao has over 15 years of experience in corporate finance and management.  Prior to his joining the Company, Mr. Hsiao served as Chief Financial Officer for China Advanced Construction Materials Group Inc. (NASDAQ:CADC) from 2008 to 2010, where he was responsible for all U.S. affairs as well as corporate finance functions in China.  From 2000 to 2008, he served as Controller of Milligan and Company, LLC, where he managed the overall accounting and financial reporting functions as well as the company’s internal control processes.  From 1997 to 1999, he served as Finance Manager for J&J Snack Foods Corporation (Nasdaq:JJSF), where he was responsible for financial reporting and SEC schedule preparation.  From 1995 to 1997, he served as Accounting Supervisor of RCN Corporation (NASDAQ:RCNI) and as the Senior Operation Analyst at ARAMARK Corporation from 1992 to 1995.  Mr. Hsiao received his B.S. degree from Drexel University in Philadelphia.





Ning Tang was appointed as Bohai’s Vice President — Operations in November 2007 and our Vice President – Operations in June 2010.  Mr. Tang has over 25 years of experience in management of pharmaceuticals companies in China.  Prior to his appointment with Bohai, Mr. Tang served as General Manager for Yantai Xiangyu Environmental Protection Equipment Co., Ltd. from 2004 to 2007, where he was responsible for all affairs of corporate operations in China.  He served as Vice President of Yantai Rongchang Pharmaceuticals Co., Ltd. from 1998 to 2004, where he managed the departments of operation, administration, manufacturing and product quality.  From 1986 to 1998, he served as Deputy Director for Yantai TCM Pharmaceuticals Corporation, where he was responsible for production, product quality, purchase, research and development and sales.  He received his B.S. degree in international trade and business from Shandong Economic University.


62


Hongbin Shan was appointed as Bohai’s General Manager of Sales in May 2010 and as the Vice President – Sales and Marketing as of June 2010.  Mr. Shan has over 10 years of experience in sales, marketing and management.  Prior to his appointment with us, from 1994 to 2010, Mr. Shan served as General Manager for the Qingdao Branch, Shandong Province of Shandong Green Leaf Pharmaceutical Co., Ltd. and manager of the Su-Min Region (including Jiangsu, Fujian, Hubei, Jiangxi and Anhui provinces) where he was responsible for all affairs of marketing and sales.  He also served in the capacity of Assistant Director of the Oncology Division, responsible for the national market of Shandong Green Leaf’s tumor line.  He received his B.S. degree from Yantai University and educational certificate from the senior MBA program of Tsinghua University.





Chunhong Jiang was appointed as Bohai’s General Manager of Finance, Secretary and Treasurer in May 2007 and as our Secretary and Treasurer in June 2010.  Ms. Jiang has over 20 years of experience in corporate finance, accounting and management.  Prior to her appointment with Bohai, Ms. Jiang served as Financial Manager for Yantai Furao Trading Group from 2004 to 2007.  She served as Financial Manager and department director for Yantai Garment Company, a subsidiary of China Garment Group from 1994 to 2003, where she was responsible for overall accounting and financial reporting functions. She served as statistician, accountant and financial chief for Yantai Hardware Factory from 1987 to 1993, where she managed the overall statistics, accounting and financial reporting functions.  She graduated from Shandong Economic University.





Chengde Wang became an independent director of our company on July 12, 2010.  Mr. Wang has served as the director medical doctor and Ph.D./MD advisor of Beijing Shuntiande Chinese Medicine Hospital since October 2005, where he is responsible for managing medical practice and research projects.  Prior to joining Beijing Shuntiande Chinese Medicine Hospital, Mr. Wang worked at Guang Anmen Hospital under China Academy of Chinese Medical Science and was the professor and the chief physician in the Beijing University of Chinese Medicine.  Mr. Wang is an expert in Traditional Chinese Medicine and has been honored by the P.R.C. State Council.  He is a member of National Committee of The Chinese People’s Political Consultative Conference, a director of Cooperation Center of State Administration of Traditional Chinese Medicine with Taiwan, Hong Kong and Macao, director and Secretary-General of the Center of Traditional Chinese Medicine Society and expert of review committee of National Essential Drugs Association.  Mr. Wang graduated from Beijing University of Chinese Medicine.





Adam Wasserman became an independent director of our company on July 12, 2010.  Mr. Wasserman has served as the chief financial officer of Gold Horse International, Inc. (OTCBB:GHII) since July 2007, chief financial officer of Emerald Acquisition Corporation (PINK:PEAR) since June 2010 and as a director of China Direct Industries, Inc. (NASDAQ:CDII) since January 2010.  Since November 1999, Mr. Wasserman has been CEO of CFO Oncall, Inc., a Weston, Florida-based provider of consulting and accounting services specializing in SEC reporting, financial reporting, budgeting and planning, mergers and acquisitions, audit preparation services, accounting department supervision, and internal controls.  Mr. Wasserman has previously served as the chief financial officer of China Wind Systems, Inc. (November 2007 to December 2008), Genesis Pharmaceuticals Enterprises, Inc. (October 2001 until October 2007), and other companies, all client companies of CFO Oncall, Inc.  From June 1991 to November 1999, he was Senior Audit Manager at American Express Tax and Business Services, in Fort Lauderdale, Florida where his responsibilities included supervising, training and evaluating senior staff members, work paper review, auditing, maintaining positive client relations, preparation of tax returns and preparation of financial statements and the related footnotes. From September 1986 to May 1991, he was employed by Deloitte & Touche, LLP.  During his employment, his significant assignments included audits of public (SEC reporting) and private companies, tax preparation and planning, management consulting, systems design, staff instruction, and recruiting.  Mr. Wasserman holds a Bachelor of Science in Accounting from the State University of New York at Albany.  He is a member of The American Institute of Certified Public Accountants and is a director, treasurer and executive board member of Gold Coast Venture Capital Association.




63




Thomas Tan became an independent director of our company on September 6, 2011. Mr. Tan has over 15 years of experience in corporate finance and management in the United States. In the last 3 years, he has served as the Managing Director of Capital Markets Group at Euro Pacific Capital, Inc., responsible for leading private placements for US listed Chinese companies and Canadian listed mining companies.  In addition, Mr. Tan has focused on the precious metals and mining sectors since 2004, becoming, at the time, a popular independent blogger, writer and contributor for many financial and precious metal websites.  Many of Mr. Tan’s articles were published and treated as Editor’s Picks by Seeking Alpha.  Before joining Euro Pacific in 2008, from 1998 to 2008, Mr. Tan served in various corporate finance positions at Pfizer, Inc. in the financial planning and analysis area,supporting research and development, legal and manufacturing functions.  In 1997, he worked briefly as a banker for the Capital Markets Group at Cargill, Inc.  Mr. Tan holds an MBA in Finance from the Fuqua School of Business at Duke University and has held the Chartered Financial Analyst (CFA) designation since 2004.




Audit, Nominating, Compensation Committees and Director Independence





Our board of directors is comprised of a majority of “independent” directors (as defined under the Nasdaq Marketplace rules).





As part of obligations under the Securities Purchase Agreement in connection with our January 2010 private placement, one of our directors is designated by Euro Pacific Capital, the lead placement agent for such private placement.  Louis A. Bevilacqua is the director designated by Euro Pacific Capital.





Effectively February 2, 2011, the Board established three committees of the Board: an Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee.  In addition, the Board appointed the following directors to serve on such committees, as indicated below;





Audit Committee

Chairman: Adam WassermanMembers: Thomas TanNominating and Corporate

Governance Committee

Chairman: Thomas Tan

Members: Chengde WangCompensation Committee

Chairman: Thomas Tan

Members: Chengde Wang





Note: Louis A. Bevilacqua resigned from our board of directors on July 28, 2011 and Anthony K. Chan resigned from board of directors on August 31, 2011.





The Board of Directors has determined that Mr. Wasserman qualifies as an “audit committee financial expert” as defined by applicable SEC rules.





Communication with our Directors





Shareholders or other interested parties may communicate with our directors by sending mail to Mr. Hongwei Qu, c/o Yantai Bohai Pharmaceuticals Group Co. Ltd., No.9 Daxin Road, Zhifu District, Yantai, Shandong Province, China 264000.





Board of Directors’ Meetings





During our fiscal year ended June 30, 2010, we did not hold any meetings of the board of directors, although our board of directors did act by unanimous written consent.





Section 16(a) Beneficial Ownership Reporting Compliance





Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers, directors and persons who beneficially own more than 10% of a registered class of our equity securities (“ten percent shareholders”) to file reports of ownership and changes in ownership with the SEC. Officers, directors and ten percent shareholders are charged by the SEC regulations to furnish us with copies of all Section 16(a) forms they file.


64




Based solely upon a review of copies of Section 16(a) reports and representations received by us from reporting persons, and without conducting any independent investigation of our own, in fiscal year ended on June 30, 2010, our officers, directors and ten percent shareholders are in compliance with Section 16(a).





Item 11. Executive Compensation





The following table sets forth all compensation received during the last two fiscal years by our Chief Executive Officer, Chief Financial Officer and each of the other most highly compensated executive officers whose total compensation exceeds $100,000 in such fiscal years.  These officers are referred to as the Named Executive Officers in this Annual Report.





All the executive officers were paid in RMB and the amounts reported in this table have been converted from Renminbi to U.S. dollars based on the June 30, 2011 conversion rate of RMB 6.6278 to $1.00.





SUMMARY COMPENSATION TABLENameand Principal

Position

Fiscal

Year

Salary

($)


Bonus

($)


Stock

Awards

($)


Option

Awards

($)


Non-Equity

Incentive Plan

Compensation

($)


Change in

Pension Value

and

Nonqualified

Deferred

Compensation

Earnings

($)


All Other

Compensation

($)


Total

($)Hongwei Qu

2011

$
36,211



-



-



-



-



-



-


$
36,211Chief Executive Officer

2010

$
35,105



-



-



-



-



-



-


$
35,105Gene Hsiao

2011

$
120,000






$
95,000



-



-



-



-


$
215,000Chief Financial Officer

2010

$
9,000-



-



-



-



-



-



-


$
9,000





Employment Agreements





We presently do not have any employment agreements or other compensation arrangements with Mr. Qu.





On June 4, 2010, we entered into an employment agreement with Gene Hsiao, our Chief Financial Officer (the “Hsiao Agreement”).  The Hsiao Agreement provides for with an initial term of three (3) years and an annual base compensation of $120,000.  Pursuant to the Hsiao Agreement, Mr. Hsiao will be eligible for an annual bonus, if any, as may be determined by the Company and for customary benefits generally available to all of the Company’s officers, and may earn up to 120,000 shares of the Company’s common stock, which shall vest on a yearly basis at a rate of 40,000 shares each year provided that he is employed by the Company.





We may terminate the Hsiao agreement without cause and Mr. Hsiao may resign upon 30 days advance written notice. We may immediately terminate the Hsiao agreement for Cause (as defined in the agreement). Upon the termination of the Hsiao agreement for any reason, Mr. Hsiao will continue to receive payment of any base salary earned but unpaid through the date of termination and any other payment or benefit to which he is entitled under the applicable terms of any applicable company arrangements. If Mr. Hsiao is terminated during the term of the employment agreement other than for Cause (as defined in the Hsiao agreement), Mr. Hsiao is entitled to a lump sum severance payment equal to 3 months of his base compensation. The Hsiao agreement will terminate prior to its scheduled expiration date in the event of Mr. Hsiao’s death or disability.


65





The Hsiao agreement also includes a 1 year non-competition and non-solicitation and confidentiality covenants. Under the terms of this agreement, he is also entitled to 2 weeks paid vacations and expense reimbursement.





Director Compensation


Name (a)

Fees

Earned

orPaid

inCash

($)(1)


Stock

Awards

($)


Option

Awards

($)


Non-Equity

Incentive Plan

Compensation

($)


Non-Qualified

Deferred

Compensation

Earnings

($)


All Other

Compensation

($)


Total($)Hongwei Qu


-



-



-



-



-



-



-Chengde Wang


-



-







-



-



-



-Louis A. Bevilacqua *

$
14,000



-


$
18,342



-



-



-


$
32,342Adam Wasserman

$
19,200



-


$
5,502



-



-



-


$
24,702Gene Hsiao


-



-







-



-



-Anthony K. Chan **

$
8,333



-


$
3,184



-



-



-


$
11,517





*         Mr. Bevilacqua resigned from our board of directors on July 28, 2011.


**       Mr. Anthony K. Chan resigned from our board of directors on August 31, 2011.





Hongwei Qu is paid in his capacity as executive officer of our company and he does not receive any additional compensation for his service as director.





Gene Hsiao is paid in his capacity as chief financial officer of our company and he does not receive any additional compensation for his service as director.





On July 6, 2010, Adam Wasserman entered into an independent director and indemnification agreement with the Company, and on January 11, 2010, Dr. Chengde Wang entered into such agreements with the Company, each of which became effective on July 12, 2010 with their appointments to the Company’s board of directors and the Company’s execution thereof.  On September 6, 2011, Thomas Tan entered into an independent director and indemnification agreement with the Company and it is effective as of such date.  The form of independent director and indemnification agreements are filed as Exhibit 10.1 to our Current Report on Form 8-K, dated July 13, 2010 (the “Independent Director Agreement”).





Pursuant to the Independent Director Agreements:





(i)           each independent director will be retained as a director of the Company until the director or the Company terminates the agreement upon thirty (30) days prior written notice, with or without cause;





(ii)          Mr. Wasserman and Mr. Tan receive a $20,000 annual director’s fee and a five year non-qualified option to purchase 6,000 shares of restricted common stock of the Company at a price equal to $2.00 per share with cashless exercise feature; and





(iii) Dr. Wang receives a $22,000 annual director’s fee.





The Independent Director Agreement also contains standard confidentiality provisions and provides that the Company shall indemnify the directors to the fullest extent permitted by law against personal liability for actions taken in the performance of their duties to the Company.


66


Item 12.  Security Ownership of Certain Beneficial Owners and Management





The table sets forth below certain information regarding the beneficial ownership of our common stock as of the date of this Annual Report, based on 17,861,085 aggregate shares of common stock outstanding as of such date, by: (i) each person who is known by us to own beneficially more than 5% of our outstanding common stock with the address of each such person, (ii) each of our present directors and officers, and (iii) all officers and directors as a group. Beneficial ownership is determined in accordance with SEC rules and generally includes voting or investment power with respect to securities. Unless otherwise indicated, the shareholders listed in the table have sole voting and investment power with respect to the shares indicated. Unless otherwise noted, the principal address of each of the shareholders, directors and officers listed below is No. 9 Daxin Road, Zhifu District, Yantai, Shandong Province, China. All share ownership figures include shares of our Common Stock issuable upon securities convertible or exchangeable into shares of our Common Stock within sixty (60) days of the date of this Annual Report, which are deemed outstanding and beneficially owned by such person for purposes of computing his or her percentage ownership, but not for purposes of computing the percentage ownership of any other person.





Name of Beneficial Owner

Shares of Common

Stock Owned


Percent of Class

Beneficially Owned (1)Glory Period Limited (2)(3)(4)


8,942,471



50.18
%Hongwei Qu (4)


8,942,471



50.18
%Gene Hsiao (5)


40,000



0.22
%Chengde Wang (6)


—



—Adam Wasserman (7)


—



—Thomas Tan (8)


—



—All Executive Officers and Directors as a group


8,982,471



50.40
%





(1)
Based on 17,861,085 shares of common stock issued and outstanding as of June 28, 2011.


(2)
Joshua Tan is the sole shareholder of Glory Period, but pursuant to a Call Option Agreement, he has no right to sell any shares without prior written consent by Hongwei Qu.


(3)
Hongwei Qu is the executive director of Glory Period.


(4)
On December 7, 2009, Mr. Qu, who is a PRC citizen, entered into the Call Option Agreement with Mr. Tan, a Singapore passport holder and the sole shareholder of Glory Period.  Under the Call Option Agreement, Mr. Qu shall have right and option to acquire up to 100% shares of Glory Period for nominal consideration within the next 3 years.  The Call Option Agreement also provides that Mr. Tan shall not dispose any of the shares of Glory Period without Mr. Qu’s consent.


(5)
Mr. Hsiao is our Chief Financial Officer and also a director of our company.  Pursuant to his employment agreement with us, Mr. Hsiao is entitled to be granted up to an aggregate of 120,000 shares of our common stock, vesting in three annual installments of 40,000 beginning June 4, 2011, provided he is then employed by our company.


(6)
Dr, Wang is a director of our company.


(7)
Mr. Wasserman is a director of our company.  Pursuant to his independent director agreement with us, Mr. Wasserman is expected to receive, effective October 13, 2010, and provided he is still serving with our company, a five year non-qualified option to purchase 20,000 shares of restricted common stock of the Company at a price equal to $2.00 per share with cashless exercise feature.


(8)
Mr. Tan is a director of the Company. Pursuant to his independent directors agreement with us, Mr. Chan is expected to receive, effective September 6, 2011, and provided he is still serving with our company, a five year non-qualified option to purchase 20,000 shares of restricted common stock of the Company at a price equal to $2.00 per share with cashless exercise feature




67


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





Chance High owns 100% of the issued and outstanding capital stock of WFOE, a wholly foreign owned enterprise incorporated under the laws of the PRC.  On December 7, 2009, WFOE entered into the VIE Agreements with Bohai, a company incorporated under the laws of the PRC, and its three shareholders which include Mr. Qu (our President and Chief Executive Officer, who owns 90% of Bohai’s shares) and two unaffiliated parties.  Pursuant to the VIE Agreements, WFOE does not directly own the equity of our operating subsidiary, but rather assumed management of the business activities of Bohai and has the right to appoint all executives and senior management and the members of the board of directors of Bohai.  The VIE Agreements are comprised of a series of agreements, including a Consulting Services Agreement, Operating Agreement, Proxy Agreement, Equity Pledge Agreement, and Option Agreement, through which WFOE has the right to advise, consult, manage and operate Bohai for an annual fee in the amount of Bohai’s yearly net profits after tax.  Additionally, Bohai’s shareholders have pledged their rights, titles and equity interest in Bohai as security for WFOE to collect consulting and services fees provided to Bohai through an Equity Pledge Agreement. In order to further reinforce WFOE’s rights to control and operate Bohai, Bohai’s shareholders have granted WFOE the exclusive right and option to acquire all of their equity interests in Bohai through an Option Agreement.





Through WFOE, Chance High operates and controls Bohai through the VIE Agreements. WFOE used the contractual arrangements to acquire control of Bohai, instead of using a complete acquisition of Bohai’s assets or equity to make Bohai a wholly-owned subsidiary of WFOE because: (i) PRC laws governing share exchanges with foreign entities, which became effective on September 8, 2006, make the consequences of such acquisitions uncertain and (ii) other than by share exchange transactions, PRC laws require Bohai to be acquired for cash and WFOE was not able to raise sufficient funds to pay the full appraised value for Bohai’s assets or shares as required under PRC laws.





Slow Walk Arrangements





On December 7, 2009, Mr. Qu, who is a PRC citizen, entered into the Call Option Agreement with Joshua Tan, a Singapore passport holder and the sole shareholder of Glory Period.  Under the Call Option Agreement, Mr. Qu shall have right and option to acquire up to 100% shares of Glory Period for nominal consideration within the next 3 years.  The Call Option Agreement also provides that Mr. Tan shall not dispose any of the shares of Glory Period without Mr. Qu’s consent.





Guarantee for the loans with banks by Mr. Qu





Mr. Qu, our President, Chief Executive Officer and Chairman, is providing a guaranty for Bohai’s loans with Pudong Development Bank Qingdao Branch in a total amount of $2.2 million, or RMB 15 million. As of March 31, 2011, the loans were paid in full.





Loans to Mr. Qu





As of September 30, 2009, Bohai extended a loan of $1,465,000 to Mr. Qu.  The loan was unsecured, interest bearing at 3.93% per annum and has no fixed term of repayment.  The loan was repaid on December 10, 2009.





Other





Other than employment and the foregoing arrangements, none of the following persons has any direct or indirect material interest in any transaction to which we are a party since our incorporation or in any proposed transaction to which we are proposed to be a party: (i) any of Bohai’s directors or officers; (ii) any person who beneficially owns, directly or indirectly, shares carrying more than 10% of the voting rights attached to our common stock; or any relative or spouse of any of the foregoing persons, or any relative of such spouse, who has the same house as such person or who is a director or officer of any parent or subsidiary of our company.




68


Review, Approval or Ratification of Related Party Transactions





Our board of directors is responsible for reviewing all “Related Person Transactions” as defined by Item 404 of Regulation S-K of the rules promulgated by the SEC.  Directors and executive officers are responsible for bringing a potential Related Person Transaction to the attention of our Board.





In reviewing a related person transaction, our board of directors will, after reviewing all material information regarding the transaction, take into account, among other factors it deems appropriate, whether the transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the related person’s interest in the transaction.





Item 14.  Principal Accountant Fees and Services.





The following table sets forth fees billed to us by our independent registered public accounting firms Marcum Bernstein & Pinchuk, LLP, John Kinross-Kennedy and Parker Randall CF (H.K.) CPA Limited (the “Parker Randall”), during the fiscal years ended June 30, 2011 and June 30, 2010, respectfully for: (i) services rendered for the audit of our annual financial statements and the review of our quarterly financial statements; (ii) services by our independent registered public accounting firms that are reasonably related to the performance of the audit or review of our financial statements and that are not reported as audit fees; (iii) services rendered in connection with tax compliance, tax advice and tax planning; and (iv) all other fees for services rendered.





June 2011


June 2010Audit Fees

$
93,000


$
40,000Audit Related Fees


664



6,000Tax Fees


3,000



-All Other Fees


-



-TOTAL

$
96,664


$
46,000


69


Part IV





Item 15.  Exhibits





Exhibit

No.

Description2.1

Share Exchange Agreement, dated January 5, 2010, by and among the Company, Chance High and Shareholders of Chance High (1)3.1

Articles of Incorporation of the Company (2)3.2

Bylaws of the Company (3)3.3

Certificate of Amendment to Articles of Incorporation (4)3.4

Articles of Merger and Agreement and Plan of Merger as filed with the Secretary of State of Nevada on January 29, 2010 (5)4.1

Form of Note issued to the Investors in the Private Placement, dated January 5, 2010 (1)4.2

Form of Warrant issued to the Investors in the Private Placement, dated January 5, 2010 (1)4.3

Form of Placement Agent Warrant issued to affiliates of Euro Pacific Capital, Inc. and to Chardan Capital Markets, LLC, dated January 5, 2010 (1)5.1

Opinion of Ellenoff Grossman & Schole LLP*10.1

Securities Purchase Agreement, dated January 5, 2010, by and among the Company, the Investors in the Private Placement and Euro Pacific Capital, Inc. as representative of the Investors (1)10.2

Registration Rights Agreement, dated January 5, 2010, by and among the Company and the Investors in the Private Placement (1)10.3

Securities Escrow Agreement, dated January 5, 2010, by and among the Company, Euro Pacific Capital, Inc., as representative of the Investors, Glory Period Limited and Escrow, LLC, as escrow agent (1)10.4

Closing Escrow Agreement, dated December 10, 2009, by and among the Company, Euro Pacific Capital, Inc., as representative of the Investors, and Escrow, LLC, as escrow agent (1)10.5

Form of Independent Director Agreement and Indemnify Agreement (6)10.6

Unofficial English Translation of the Intangible Assets Transfer Agreement, dated December 9, 2010, by and between the Company and Shandong Daxin Microbiology Pharmaceutical Industry Co., Ltd. (7)10.7

Form of Subscription Agreement for the Company’s Regulation S financing (8)10.8

Termination Agreement dated and entered into effective for all purposes as of March 30, 2011, by and between the Company and Euro Pacific Capital, Inc., as investor representative. (9)10.9

Unofficial English Translation of Share Purchase Agreement, dated as of August 8, 2011 among WFOE II, Mr. Jiangbo Chi, Ms. Shulian Wang and Mr. Bohai Yu. (10)21.1

Subsidiaries of the Registrant +31.1

Certification of Registrant’s Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934. +31.2

Certification of Registrant’s Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934. +32.1

Certification of Registrant’s Chief Executive Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350. +32.2

Certification of Registrant’s Chief Financial Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350. +99.1

Unofficial English translation of Consulting Services Agreement, dated December 7, 2009, between Bohai and the WFOE (1)99.2

Unofficial English translation of Operating Agreement, dated December 7, 2009, by and among Bohai, its Shareholders and the WFOE (1)99.3

Unofficial English translation of Voting Rights Proxy Agreement, dated December 7, 2009, by and among Bohai, its Shareholders and the WFOE (1)99.4

Unofficial English translation of Equity Pledge Agreement, dated December 7, 2009, by and among Bohai, its Shareholders and the WFOE (1)99.5

Unofficial English translation of Option Agreement, dated December 7, 2009, by and among Bohai, its Shareholders and the WFOE (1)99.6

Unofficial English translation of Call Option Agreement dated December 7, 2009 (1)99.7

Opinion of AllBright Law Offices, dated December 31, 2009, with respect to certain PRC matters (11)





*

Previously filed+

Filed herewith(1)

Incorporated by reference to the Company’s Current Report of Form 8-K, filed on January 11, 2010.(2)

Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement of Form S-1 (File Number 333-153102), filed on August 20, 2008.


70




(3)

Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement of Form S-1 (File Number 333-153102), filed on August 20, 2008.(4)

Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 17, 2009.(5)

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 17, 2009.(6)

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 13, 2010.(7)

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on February 4, 2010.(8)

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on January 25, 2011.(9)

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on April 1, 2011.(10)

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on August 10, 2011.(11)

Incorporated by reference to Exhibit 99.7 to the Company’s Registration Statement on Form S-1, filed on June 1, 2010.


71


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the Audit Committee of the Board of Directors and Shareholders


of Bohai Pharmaceuticals Group, Inc.





We have audited the accompanying consolidated balance sheet of Bohai Pharmaceuticals Group, Inc. and Subsidiaries (the “Company”) as of June 30, 2011 and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.





We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an 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 purpose 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 provide a reasonable basis for our opinion.





In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bohai Pharmaceuticals Group, Inc and Subsidiaries as of June 30, 2011 and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.





/s/ Marcum Bernstein & Pinchuk LLPNew York, New YorkSeptember 28, 2011


F-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the Board of Directors and Stockholders of Bohai Pharmaceuticals Group, Inc.





We have audited the accompanying consolidated balance sheets of Bohai Pharmaceuticals Group, Inc. and Subsidiaries as of June 30, 2010 and the related statements of income, changes in stockholders’ equity and cash flow for the years ended June 30, 2010 and 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.





We conducted our audits 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide 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 Bohai Pharmaceuticals Group, Inc. and Subsidiaries as of June 30, 2010 and 2009, and the results of their operations and their cash flow for the years ended June 30, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.





s/ Parker Randall CF (H.K.) CPA LimitedParker Randall CF (H.K.) CPA Limited Certified Public AccountantHong KongSeptember 28, 2010


F-2


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


CONSOLIDATED BALANCE SHEETS


AS OF JUNE 30, 2011 AND 2010





June 30,2011


2010ASSETSCurrent assets:Cash and cash equivalents

$
13,344,426


$
17,149,082Restricted cash


11,043



576,019Accounts receivable, net


15,891,642



10,409,527Inventories


1,511,021



748,422Prepaid expenses and other current assets


1,060,138



1,489,751Total current assets


31,818,270



30,372,801Property, plant and equipment, net


5,214,962



5,361,609Intangible assets – pharmaceutical formulas


25,019,377



17,342,772Long term prepayments - land use right, net


17,577,271



9,877,087Debt issue costs


485,039



1,562,617TOTAL ASSETS

$
80,114,919


$
64,516,886LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilities:Convertible notes, net of discount of $9,317,897 and $11,375,180 as of June 30, 2011 and 2010, respectively

$
1,132,103


$
124,820Accounts payable


1,291,907



741,621Accrued expenses


4,324,313



2,984,988Income taxes payable


721,771



700,326Short-term borrowings


920,554



4,398,849Derivative liabilities - investor and agent warrants


937,867



5,481,928Total current liabilities


9,328,515



14,432,532Deferred tax liability


2,878,397



2,309,321TOTAL LIABILITIES


12,206,912



16,741,853COMMITMENTS, CONTINGENCIES, AND OTHER MATTERSSHAREHOLDERS' EQUITYCommon stock , $0.001 par value, 150,000,000 shares authorized, 17,861,085 and 16,500,000 shares issued and outstanding  as of June 30, 2011 and 2010, respectively


17,861



16,500Additional paid-in capital


18,345,574



15,317,621Accumulated other comprehensive income


3,559,355



460,570Statutory reserves


2,201,817



2,201,817Retained earnings


43,783,400



29,778,525Total shareholders’ equity


67,908,007



47,775,033TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$
80,114,919


$
64,516,886





See accompanying notes to the consolidated financial statements


F-3




BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





For the Years Ended June 30,2011


2010Revenues

$
81,328,555


$
59,264,724Cost of revenues


17,293,680



10,164,853Gross profit


64,034,875



49,099,871Selling, general and administrative expenses


45,779,010



36,253,075Income from operations


18,255,865



12,846,796Other income (expense)Interest income


52,102



-Interest expense


(4,097,717
)


(1,436,952
)Other income


15,582



126,574Change in fair value of derivative liabilities


4,544,061



925,063Total other income (expenses)


514,028



(385,315
)Income before provision for income taxes


18,769,893



12,461,481Provision for income taxes


(4,765,018
)


(3,404,509
)Net income

$
14,004,875


$
9,056,972Comprehensive income:Net income


14,004,875



9,056,972Other comprehensive incomeUnrealized foreign currency translation gain


3,098,785



127,470Comprehensive income

$
17,103,660


$
9,184,442Earnings per common shareBasic

$
0.81


$
0.62Diluted

$
0.75


$
0.55Weighted average common shares outstandingBasic


17,198,917



14,722,055Diluted


22,423,917



17,569,315





See accompanying notes to the consolidated financial statements


F-4


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010


Common stock





Accumulated

other








Total$0.001


Additional


comprehensive


Statutory





Shareholders’Shares


Par value


paid-incapital


income


reserves


Retained Earnings


EquityBalance at July 1, 2009


13,162,500


$
13,163


$
8,794,838


$
333,100


$
2,201,811


$
20,721,553


$
32,064,465Recapitalization


3,087,500



3,087



419,366



-



-



-



422,453Beneficial conversion feature on convertible notes


-



-



6,175,462



-



-



-



6,175,462Conversion of convertible notes on additional paid-in capital adjustments


250,000



250



(250
)


-



-



-



-Conversion of convertible notes credits on carrying amount and deferred fees


-



-



(71,795
)


-



-



-



(71,795
)Foreign currency translation adjustment


-



-



-



127,470



-



-



127,470Net Income


-



-



-



-



6



9,056,972



9,056,978-Balances at June 30, 2010


16,500,000



16,500



15,317,621



460,570



2,201,817



29,778,525



47,775,033Restricted stock awards


85,000



85



182,415



-



-



-



182,500Amortization of stock options issued at fair value


-



-



27,027



-



-



-



27,027Conversion of convertible notes


527,703



528



948,304



-



-



-



948,832Issuance of common stock for cash


748,382



748



1,870,207



-



-



-



1,870,955Foreign currency translation adjustment


-



-



-



3,098,785



-



-



3,098,785Net Income


-



-



-



-



-



14,004,875



14,004,875Balances at June 30, 2011


17,861,085


$
17,861


$
18,345,574


$
3,559,355


$
2,201,817


$
43,783,400


$
67,908,007





See accompanying notes to the consolidated financial statements


F-5


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





For the Year EndedJune 30,2011


2010Cash flows from operating activitiesNet income

$
14,004,875


$
9,056,972Adjustments to reconcile net income to cash provided by operating activities:Depreciation and amortization


538,105



310,551Bad debt expense


26,737



-Loss on disposal of property, plant and equipment


67,048



10,589Impairment loss on intangible assets – pharmaceutical formulas


635,442



-Accretion of beneficial conversion feature


1,029,487



-Amortization of deferred fees on convertible notes


971,004



510,716Interest expense on convertible notes


1,033,201



132,146Change in fair value of warrants


(4,544,061
)


(925,063
)Stock based compensation


209,527



-Deferred income taxes


434,726



431,220Changes in operating assets and liabilities:Accounts receivable


(4,831,672
)


685,854Other receivables and prepayments


454,382



1,994,621Inventories


(704,725
)


(437,998
)Accrued liabilities


(44,951
)


292,454Accounts payable


498,030



(231,107
)Accrued liabilities


1,197,340



(99,884
)Income taxes payable


(15,552
)


20,849Net cash provided by operating activities


10,958,943



11,751,920Cash flows from in investing activitiesPurchases of property, plant and equipment


(88,152
)


(47,279
)Proceeds from disposal of property, plant and equipment


4,526



-Prepaid land use rights


(7,166,782
)


(7,313,502
)Purchase of intangible assets – pharmaceutical formulas


(7,242,222
)


-Net cash used in investing activities


(14,492,630
)


(7,360,781
)Cash flows from financing activitiesProceeds from short term borrowings


897,734



6,574,838Repayment of short term borrowings


(4,518,845
)


(8,044,852
)Note repayment from equity holder


53,562



1,422,754Payment of debt issue costs


-



(1,570,000
)Proceeds from issuance of convertible promissory notes


-



12,000,000Proceeds from issuance of common stock


1,870,955



-Release (deposit) of restricted cash


564,976



(163,981
)Net cash flows (used in) provided by financing activities


(1,131,618
)


10,218,759Effect of exchange rate change on cash and cash equivalents


860,649



45,018Net (decrease)/increase in cash


(3,804,656
)


14,654,916Cash - beginning of year


17,149,082



2,494,166Cash - end of year

$
13,344,426


$
17,149,082Cash paid during the year for:Interest

$
1,045,013


$
569,184Income taxes

$
4,345,845


$
2,952,441





See accompanying notes to the consolidated financial statements




F-6


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





1.
ORGANIZATION AND PRINCIPAL BUSINESS ACTIVITIES





Bohai Pharmaceuticals Group, Inc. (“BPGI”) was incorporated under the laws of the State of Nevada on January 9, 2008 under the name of Link Resources, Inc. Prior to January 5, 2010, BPGI was a public “shell” company in the exploration stage since its formation and did not realize any revenues from its planned operations.





Pursuant to a Share Exchange Agreement, dated January 5, 2010 (the “Share Exchange Agreement”), BPGI acquired Chance High International Limited, a British Virgin Islands company (“Chance High”), from Chance High’s shareholders (the “Chance High Shareholders”). Pursuant to the terms of the Share Exchange Agreement, BPGI acquired all of the outstanding equity securities of Chance High (the “Chance High Shares”) from the Chance High Shareholders, in exchange, for 13,162,500 newly issued shares of BPGI common stock,   As a result, the former shareholders of Chance High became the majority shareholders of BPGI following the completion of the Share Exchange transaction. Link Resources, Inc. officially changed its name to Bohai Pharmaceuticals Group, Inc. on January 29, 2010.





Chance High owns 100% of the issued and outstanding shares of capital stock of a Chinese wholly-foreign owned enterprise known as Yantai Shencaojishi Pharmaceuticals Co., Ltd. (the “WFOE”).  On December 7, 2009 (prior to the date of the Share Exchange), the WFOE entered into a series of variable interest entity contractual agreements (the “VIE Agreements”) with Yantai Bohai Pharmaceuticals Group Co., Ltd. (“Bohai”), and its three shareholders, who include Mr. Hongwei Qu, (“Mr. Qu”) who owns 90% of the outstanding equity interests of Bohai and two other shareholders who collectively own the remaining 10% of Bohai. Bohai is a Chinese company engaged in the production, manufacturing and distribution of herbal medicines, including capsules and other products, based on traditional Chinese medicine. Bohai is based, and operates solely, in the People’s Republic of China (“China” or the “PRC”).





The VIE Agreements include (i) a Consulting Services Agreement, (ii) an Operating Agreement, and (iii) a Proxy Agreement, through which the WFOE has the right to advise, consult, manage and operate Bohai for an annual fee equal to all of Bohai’s yearly net profits after tax.  Pursuant to these agreements, the WFOE indirectly owns but has 100% managerial and economic control of the business activities of Bohai including the right to appoint all executives and senior management and members of the board of directors of Bohai.  Additionally, Bohai’s shareholders pledged their rights, titles and equity interest in Bohai as security for the WFOE to collect consulting and services fees provided to Bohai pursuant to an equity pledge agreement.  In order to further reinforce the WFOE’s rights to control and operate Bohai, Bohai’s shareholders granted the WFOE an exclusive right and option to acquire all of their equity interests in Bohai through an option agreement.  The VIE Agreements have perpetual terms unless otherwise determined by PRC law, and can (particularly in the case of the Consulting Services Agreement (which is the principal VIE Agreement) be terminated by the parties under certain circumstances, including material breach, the termination of Bohai’s business or a liquidation of Bohai.  The WFOE (which is controlled indirectly by BPGI) can also terminate the Consulting Services Agreement at will.





The Share Exchange was accounted for as a reverse merger and recapitalization of Chance High effective January 5, 2010. Although BPGI legally acquired Chance High and its 100% controlled subsidiary Bohai, for accounting purposes, Chance High and Bohai are considered to be the accounting acquirers and BPGI is the accounting acquiree.  As a result, the historical consolidated financial statements for periods prior to January 5, 2010 are those of Chance High, it wholly owned WFOE and Bohai.





BPGI, its wholly owned subsidiary Chance High, WFOE and Bohai are referred to herein collectively and as a consolidated basis as the “Company” or “we”, “us” or “our” or similar terminology.  Mr. Qu currently serves the Company’s Chairman, Chief Executive Officer and President. The Company has continued to be engaged in the production, manufacturing and distribution of herbal pharmaceuticals based on traditional Chinese medicine (“TCM”) in the People’s Republic of China.  The Company is headquartered and maintains its principal operations in the city of Yantai, Shandong Province, China, and conducts business operations  exclusively in the PRC.


F-7





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





2.
LIQUIDITY AND FINANCIAL CONDITION





We completed the acquisition of Yantai Nirui Pharmaceuticals, Ltd on August 8, 2011 (Note 19).





The Company’s net income and cash flows from operations amounted to $14,004,875 and $10,958,858, respectively for the year ended June 30, 2011. The Company’s has working capital of approximately $14,109,725, after giving effect a $10,450,000 convertible note obligation that matures on January 5, 2012 (Note 12) but excluding a $937,867 derivative liability for the fair value of warrants that are not expected to result in a cash settlement. The Company has historically financed its operations principally from cash flows generated from operating activities and external financing raised in private placement transactions completed since the time of the Share Exchange Transaction. As described in Note 19, the Company completed its acquisition of Yantai Tianzheng Pharmaceuticals Company, Ltd. for aggregate purchase consideration of US$35,000,000 payable in four installments of which the equivalent in Chinese Renminbi, the functional currency of the PRC (“RMB”), $6,000,000 was paid on the (10) calendar day after the execution date of the acquisition, $12,000,000 will be paid on or before (6) months after the execution date, $12,000,000 will be paid on or before the (12) months after the execution date, and the remaining $5,000,000 will be paid on or before the (18) months after the Execution Date.  As described in Note 19, the Company has the ability to convert the remaining payments that are due into two year installment obligations bearing interest at 6% per annum. The election of this option would reduce the $12,000,000 cash payment to the sellers by February 2012 to approximately $3,000,000.





The Company has also undertaken a plan to diversify the business and expand its existing product lines through the acquisition of Yantai Tianzheng Pharmaceuticals Company, Ltd (Note 20), and gain the benefits of the economies of scale that management believes could be realized by combining and streamlining the cost structures of its historical and acquired businesses.





Management believes, based on the Company’s historical ability to fund operations using internally generated cash flow and the progress made towards expanding the business through the recent acquisition, that the Company’s currently available cash and funds it expects to generate from operations will enable it to operate the  business and satisfy short term obligations through at least July 1, 2012.  However, the Company has ongoing obligations with respect to the acquisition, whether or not the acquisition is successful, and must also repay the $10,450,000 balance due on convertible notes on the contractual maturity date of January 5, 2012. Accordingly, the Company will require additional capital in order to fund these obligations and execute its longer term business plan. If the Company is unable to raise additional capital, or encounters unforeseen circumstances that place constraints on its capital resources, management will be required to take various measures to conserve liquidity, which could include, but not necessarily be limited to, curtailing the Company’s business development activities, suspending the pursuit of its business plan, and controlling overhead expenses. Management cannot provide any assurance that the Company will raise additional capital if needed. The Company has not received any commitments for new financing, and cannot provide any assurance that new financing will be available to the Company on acceptable terms, if at all.





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principles of Consolidation




The accompanying consolidated financial statements include the accounts of BPGI, its wholly-owned subsidiary Chance High, WFOE and Bohai. All significant intercompany accounts and transactions have been eliminated in consolidation.





The Company, in determining whether it is required to consolidate investee businesses, considers both the voting and variable interest models of consolidation as required under applicable GAAP.  We adopted FAS Accounting Standards Codification (“ASC”) 810-10-15-14 and also ASC 810-10-05-8, which requires that a Variable Interest Entity (“VIE”) to be consolidated by a company if that company is entitled to receive a majority of the VIE’s residual returns and has the direct ability to make decisions on all operating activities of the VIE.  We control Bohai through the VIE Agreements described in Note 1. Under the following series of agreements entered into on December 7, 2009.


F-8





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued




Under the Operating Agreement entered into between WFOE and Bohai, the WFOE has the direct ability to make decisions on all the operating activities and exercise all voting rights of Bohai. Under the Consultant Service Agreement entered into between WFOE and Bohai, Bohai agreed to pay all of its net income to WFOE quarterly as a consulting fee. Accordingly, WFOE has the right to receive the expected residual returns of Bohai.  As such, the Company is the primary beneficiary of and maintains controlling managerial and financial interest in, Bohai in accordance with ASC 810-10-15-14. Accordingly, Bohai’s financial position and results of operations are consolidated with those of the Company for all periods presented.




We initially measured the assets, liabilities, and non-controlling interests of Bohai at their carrying amounts as of the date of the acquisition. We have subsequently accounted for the assets, liabilities, and non-controlling interest of Bohai as if it was consolidated based on voting interests.  The usual accounting rules for which the VIE operates are applied as they would to a consolidated subsidiary as follows:





·
Carrying amounts of the VIE are consolidated into the financial statements of the Company as the primary beneficiary, or Primary Beneficiary (“PB”); and





·
Inter-company transactions and balances, such as revenues and costs, receivables and payables between or among the PB and the VIE(s) are eliminated in their entirety.





The carrying amount and classification of Yantai Bohai’s assets and liabilities included in the Consolidated Balance Sheets are as follows:





June 30,2011


2010Total current assets*

$
32,711,620


$
20,834,123Total assets*


80,523,230



53,415,591Total current liabilities**


18,674,129



9,005,735Total liabilities**


21,552,525



11,315,056





* Includes intercompany accounts in the amounts of $1,896,933 and $394,821 in current assets as at June 30, 2011 and 2010, respectively that were eliminated in consolidation.





** Includes intercompany accounts in the amounts of $11,660,222 and $457,004 in current liabilities as at June 30, 2011 and 2010, respectively that were eliminated in consolidation.




F-9


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





Business Combinations





The Company uses the acquisition method of accounting for business combinations which requires that the assets acquired and liabilities assumed be recorded at the date of the acquisition at their respective fair values. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can reasonably be estimated. If the acquisition date fair value of an asset acquired or liability assumed that arises from a contingency cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of acquired business are reflected in the acquirer’s consolidated financial statements and results of operations after the date of the acquisition.





Reclassifications





Certain amounts in the June 30, 2010 consolidated financial statement have been reclassified to conform to the June 30, 2011 presentation.





Business Segments





The Company’s operations are classified into one principal reportable segment that provides different products or services.





Use of Estimates





The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those results.





Significant estimates and assumptions include valuing equity securities and derivative financial instruments issued in financing transactions and in share-based payment arrangements, accounts receivable reserves, and inventory, and the carrying amounts of intangible assets. Certain estimates, including accounts receivable and inventory reserves and the carrying amounts of intangible assets (including present value of future cash flow estimates for our pharmaceutical formulas) could be affected by external conditions including those unique to our industry and general economic conditions. It is reasonably possible that these external factors could have an effect on our estimates that could cause actual results to differ from our estimates. We re-evaluate all of our accounting estimates at least quarterly based on these conditions and record adjustments, when necessary.





Cash and Cash Equivalents





We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.  We maintain bank accounts in the PRC and a checking account in the United States of America that principally consist of demand deposits. We also have restricted cash accounts in the United States that include funds designated for interest payments due to convertible note holders and for use in investor relations programs pursuant to a securities purchase agreement.


F-10





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





Accounts Receivable





Accounts receivable consists of amounts due from customers. We extend unsecured credit to our customers in the ordinary course of business but mitigate the associated risks by performing credit checks and actively pursuing past due accounts.  An allowance for doubtful accounts is established and determined based on management’s assessment of known requirements, aging of receivables, payment history, the customer’s current credit worthiness





and the economic environment.  As of June 30, 2011 and 2010, no allowance for doubtful accounts was deemed necessary based on management’s assessment.





Inventories





Inventories are valued at the lower of cost, determined using the weighted average method, or market. Finished goods inventories include the costs of raw materials, direct labor and overhead associated with the manufacturing process. In assessing the ultimate realization of inventories, management makes judgments as to future demand requirements compared to current or committed inventory levels.  Our reserve requirements generally increase/decrease due to management’s projected demand requirements, market conditions and product life cycle changes.  As of June 30, 2011 and 2010, management does not believe that any reserves are necessary.





Property, Plant and Equipment





Property, plant and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets which range from 5 to 10 years for office equipment, machinery, and vehicles and 30 to 40 years for buildings. The cost of repairs and maintenance is charged to expense as incurred; major replacements and improvements are capitalized.  When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. We examine the possibility of impairment in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.





Intangible Asset – Pharmaceutical Formulas





The Company has purchased pharmaceutical formulas that were approved by State Food and Drug Administration of China (“SFDA”). These formulas can be renewed every 5 years without limitation for a minimum fee and are subject to certain protections under PRC drug regulations for an indefinite period of time these regulations that mitigate competition and the ability of other suppliers to replicate our products or produce comparable substitutes. These intangible assets are measured initially at cost not subject to amortization and are tested for impairment annually or in interim reporting periods if events or changes in circumstances indicate that the carrying amounts of these intangible asset might not be recoverable.





The Company recorded an $635,442 impairment charge during the year ended June 30, 2011 based on management’s decision to no longer produce or seek to develop markets for eight specific products.  There were no impairment charges to record during the year ended June 30 2010.




F-11





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued


Common Stock Purchase Warrants and Other Derivative Financial Instruments
  The Company accounts for the issuance of common stock purchase warrants issued and other free standing derivative financial instruments in accordance with the applicable provisions ASC 810 “Derivatives and Hedging Activities.” Based on this guidance, the Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) gives the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement). The Company assesses classification of its freestanding derivatives at each reporting date to determine whether a change in classification between assets andliabilities is required. The Company determined that its freestanding derivatives, which principally consist of warrants to purchase common stock required classification as liability instruments at June 30, 2010 and 2011 due to the existence of non-standard anti-dilution privileges that caused the warrants to not be indexed to the Company’s own stock.





Fair Value Measurements and Fair Value of Financial Instruments





We adopted the guidance of ASC 820 for fair value measurements, which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:





Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.





Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.





Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.





The carrying amounts reported in the balance sheets for cash, accounts receivable, other receivables, short-term borrowings, accounts payable and accrued expenses, customer advances, and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments.





ASC 825-10 “Financial Instruments,” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. We use Level 3 inputs to value our derivative liabilities.





The following table reflects gains and losses for years ended June 30, 2011 and 2010 for all financial assets and liabilities categorized as Level 3 as of June 30, 2011 and 2010.





Liabilities:Balance of derivative liabilities as of July 1, 2009

$
-Initial fair value of derivative liabilities


6,406,991Change in the fair value of derivative liabilities


(925,063
)Balance of derivative liabilities as of June 30, 2010

$
5,481,928Change in the fair value of derivative liabilities


(4,544,061
)Balance of derivative liabilities as of June 30, 2011

$
937,867


F-12




BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





Estimating the fair value of derivative financial instruments require the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. The assumptions used to value our derivatives, which had a direct affect on the fair values described above are more fully described in (Note 12). In addition, valuation techniques are sensitive to changes in the trading market price of our Common Stock and its estimated volatility interest rate changes and other variables or market conditions not within our control that can significantly affect our estimates of fair value and changes in fair value. Because derivative financial instruments are initially and subsequently carried at fair value, our net income may include significant charges or credits as these estimates and assumptions change.





Foreign Currency Translation





Our reporting currency is the U.S. dollar. The functional currency of the Company’s operating business based in the PRC is the RMB.  For our subsidiaries and affiliates whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the exchange rate in effect as of the end of the period, and equity is translated at historical exchange rates. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in comprehensive income.





Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods. All of our revenue transactions are transacted in the functional currency. We have not entered into any material transactions that are either originated, or to be settled, in currencies other than the RMB. Accordingly, transaction gains or losses have not had, and are not expected to have a material effect on our results of operations.





Period end exchange rates used to translate assets and liabilities and average exchange rates is used to translate  revenue and expenses in each of the reporting periods are as follows:




June 30,2011


2010Period end US$: RMB exchange rate


6.4635



6.8086Average periodic US$: RMB exchange rate


6.6278



6.8367





The RMB is not freely convertible into any other currencies. In addition, all foreign exchange transactions in the PRC must be conducted through authorized institutions. Accordingly, management cannot provide any assurance that the RMB underlying the consolidated financial statement amounts could have been, or could be, converted into US dollars at the exchange rates used to translate the functional currency into the reporting currency.





Revenue Recognition





Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to distributors. Pursuant to the guidance of ASC Topic 605 and ASC Topic 36, revenue is recognized when all of the following criteria are met:





·
Persuasive evidence of an arrangement exists;


·
Delivery has occurred or services have been rendered;


·
The seller’s price to the buyer is fixed or determinable; and


·
Collectability is reasonably assured.


F-13


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





We account for sales returns by establishing an accrual in an amount equal to our estimate of sales recorded for which the related products are expected to be returned. We determine the estimate of the sales return accrual primarily based on our historical experience regarding sales returns, but also by considering other factors that could impact sales returns. These factors include levels of inventory in the distribution channel, estimated shelf life, product discontinuances, and price changes of competitive products, introductions of generic products and introductions of competitive new products.  For the years ended June 30, 2011 and 2010, our sales return rate is low and deemed immaterial and accordingly, no provision for sales returns was recorded.





Cost of Revenue





Cost of revenue consists primarily of raw material costs, labor cost, overhead costs associated with the manufacturing process and related expenses which are directly attributable to our revenues.





Stock-based Compensation





Stock based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC 718 which requires recognition in the consolidated financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the employee or director’s requisite service period (presumptively, the vesting period). The FASB Accounting Standards Codification also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.





Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. We record compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.





Research and Development Costs





Research and development costs are charged to expense as incurred and included in operating expenses. We have only one full-time employee who is engaged in research and development, so we are mainly dependent on a third-party, Yantai Tianzheng Medicine Research and Development Co., Ltd., to perform the limited amount of research and development that we undertake.  Research and development costs were primarily incurred from Yantai Tianzheng Medicine Research and Development Co., Ltd., and were $497,903 and $440,931 for the years ended June 30, 2011 and 2010, respectively.





Shipping costs





Shipping costs are included in selling, general and administrative expense.  Shipping costs amounted to $832,401 and $525,611 for the years ended June 30, 2011 and 2010, respectively.





Advertising and Promotion





Advertising and promotion costs are charged to expense as incurred. Advertising and promotion expenses included in selling general and administrative expenses amounted to $14,822,116 and $13,237,648 for the years ended June 30, 2011 and 2010, respectively. Advertising expense amounted approximately to $8,400,000 and $7,800,000 for the years ended June 30, 2011 and 2010, respectively.


F-14


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





Income Taxes





We are governed by the PRC’s Income Tax Laws and the Internal Revenue Code of the United States. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement and income tax base of assets and liabilities and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent that management concludes it is more likely than not that the benefit of such tax assets will not be realized in future periods. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the periods that include the enactment date.





The deferred tax liability on indefinite lived intangible assets is attributable to the tax effect of temporary differences between the financial statement and income tax bases of our pharmaceutical formulas, which have indefinite useful lives and are not being amortized for financial reporting purpose but are being amortized over 10 years for income tax purposes.





We account for certain tax positions based upon authoritative guidance that prescribes a recognition threshold and measurement processes for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  The guidance also provides direction on decognition, classification, interest and penalties, accounting in interim periods and related disclosure.





Our policy is to classify assessments, if any, for tax related to interest as interest expense and penalties as general and administrative expense.





Earnings per Share





We report earnings per share in accordance with ASC Topic 260, “Earnings Per Share”.  Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period. Common equivalent shares are excluded from the computation of diluted shares in periods for which they have an anti-dilutive effect. Diluted shares underlying stock options and common stock purchase warrants are included in the determination of diluted earnings per share using the treasury stock method.  Diluted shares underlying convertible debt obligations are included in the determination of diluted loss per share using the “if converted” method (Note 15).





Recent Accounting Pronouncements





In January 2010, the FASB issued ASU No. 2010-05, Compensation - Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. This update codifies Emerging Issues Task Force D-110. The adoption of this standard did not have a material impact to the Company’s consolidated financial statements.





In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. This standard is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after


F-15


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





December 15, 2010 and for interim periods within those fiscal years. The adoption of this standard did not have a material impact to the Company’s consolidated balance sheets.





In April 2010, the FASB issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades - a consensus of the FASB Emerging Issues Task Force.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after





December 15, 2010.  Earlier application is permitted.  We do not expect the provisions of ASU 2010-13 to have a material effect on our consolidated financial statements.





In December 2010, the FASB issued ASU No. 2010-28, Intangibles - Goodwill and Other(ASC Topic 350). Under Topic 350 on goodwill and other intangible assets, testing for goodwill impairment is a two-step test. When a goodwill impairment test is performed (either on an annual or interim basis), an entity must assess whether the carrying amount of a reporting unit exceeds its fair value (Step 1). I f it does, an entity must perform an additional test to determine whether goodwill has been impaired and to calculate the amount of that impairment (Step 2).  The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist.  The qualitative factors require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted.  The Company is assessing the impact of adopting this standard on our consolidated financial statements





In December 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-29, Business Combinations(ASC Topic 805). The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination(s). The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is permitted. The Company is currently assessing the impact if adopting this standard on our financial statement disclosures.





In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about the fair value measurements. The amendments include the following:





·
Those that clarify the intent of the Company’s Board of Directors regarding the application of existing fair value measurement and disclosure requirements.





·
Those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.








F-16





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued





The Company is currently evaluating the impact of this standard and do not expect its adoption have a material impact on the Company’s consolidated financial statements.





In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The presentation option under current GAAP to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity has been eliminated.





The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted because compliance with amendments is already permitted. The Company already complies with this presentation.





4.
INVENTORIES





Inventories consist of the following:





June 30,2011


2010Raw materials

$
739,363


$
328,859Work in progress


423,202



116,834Finished goods


348,456



302,729Total inventories

$
1,511,021


$
748,422





5.
PREPAID EXPENSES AND OTHER CURRENT ASSETS





Prepaid expenses and other currents assets consist of the following:





June 30,2011


2010Prepaid advertising and promotion

$
935,275


$
1,198,484Other receivables


106,626



261,475Other miscellaneous deposits and prepayments


18,237



29,792Prepaid expenses and other current assets

$
1,060,138


$
1,489,751




$40,160 due from Mr. Qu that was repaid in July 2010.




F-17





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





6.
PROPERTY, PLANT AND EQUIPMENT, NET





Property, plant and equipment consist of the following:





June 30,2011


2010Buildings

$
5,122,557


$
4,862,916Plant equipment


1,348,819



1,234,994Office equipment


107,520



85,174Motor vehicles


258,720



414,622Total


6,837,616



6,597,706Less: accumulated depreciation


(1,622,654
)


(1,236,097
)Property, plant and equipment, net

$
5,214,962


$
5,361,609





Depreciation expense for property, plant and equipment for the years ended June 30, 2011 and 2010 amounted to $366,338 and $238,813, respectively.





As discussed in Notes 11 and 12, substantially at the Company’s assets are pledged as collateral for its debt obligations. As of June 30, 2011 and 2010, the Company has specifically pledged certain plant equipment and machinery having a carrying amount of $391,317and $534,102, respectively to secure a bank loan to the Bohai.





7.
INTANGIBLE ASSETS – PHARMACEUTICALS FORMULAS





Intangible assets consist of the following:




June 30,2011


2010Pharmaceuticals formulas, at cost

$
25,019,377


$
17,342,772





On December 9, 2010, we entered into an Intangible Assets Transfer Agreement with Shandong Daxin Microbiology Pharmaceutical Industry Co., Ltd. (“Daxin”), an unrelated party, pursuant to which Daxin transferred to us all rights and title for 14 State Food and Drug Administration previously approved traditional Chinese medicine formulas. The aggregate purchase price of approximately $7,186,100 (RMB 48,000,000) was paid during the quarter ended March 31, 2011.  The 14 new formulas consist of two new product categories, powder and pellet formulations. Additionally, 4 of the 14 formulas are included in the Chinese government’s Essential Drug List (“EDL”) and an additional 5 medicines are included in the National Drug Reimbursement List (“NDRL”).






F-18





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





8.
LONG TERM PREPAYMENTS - LAND USE RIGHTS, NET




June 30,2011


2010Land use rights, at cost

$
17,999,002


$
10,110,236Less: Accumulated amortization


(421,731
)


(233,149
)Intangible assets – land use rights, net

$
17,577,271


$
9,877,087


We currently have two land use rights in the City of Yantai. One was acquired in 2011 described below and will be used as our future manufacturing site. The certificate of the land use right will expire in 49 years. The other was acquired in March 2007 and it is located at our present manufacturing site. We have not received the certificate of land use right relating to our current manufacturing site since we acquired it in 2007 due to changes in zoning plans by the City of Yantai (Note 13). Amortization expense amounted $171,767 and $71,443 for the years ended June 30, 2011 and 2010, respectively.





Amortization of land use rights for fiscal years ending subsequent to June 30, is as follows:





Year ending June 30,

Amortization2012

$
377,3002013


377,3002014


377,3002015


377,3002016


377,300Thereafter


15,690,771Total, net

$
17,577,271





On February 22, 2010, we entered into a land-use right purchase agreement with Shandong Yantai Bureau of Land and Resources, pursuant to which we acquired the land use right for a parcel of land totaling 333,335 square meters for RMB 97,500,000 (approximately $14,480,284).  We paid $7,166,782 and $7,313,502 in fiscal year 2011 and 2010, respectively for the parcel of land. As of March 31, 2011, this purchase price was paid in full.




9.
DEBT ISSUE COSTS




We incurred total placement fees of $2,152,454 in connection with our private placement of Convertible Notes (see Note 12) that occurred on January 5, 2010. The placement fees are being amortized on a straight line basis over the two year expected life of the Convertible Notes, starting on the date of closing, January 5, 2010.





June 30,2011


2010Beginning balance

$
1,562,617


$
2,152,454Transferred to equity on conversion


(106,574
)


(79,120
)Amortization


(971,004
)


(510,717
)Ending balance

$
485,039


$
1,562,617


F-19


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





10.
ACCRUED EXPENSES





Accrued expense consists of the following:





June 30,2011


2010Selling expenses

$
2,605,375


$
1,542,280Value added tax


913,821



686,478Compensation


261,144



221,810Other


531,993



534,420Due to equity holder


11,980



-Total

$
4,324,313


$
2,984,988





11.
SHORT-TERM BORROWINGS





Bohai obtained several short-term loan facilities from financial institutions in the PRC.  Short-term borrowings as of June 30, 2011 and 2010 consist of the following:





Loan from



Annual


June 30,financialinstitution

Loan period

interest rate


2011


2010China Construction Bank

February 24, 2010 to February 23, 2011


5.84
%

$
-


$
3,524,954Yantai Laishan Rural Credit Union

September 28, 2009 to September 26, 2010


9.03
%


-



587,492Yantai Laishan Rural Credit Union

September 28, 2009 to September 26, 2010


6.90
%


-



286,403Yantai Laishan Rural Credit Union

September 21, 2010 to September 20, 2011


9.03
%


618,860



-Yantai Laishan Rural Credit Union

September 21, 2010 to September 20, 2011


6.90
%


301,694



-$
920,554


$
4,398,849





Substantially all of the Company’s assets are pledged as collateral on a collective basis for these obligations and the secured note obligation described in Note 12.





12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS





On January 5, 2010, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”) with 128 accredited investors (the “Investors”), we sold 6,000,000 units for aggregate gross proceeds of $12,000,000, each unit consisting of an 8% senior convertible promissory note in the principal amount of $2 and one Common Stock purchase warrant (collectively, the “Investor Warrants”).  By agreement with the Investors, each investor received: (i) a single Note representing the aggregate number of Notes purchased by them as part of the units (each, a “Note” and collectively, the “Notes”) and (ii) a single Investor Warrant representing the aggregate number of Investor Warrants purchased by them as part of the units. The majority of this debt is guaranteed by third-parties and our CEO, Mr. Qu, and a portion is secured by our inventories and fixedassets.


F-20





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS – Continued





The Notes bear interest at 8% per annum, payable quarterly in arrears on the last day of each fiscal quarter of the Company. No principal payments are required until maturity of the Notes on January 5, 2012. Each Note, plus all accrued but unpaid interest thereon, is convertible, in whole but not in part, at any time at the option of the holder, into shares of Common Stock at a conversion price of $2.00 per share, subject to adjustment as set forth in the Note.  The Notes issued have face amounts that range from $43,200 to $500,000.





The conversion price of the Notes is subject to standard anti-dilution adjustments for stock splits and similar events. In addition, if we issue or sell any additional shares of Common Stock or instruments convertible or exchangeable for Common Stock at a price per share less than the conversion price then in effect or without consideration, then the conversion price upon each such issuance will be adjusted to that price determined by multiplying the conversion price then in effect by a fraction: (1) the numerator of which is the sum of (x) the number of shares of Common Stock outstanding immediately prior to the issuance of such additional shares of Common Stock plus (y) the number of shares of Common Stock which the aggregate consideration for the total number of such additional shares of Common Stock so issued would purchase at a price per share equal to the conversion price then in effect, and (2) the denominator of which is the number of shares of Common Stock outstanding immediately after the issuance of such additional shares of Common Stock. Notwithstanding any provision of the Note to the contrary, no adjustment will cause the conversion price to be less than $1.00, as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction.





Effective as of June 30, 2010, we entered into an Amendment and Agreement (the “A&A”) with Euro Pacific Capital, Inc., as representative of the Investors (the “Investor Representative”), pursuant to which the Company and the Investors agreed to make certain amendments to the Notes and the Warrants.  Pursuant to the A&A, the anti-dilution protection provisions in the Notes and the Warrants were eliminated and a provision specifically precluding net cash settlement by us of the Notes and the Warrants was added.  In return, and subject to certain non-financing exceptions, we agreed not to issue any new equity securities at a price per share below $2.20 until the earlier of (i) January 5, 2013 or (ii) the date on which, collectively with any prior conversions or exercises of Notes and Warrants, 75% of the principal face value of the Notes in the aggregate has been converted into shares of Common Stock and Warrants representing, in the aggregate, 75% of the aggregate shares of Common Stock underlying the Warrants have been exercised.  The A&A did not change the Company’s accounting for the Notes and the Warrants described below.





On and effective as of March 30, 2011, the Company entered into a Termination Agreement (the "Termination Agreement") with the Investor Representative pursuant to which the Company and the Investor Representative agreed to terminate the A&A. As a result of the Termination Agreement, the A&A and each of its provisions were terminated. The Termination Agreement was entered into because, after further study, the Company concluded that the original purpose of the A&A (to mitigate the impact of certain non-cash embedded derivative liabilities associated with the Notes, Warrants and Agent Warrants) would not be achieved. Therefore, the Company determined and agreed with the Investor Representative to terminate the A&A and to thereby restore the Notes, Warrants and Agent Warrants to their original terms.





The Notes contain certain events of default, including non-payment of interest or principal when due, bankruptcy, failure to maintain a listing of the Common Stock or to make required filings on a timely basis. No premium is payable by us if an event of default occurs. However, upon an Event of Default, and provided no more than 50% of the aggregate face amount of the Notes have been converted, the Investors holding Notes have the right to receive a portion, based on their pro-rata participation in the transaction, of 1,000,000 shares of our Common Stock that have been placed in escrow by our principal shareholder. The shares in escrow will be returned to our principal shareholder when 50% of the aggregate face amount of the Notes has been converted or, if later, when the Notes are repaid.


F-21


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued





The Investor Warrants expire on January 5, 2013 and may be exercised by the holder at any time to purchase one share of Common Stock at an exercise price of $2.40 per share (subject to adjustment as set forth in the Investor Warrants). The exercise price of the Investor Warrants is subject to adjustment in the same manner as the conversion price of the Notes described above, except that the exercise price will not be adjusted to less than $1.20, as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction. The Investor Warrants may only be exercised for cash and do not permit the holder to perform a cashless exercise.





In connection with the sale of the units, we paid our placement agents a cash fee of $1,200,000. In addition, the placement agents received warrants (the “Placement Agent Warrants” and, together with the Investor Warrants, the “Warrants”) to purchase 600,000 shares of Common Stock, which Placement Agent Warrants are substantially identical to the Investor Warrants, except that, pursuant to separate lock-up agreements executed by the holders of the Placement Agent Warrants, the Placement Agent Warrants are not exercisable until the six month anniversary of the later of: (i) the date of effectiveness of the registration statement registering the resale of the Common Stock underlying the Notes and Warrants or (ii) the date of commencement of sales in connection with such registration statement.





In addition to the placement agent fee, we paid $370,000 of legal and other expenses. As required by the Securities Purchase Agreement, $500,000 of the proceeds from the sale of the units were placed in escrow to pay investor relations expenses to be incurred by us and $240,000, equivalent to one quarter’s interest expense on the Notes, was also placed in escrow. The interest escrow will be released to us at such time as 75% of all shares underlying the Notes have been issued upon conversion of Notes. After payment of the placement agent fees and other expenses and the amounts required to be placed in escrow, we received net proceeds of $9,690,000. At June 30, 2011 and 2010, $11,043 and $576,019, respectively, remained in escrow and is included in restricted cash.





We also entered into a Registration Rights Agreement with the Investors. We agreed to file, no later than March 6, 2010, a registration statement to register the shares underlying the Notes and the Warrants and to have such registration statement effective no later than August 13, 2010. The required registration statement was filed on March 2, 2010 and became effective on August 12, 2010. Accordingly, we did not incur any registration delay payments.





Valuation





At the time the Notes and Warrants were issued, there had not been any market activity for the Common Stock.  Accordingly, determining the fair value of the Common Stock required us to make complex and subjective judgments. We estimated the value of our enterprise as of January 5, 2010 based on a review of the enterprise value derived from the use of market and income valuation approaches. We also reviewed an asset-based approach to assess whether the result of such an approach was consistent with the value derived from the market and income valuation approaches. The market approach was based on the market price to earnings multiple for companies considered by management to be comparable to us. The income approach was based on applying discount rates to estimated future net income. The estimated enterprise value was then allocated to our existing outstanding Common Stock, the Notes and the Warrants using the Binomial option pricing method. The option pricing method was based on the two year period to maturity of the Notes and the three year period to expiration of the Warrants, risk-free interest rates commensurate with those periods and the expected volatility used was based on a review of the historical volatility of companies considered by management to be comparable to us.


F-22





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010




12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued





Based on the allocation of the estimated enterprise value, we estimated the fair value of the Common Stock at $2.28 per share, as of January 5, 2010. The Investor Warrants and the Placement Agent Warrants were valued at $5,824,538 and $582,454, respectively, based on the estimated fair value of the Common Stock of $2.28, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 1.57% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life of the Warrants and estimated volatility of 65%, based on a review of the historical volatility of companies considered by management to be comparable to us.  As noted above, prior to the June 30, 2010 Amendment described above, the Warrants contained a down-round anti-dilution protection feature. As of January 5, 2010, the value of this feature was not considered to be material and no adjustment was made for it in the estimated fair value of the Warrants.





Accounting for Convertible Notes





At January 5, 2010 and June 30, 2011, the conversion options embedded in the Notes are not derivative instruments as defined in FASB ASC 815-10-15-83 because the Notes do not permit or require net settlement, there is no market mechanism outside the contracts that permits net settlement and the shares to be received on conversion of the Notes are not readily convertible to cash. At the time the Notes were issued, there had not been any market activity for the Common Stock.  Although market trading activity for our Common Stock has developed, the Notes can be exercised only in whole but not in part and through June 30, 2011 and continuing, there has been insufficient trading volumeto permit the shares to be received on conversion of each Note to be readily sold in the market, thus precluding the shares to be received by the holder of each Note from being readily convertible to cash.





In future periods, whether or not the embedded conversion option in each Note is considered to be a derivative instrument will depend on whether or not the aggregate number of shares to be received on exercise of each of the Notes, which Notes can be exercised only in whole but not in part, could be readily sold in the market without significantly affecting the market price of the Common Stock, thus permitting the shares received by the holder of each Note to be readily convertible to cash. At each reporting date, the Company will re- evaluate each Note, based on the level of activity in the market for the Common Stock at that time, to determine whether or not the embedded conversion option in each Note is a derivative instrument. Depending on the trading volume for the Common Stock that develops in the future and the face amount of each Note, the embedded conversion option may be considered a derivative instrument for some Notes but not for others and its status as a derivative instrument may vary from period to period.





FASB ASC 815-10-15-74 provides that a contract which would otherwise meet the definition of a derivative instrument but that is both (a) indexed to a company’s own stock and (b) classified in shareholders’ equity in the statement of financial position would not be considered a derivative financial instrument. FASB ASC 815-40-15 and 815-40-25 provide guidance for determining whether those two criteria are met. Because the Company’s functional currency is the Renminbi, but the Notes are denominated in U.S. Dollars, FASB ASC 815-40-15-71 provides that the embedded conversion options are not considered to be indexed only to our Common Stock. Furthermore, prior to the June 30, 2010 Amendment described above, the criteria that the instruments be indexed only to the Common Stock was also not met because the conversion price of the Notes would be reduced if we issued securities at a lower exercise or conversion price.




Because the requirement that the instruments be indexed only to the Common Stock is not met, the exemption in FASB ASC 815-10-15-74 will not be available and we will account for the embedded conversion options in the Notes as derivative instrument liabilities, if and when the shares to be issued on conversion are considered to be readily convertible to cash.





Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. If and when the embedded conversion option in any of the Notes first qualifies as a derivative instrument, the fair value at that time of the embedded derivative instrument will be re-classified and separately recognized and subsequently marked-to- market each reporting period, as long as the embedded conversion option continues to qualify as a derivative instrument. If the embedded conversion option ceases to be a derivative instrument, it will be marked-to-market as of the date of re-classification but thereafter will no longer be marked-to-market.


F-23


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued





Warrants





Because our functional currency is the RMB but the Warrants are denominated in U.S. Dollars, the Warrants are not considered to be indexed only to our Common Stock. Furthermore, prior to the June 30, 2010 Amendment described above, the criteria that the instruments be indexed only to the Common Stock was also not met because the exercise price of the Warrants would be reduced if we issued securities at a lower exercise or conversion price. In accordance with ASC 815-10-S99-4, the Warrants (including the Placement Agent Warrants) are accounted for at fair value, with changes in their fair value charged or credited to income each period.





At January 5, 2010, the Investor Warrants were valued at $5,824,538, as described above. At June 30, 2011, the Investor Warrants were re-valued at $852,607 using a binomial model, based on the closing market price on that date of $1.05, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 0.33% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life of the Warrants and estimated volatility of 55%, based on a review of the historical volatility of companies considered by management to be comparable to the Company. The effect of the down-round anti-dilution protection was not considered to be material and no adjustment was made for it in the estimated fair value of the Investor Warrants.





The Placement Agent Warrants were initially valued at $582,454, as described above. The cost of these instruments, together with the cash fees paid to the placement agents and the other fees and expenses paid by us, as described above, in the aggregate amount of $2,152,454, have been deferred and are being amortized on a straight-line basis over the two year period to maturity of the Notes. At June 30, 2011, the Placement Agent Warrants were re-valued at $85,260, based on the closing market price on that date of $1.05, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free interest rate of 0.33% and estimated volatility of 55%. The effect of the down-round anti-dilution protection was not considered to be material and no adjustment was made for it in the estimated fair value of the Placement Agent Warrants.





The aggregate change in the value of the Investor and Placement Agent Warrants for the years ended June 30, 2011 and 2010 of $4,544,061 and $925,063, respectively, has been recorded as a gain on the consolidated statement of income.


F-24





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010




12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued


The following table summarizes the weighted average remaining contractual life and exercise price of all of our outstanding warrants.





Warrants OutstandingNumberOutstanding


Weighted


Weighted AverageNumber

Currently


Average


Exercise Price ofOutstanding

Exercisable


Remaining


WarrantsExercise

at

at


Contractual Life


currentlyPrice

June 30, 2011

June 30, 2011


(Years)


exercisable$
2.40

6,600,000

6,600,000


1.52


$
2.40





Convertible Notes





The Investor Warrants were initially recorded at their fair value of $5,824,538 and the remainder of the $12,000,000 gross proceeds received from the Investors of $6,175,462 was allocated to the Notes. Based on the proceeds allocated to the Notes, the Notes are convertible into Common Stock at an effective conversion price of approximately $1.03 per share. Because the effective conversion price is less than the fair value of the Common Stock at the time the Notes were issued, the Company recognized a beneficial conversion feature, which was limited to the amount of proceeds allocated to the Notes of $6,175,462. The Notes were initially recorded at a carrying value of zero and are being amortized, together with interest accruing on the Notes, to their maturity value over the period to maturity, at an effective interest rate of approximately 540% per annum. Interest expense for the years ended June 30, 2011 and 2010 was $1,889,202 and $588,811, respectively. As of June 30, 2011, Notes with an aggregate face amount of $1,550,000 and interest of $5,406 on the Notes were converted into 777,703 shares of Common Stock. In the event the Convertible Note holders did not convert their notes by January, 5 2012, the Company has right to redeem the outstanding convertible notes at $2.0 per each note. Total number of Outstanding Convertible Notes was 5,225,000 for the period ended June 30, 2011.


F-25


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





12.
CONVERTIBLE PROMISSORY NOTES AND WARRANTS - Continued




The convertible note liability is as follows at June 30, 2011 and 2010:





June 30,2011


2010Convertible notes payable, at full principal value

$
10,450,000


$
11,500,000Less: unamortized beneficial conversion feature and warrants discount on convertible notes


(9,317,897
)


(11,375,180
)Convertible notes, net

$
1,132,103


$
124,820





Escrowed Shares





As of January 5, 2010 and at June 30, 2011, our principal shareholder, Mr. Qu, is obligated to deliver 1,000,000 shares of Common Stock to the Investors if certain Events of Default occur (as defined in the Notes).




13.
COMMITMENTS, CONTINGENCIES AND OTHER MATTERS





(a)
Contract Research and Development Arrangement





On May 2009, we entered into a contract with Yantai Tianzheng Medicine Research and Development Co. to perform research and development on two new pharmaceutical products, namely Fern Injection and Forsythia Capsule, on behalf of us. The total contract price is approximately $2,320,724 (RMB 15,000,000). Yantai Tianzheng Medicine Research and Development Co. is committed to complete all research work required for the clinical trial within 3 years.  As of June 30, 2011, we have paid $1,284,134 (RMB 8,300,000) and the remaining contract amount will be paid progressively in installments. The final payment will be paid upon obtaining new drug certifications from the applied government regulatory authority.


F-26


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





13.
COMMITMENTS, CONTINGENCIES AND OTHER MATTERS - Continued





(b)
Supplier Concentrations





We have the following concentrations of business with each supplier constituting greater than 10% of our purchases of raw materials or other supplies:





Year ended


Year endedJune 30, 2011


June 30, 2010Shandong Yantai Medicine Procurement and Supply Station


14.6
%


13.5
%Anhui DeChang Pharmaceutical Co. Ltd.


*



11.9
%




* Constitutes less than 10% of the Company’s purchases.


We have short term raw material purchase obligations from various unrelated third parties in the amount of $1,569,907 (RMB 10,147,095) and the contractual obligation was fulfilled in July 2011.





(c)
Sales Product Concentrations





Four of our products, namely Tongbi Capsules, Tongbi Tablets, Lung Nourishing Syrup and Shangtongning Tablets represented approximately 27.41%, 14.37%, 26.23%, and 8.66%, respectively, of total sales as of June 30, 2011.





(d)
Economic and Political Risks





Our operations are conducted solely in the PRC.  There are significant risks associated with doing business in the PRC, which include, among others, political, economic, legal and foreign currency exchange risks. Our results may be adversely affected by changes in political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.





(e)
Concentrations of Credit Risk





Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of our cash is deposited in state-owned banks within the PRC, and no deposits are covered by insurance. We have not experienced any losses in such accounts and believe that our loss exposure is insignificant due to the fact that banks in the PRC are state owned and are generally high credit quality financial institutions. A significant portion of our sales are credit sales which are made primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas. We continually monitor the credit worthiness of our customers in an effort to reduce credit risk.





At June 30, 2011 and 2010, our cash balances by geographic area were as follows:


F-27


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





13.
COMMITMENTS, CONTINGENCIES AND OTHER MATTERS - Continued





June 30,2011


2010Country:United States

$
198,521



1
%

$
-



0
%China


13,145,905



99
%


17,149,082



100
%Total cash and cash equivalents

$
13,344,426



100
%

$
17,149,082



100
%





(f)
Certificate of land use right





Our corporate headquarters is located at No. 9 Daxin Road, Zhifu District, Yantai, Shandong Province in China. Under the current PRC laws, land is owned by the state, and parcels of land in rural areas which are known as collective land are owned by the rural collective economic organization. “Land use rights” are granted to an individual or entity after payment of a land use right fee is made to the applicable state or rural collective economic organization. Land use rights allow the holder of the right to use the land for a specified long-term period. We have a land use right, expiring in 2047, for a total of approximately 30,637 square meters of land, on which we maintain our manufacturing facility. We currently have not obtained a land use right certificate for a piece of land located in Xingfu Twelve Village of Zhifu District with the area of 11,222 square meters, on which we maintain our corporate headquarters. In the process of the planning of Yantai City, the usage of the aforesaid land use right has been changed from “industrial use” to “commercial use” and therefore, the approval process for the land use right certificates on five relevant parcels of land including the land occupied by us is suspended until the completion of the planning. We cannot provide any assurance that we will eventually obtain the land use right certificate for this land. If we are asked by the local government to relocate our facility, we believe that estimated relocation and other costs at approximately will be reimbursed by the local government. The Company does not believe that a requirement to relocate operations would have a material adverse effect on the business.





(g)
Purchase obligation





We had a commitment to purchase certain raw materials $1,569,907 as of June 30, 2011 that was fulfilled upon the delivery of the goods in July 2011.





(h)
Business insurance





Business insurance is not readily available in the PRC. To the extent that we suffer a loss of a type which would normally be covered by insurance in the United States, such as product liability and general liability insurance, we would incur significant expenses in both defending any action and in paying any claims that result from a settlement or judgment.


F-28





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





14.
SHAREHOLDERS’ EQUITY





Authorized Capital





We are authorized to issue 150 million shares of Common Stock, par value $0.001 per share.  Holders of our Common Stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders.





Issuance of Common Stock





On January 21, 2011, we closed a financing transaction in which we sold an aggregate of 748,382 shares of Common Stock to a total of 42 individual investors domiciled in the PRC at $2.50 per share, for total gross proceeds of $1,870,955.





Notes with an aggregate face amount of $1,050,000 and accrual interest of $5,406 were converted into 527,703 shares of Common Stock during the year ended June 30, 2011.





Restricted Stock Awards





On June 4, 2010, we granted 120,000 shares of Restricted Common Stock to our Chief Financial Officer for three years of service. The Restricted Common Stock vests in three equal annual installments over the related service period. We issued 40,000 shares of Restricted Common Stock with an aggregate fair value of $95,000 under this agreement during the year ended June 30, 2011.





On November 10, 2010, we issued 25,000 shares of fully vested, non-forfeitable Common Stock to a non-employee service provider to create investor awareness programs. For the year ended June 30, 2011, the company recorded $52,500 as a general and administrative expense.





On January 5, 2011, we issued 20,000 shares of fully vested, non-forfeitable Common Stock to a non-employee service provider to create investor awareness programs. For the year ended June 30, 2011, the Company recognized $35,000 for the fair value of these shares as a general and administrative expense.





Statutory Reserves





According to the laws and regulations in the PRC, we are required to provide for certain statutory funds, namely, reserve fund by an appropriation from net profit after taxes but before dividend distribution based on the local statutory financial statements of the PRC company prepared in accordance with the accounting principles and relevant financial regulations.





In the PRC, we are required to allocate at least 10% of our net profit to the reserve fund until the balance of such fund has reached 50% of its registered capital. Appropriation of enterprise expansion fund are determined at the discretion of it directors.  We had satisfied statutory reserve requirement by the first quarter of the fiscal year 2010, no further allocation to the statutory reserve is required.





The reserve fund can only be used, upon approval by the relevant authority, to offset accumulated losses or increase capital.


F-29


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





15.
EARNINGS PER SHARE





Basic earnings per share is computed on the basis of the weighted average number of shares of Common Stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of Common Stock plus the effect of potentially dilutive common shares outstanding during the period using the if-converted method for the convertible notes and the treasury stock method for stock options and common stock purchase warrants.  The following table sets forth the computation of basic and diluted net income per common share:





June 30,2011


2010Net income available for common Shareholders-basic

$
14,004,875


$
9,056,972Effective interest on convertible notes and amortization of debt issue costs


2,860,206



588,811Net income available for common shareholders – diluted

$
16,865,081


$
9,645,783





Year ended


Year endedJune 30, 2011


June 30, 2010Weighted average number of common shares outstanding - basic


17,198,917



14,722,055Common shares if converted from Convertible Debt


5,225,000



2,847,260Weighted average number of common shares outstanding - diluted


22,423,917



17,569,315Earnings per share:Basic

$
0.81


$
0.62Diluted

$
0.75


$
0.55





Warrants to purchase 6,600,000 shares of Common Stock and stock options to purchase 32,000 shares of Common Stock were outstanding during the year ended June 30, 2011 but were excluded from the computation of diluted earnings per share as these exercise prices exceeded the average stock price for the year ended June 30, 2011.


F-30


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





16.
STOCK OPTIONS





On October 13, 2010, we granted stock options to two directors for the purchase of 26,000 shares of our Common Stock at an exercise price of $2.00 per share.  The options vested immediately and expire five years from the date of issuance.





These options have been valued at $23,844. We use a binomial option pricing model to calculate the grant date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 70%, risk free interest rate of 0.3%, expected term of 2.5 years.





On May 2, 2011, we granted stock options to a director for the purchase of 6,000 shares of our Common Stock at an exercise price of $2.00 per share.  The options vested immediately and expire five years from the date of issuance. These options have been valued at $3,184. We use a binomial option pricing model to calculate the grant date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 55%, risk free interest rate of 0.3%, expected term of 5 years.





The following table summarizes the weighted average remaining contractual life and exercise price of our outstanding options as of June 30, 2011:





Options OutstandingNumberOutstanding


Weighted


Weighted AverageNumber

Currently


Average


Exercise Price ofOutstanding

Exercisable


Remaining


WarrantsExercise

Price

at

June 30, 2011

at

June 30, 2011


Contractual Life

(Years)


currently

exercisable$
2.00

32,000


32,000



4.39


$
2.00





We account for share-based payments in accordance with ASC 718. Accordingly, we expense the fair value of awards granted to the directors. Total compensation expense related to the stock options for the years ended June 30, 2011 and 2010 was $27,027 and $0, respectively and was recorded as general and administrative expense.





A summary of our stock option activity as of June 30, 2011, and changes during the twelve months ended June 30, 2011 is presented in the following table:


F-31


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





16.
STOCK OPTIONS - Continued





Exercise PriceOption


Vested


per CommonShares


Shares


Stock RangeBalance, June 30, 2010


-



-


$
-Granted or vested during the year ended June 30, 2011


32,000



32,000


$
2.00Exercised during the year ended June 30, 2011


-



-


$
-Expired during the year ended June 30, 2011


-



-


$
-Balance, June 30, 2011


32,000



32,000


$
2.00





17.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE





For the years ended June 30, 2011 and 2010, selling, general and administrative expenses consisted of the following:





Year ended


Year endedJune 30, 2011


June 30, 2010Travel and accommodation

$
9,421,895


$
6,479,787Advertising and promotion


14,822,116



13,237,648Audit fees and expenses


197,348



40,073Commission


3,861,379



4,092,716Conferences


5,713,002



4,010,143Depreciation and amortization


228,873



37,726Staff costs


2,669,702



2,034,566Research and development cost


497,903



440,931Other operating expenses


7,731,350



5,879,485Impairment loss on Pharmaceutical formulas


635,442



-Total selling, general and administrative expenses

$
45,779,010


$
36,253,075


F-32





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





18.
INCOME TAXES





For the years ended June 30, 2011 and 2010, the provision for income taxes consisted of the following:





Years Ended June 30,2011


2010Current taxesUnited States

$
-


$
-PRC


4,330,292



2,973,289Deferred taxes (benefit)United States


(391,282
)


(308,406
)PRC


434,726



431,220Change in valuation allowance


391,282



308,406Provision for Income Taxes

$
4,765,018


$
3,404,509





As of June 30, 2011, we had $9,699,386 of net operating loss carry forwards available for federal tax income purposes that may be used to offset future taxable income and will begin to expire in 2029.We provided for full valuation allowance against the net deferred tax assets of $699,688 on the expected future tax benefits from the net operating loss carry forwards as management believes it is more likely than not that these assets will not be realized in the future. During the years ended June 30, 2011 and 2010, the valuation allowance increased by 391,282 and 308,406 respectively.




F-33


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





18.
INCOME TAXES — Continued





We are subject to income tax in the United States and the PRC. There was a benefit for income tax in the United States because we had a taxable loss in the United States for the years ended June 30, 2011and 2010. The statutory tax federal rate is 34%. The table below summarizes the differences between the U.S. statutory federal rate and our effective tax rate as follows for the years ended June 30, 2011 and 2010:





For the Years Ended June 30,2011


2010US tax at statutory rate

$
6,381,764


$
4,236,906Foreign tax differential


(1,699,616
)


(1,125,392
)Permanent differences


(1,544,980
)


-NOL True-up


(763,431
)


-Record prior year DTL


2,000,000



292,995Change in valuation allowance


391,282



-Provision for Income Taxes

$
4,765,018


$
3,404,509





Our deferred tax assets as of June 30, 2011 and 2010 are as follows:




June 30,2011


2010Deferred tax asset:NOL carryover

$
3,297,791


$
308,406Stock compensation


71,240



-Sub-total

$
3,369,031


$
308,406Deferred tax liabilities:Debt discount

$
(1,649,343
)

$
-Interest


(1,020,000
)


-Sub-total

$
(2,669,343
)

$
-Valuation allowance


(699,688
)


(308,406
)Total

$
-


$
-









We have permanently reinvested earnings in its foreign subsidiary. At June 30, 2011, $44,938,907 of accumulated earnings was permanently reinvested. At current tax rates, additional federal income taxes (net of available tax credits) of approximately $5,994,000 would become payable if such income were to be repatriated.





Management has evaluated and concluded that there were no material uncertain tax positions requiring recognition in the Company’s consolidated financial statements for the years ended June 30, 2011 and 2010. Further, it is not anticipated that the unrecognized benefits will significantly change over the next twelve months.





We and our subsidiaries file income tax returns in the U.S. federal jurisdiction and in the PRC. For federal tax purposes, years beginning after June 30, 2008 are still open to examination. Currently, no income tax returns are under examination.


F-34


BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010




19.
VIE





To satisfy PRC laws and regulations, the Company conducts certain business in the PRC througj the VIEs.





Resulting from the VIE Agreement signed between Yantai Shencaojishi Pharmaceuticals Co., Ltd (“WFOE”) and Yantai Bohai Pharmaceuticals Group Co. Ltd (“Bohai”), the Company includes the assets, liabilities, revenues and expenses of Yantai Bohai Pharmaceuticals Group Co. Ltd (the “VIE”) in its consolidated financial statements.





The VIE Agreements include:




Equity Interest Pledge Agreement.The WFOE and Bohai Shareholders have entered into Equity Interest Pledge Agreements, pursuant to which each Bohai Shareholder has pledged all of his shares of Bohai to the WFOE in order to guarantee cash-flow payments under the applicable Consulting Services Agreement. The Equity Pledge Agreement further entitles the WFOE to collect dividends from Bohai during the term of the pledge.





Consulting Service Agreement.Bohai and the WFOE has entered into a Consulting Services Agreement, which provides that the WFOE will be the exclusive provider of technology services to Bohai and Bohai will pay all of its net income based on the quarterly financial statements to the WFOE for such services. Any such payment from the WFOE to the Company would need to comply with applicable Chinese laws affecting payments from Chinese companies to non-Chinese companies. See “Risk Factors – Risks Associated With Doing Business in China.”





Operating Agreement. Pursuant to the operating agreement among the WFOE, Bohai and each of Bohai Shareholder, the WFOE provides guidance and instructions on Bohai’s daily operations and financial affairs. The Bohai Shareholders must designate the candidates recommended by the WFOE as their representatives on their respective boards of directors. The WFOE has the right to appoint senior executives of Bohai. In addition, the WFOE agrees to guarantee Bohai’s performance under any agreements or arrangements relating to Bohai’s business arrangements with any third party. Bohai, in return, agrees to pledge its accounts receivable and all of its assets to the WFOE. Moreover, Bohai agrees that without the prior consent of the WFOE, Bohai will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of its assets or intellectual property rights in favor of a third party or transfer of any agreements relating to its business operation to any third party.





These contractual arrangement may not be as effective in the providing the Company with control over the VIEs as director ownership. Due to its VIEs structure, the Company has to rely on contract right to effect control and management of the VIEs, which exposes it to the risk of potential breach of contract by the shareholders of Yantai Bohai Pharmaceuticals Group Co. Ltd.Our VIE Agreements are subject to significant risks as set forth in the following risk factors.





·
The PRC government may determine that the VIE Agreements which we utilize to control our operating subsidiary Bohai are not in compliance with applicable PRC laws, rules and regulations and that they are therefore unenforceable.


·
There are risks involved with the operation of Bohai under the VIE Agreements. We have been advised by PRC legal counsel that if the PRC government determines the VIE Agreement used to control the operating company to be unenforceable as they circumvent the PRC restrictions relating to foreign investment restrictions, the relevant regulatory authorities would have broad discretion in dealing with such breach and could have a material adverse impact on our business, financial condition and results of operations.


F-35





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010




19.
VIE — Continued





·
We depend upon the VIE Agreements in conducting our production, manufacturing, and distribution of traditional Chinese herbal medicines in the PRC, which may not be as effective as direct ownership.





·
We conduct our production, manufacturing and distribution of traditional Chinese herbal medicines in the PRC and generate the revenues from our Bohai business through the VIE Agreements. The VIE Agreements may not be as effective in providing us with control over Bohai as direct ownership. The VIE Agreements are governed by PRC laws and provide for the resolution of disputes through arbitration proceedings pursuant to PRC laws. Accordingly, the VIE Agreements will be interpreted in accordance with PRC laws. If Bohai or its Shareholders fail to perform the obligations under the VIE Agreements, we may have to rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, and there is a risk that we may be unable to obtain these remedies. The legal environment in China is not as developed as in other jurisdictions. As a result, uncertainties in the PRC legal system could limit our ability to enforce the VIE Agreements.





·
The pricing arrangement under the VIE Agreements may be challenged by the PRC tax authorities.





·
We could face adverse tax consequences if the PRC tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations. If the PRC tax authorities determine that the VIE Agreements were not entered into on an arm’s length basis, they may adjust the income and expenses of our company for PRC tax purposes which could result in higher tax liability.





20.
SUBSEQUENT EVENTS





Acquisition of Yantai Tianzheng Pharmaceuticals Company Limited





On August 8, 2011, Yantai Nirui Pharmaceuticals, Ltd. (“Yantai Nirui”), a newly formed limited liability company formed under the laws of the PRC and wholly owned by Chance High (the Company’s wholly-owned subsidiary), signed a share transfer agreement with the Shareholders of Yantai Tianzheng Pharmaceuticals Company, Ltd. (“Yantai Tianzheng”) to acquire 100% of Yantai Tianzheng’s equity interests for a purchase consideration of US$35,000,000 in aggregate, payable in four installments of which the RMB equivalent to US$6,000,000 will be paid on or before the tenth (10) calendar day after the Execution Date (the execution date of the Share Transfer Agreement), the RMB equivalent to US$12,000,000 will be paid on or before six (6) months after the Execution Date, the RMB equivalent to US$12,000,000 will be paid on or before twelve (12) months after the Execution Date, and the RMB equivalent to US$5,000,000 will be paid on or before eighteen (18) months after the Execution Date. The Agreement is subject to a three month transition period with associated covenants and obligations as well as certain precondition requirements, as defined, prior to each scheduled installment payment.





In the event that Yantai Nirui fails to pay any of the installments when due, such outstanding installment will be automatically converted into a two-year term loan owed by Yantai Nirui to the Shareholders of Yantai Tianzheng, with interest accruing on any unpaid portion of such loan from its due date until such installment is paid in full at the rate of six percent (6%) per annum. As long as such interest payments are made on a timely basis and the outstanding principal of such loan and interest are satisfied in full within 2 years after the Conversion Date, Yantai Nirui will not be deemed in breach or default under the SPA and will continue to possess full control and legal ownership over the Shares. Furthermore, even in the event of non-payment by Yantai Nirui of any principal or interest under the loans as described above, or in the event of any other breach or default by Yantai Nirui of the SPA, the Shareholders of Yantai Tianzheng’s remedies against Yantai Nurui are limited solely to monetary damages, and in all instances the Shareholders of Yantai Tianzheng will have no right to reclaim ownership of the Shares or demand that Yantai Nirui in any way revert control or legal ownership over the Shares back to the Shareholders.


F-36





BOHAI PHARMACEUTICALS GROUP, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED JUNE 30, 2011 AND 2010





20.
SUBSEQUENT EVENTS - Continued





The purchase price for Yantai Tianzheng was allocated to fair value of the tangible assets acquired and liabilities assumed, customer lists, pharmaceutical formulas, and other intangible assets. The estimated fair value of the tangible assets acquired and liabilities assumed approximated the historical cost basis. The excess of the purchase price over the fair value of the net assets and intangible assets acquired was allocated to goodwill.





The following unaudited pro forma financial information presents the consolidated results of the Company as though the acquisition of Yantai Tianzheng was completed as at the beginning of the years ended June 30, 2011 and 2010.





Year ended


Year endedJune 30, 2011


June 30, 2010Net Sales

$
126,934,504


$
85,391,453Net income

$
21,090,583


$
13,796,299Earnings per share- basic

$
1.23


$
0.94Earnings per share- diluted

$
1.07


$
0.82





Related party transaction with Yantai Tianzheng





Bohai (our principal operating subsidiary prior to the acquisition) grants the use of its registered trademark, Xian Ge, to Yantai Tianzheng on five types of its products. The agreement is effective from February 22, 2008 to February 17, 2013. There is no fee associated with the usage of the registered trademark.





The Company has performed an evaluation of subsequent events through the date these financial statements are issued.


F-37


SIGNATURES





Pursuant to the requirements of the 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 on the 28 day of September, 2011.





Bohai Pharmaceuticals Group, Inc./s/ Hongwei QuBy:Name: Hongwei QuTile: President and Chief Executive Officer(Principal Executive Officer)/s/ Gene HsiaoBy:Name: Gene HsiaoTile: Chief Financial Officer(Principal Financial Officer)





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.





Signature

Title

Date/s/ Hongwei Qu

Chief Executive Officer and Chairman

September 28, 2011Hongwei Qu/s/ Chengde Wang

Director

September 28, 2011Chengde Wang/s/ Gene Hsiao

Director

September 28, 2011Gene Hsiao/s/ Adam Wasserman

Director

September 28, 2011Adam Wasserman/s/ Thomas Tan

Director

September 28, 2011Thomas Tan