UNITED STATES


SECURITIES AND EXCHANGE
COMMISSION


WASHINGTON, D.C.
20549





FORM 10-K





(Mark One)





x ANNUAL REPORT UNDER
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE OF 1934





For the fiscal year ended December 31,
2008





o TRANSITION REPORT UNDER
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE OF1934





For the transition period from ____ to
_____





Commission file number:
001-32581





LOTUS
      PHARMACEUTICALS, INC.(Exact
      name of registrant as
      specified in its charter)





NEVADA
            20-0507918(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)





16 Cheng Zhuang Road, Feng Tai
      District, Beijing 100071,
              People's Republic of
      China
            n/a(Address
      of principal executive offices)
            (Zip
      Code)





Registrant's
      telephone number, including area code:
            86 (10)63899868





Securities
registered under Section 12(b) of the Act:





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





Securities
registered under Section 12(g) of the Act:





Common
      stock(Title
      of class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  [ ] Yes [√] No





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


[ ] Yes
[√] No


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 [√] 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 the 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, anaccelerated filer, a non-accelerated
filer, or a smaller reporting company:





Large
      accelerated filer
            [  ]
            Accelerated
      filer
            [  ]Non-accelerated
      filer
              (Do
      not check if smaller reporting company)
            [  ]
            Smaller
      reporting company
            [√]




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act)    Yes [ ] No [√]





State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked prices of such common equity, as of the last
business day of the registrant's most recently completed second fiscal quarter
$12,441,550 on June 30, 2008.





Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.   43,377,932 shares of
common stock are issued and outstanding as of March 31, 2009.





DOCUMENTS
INCORPORATED BY REFERENCE





List
hereunder the following documents if incorporated by reference and the Part of
the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980).  None.





LOTUS
PHARMACEUTICALS, INC.


FORM
10-K


TABLE
OF CONTENTS





Page
      No.Part
      IItem
      1.
                                                                          Business.
                                                                          4Item
      1A.
                                                                          Risk
      Factors.
                                                                          16Item
      1B.
                                                                          Unresolved
      Staff Comments.
                                                                          29Item
      2.
                                                                          Properties.
                                                                          29Item
      3.
                                                                          Legal
      Proceedings.
                                                                          30Item
      4.
                                                                          Submission
      of Matters to a Vote of Security Holders.
                                                                          30Part
      IIItem
      5.
                                                                          Market
      for Registrant's Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities.
                                                                          30Item
      6.
                                                                          Selected
      Financial Data.
                                                                          32Item
      7.
                                                                          Management's
      Discussion and Analysis of Financial Condition and Results of
      Operation.
                                                                          32Item
      7A.
                                                                          Quantitative
      and Qualitative Disclosures About Market Risk.
                                                                          45Item
      8.
                                                                          Financial
      Statements and Supplementary Data.
                                                                          45Item
      9.
                                                                          Changes
      In and Disagreements With Accountants on Accounting and Financial
      Disclosure.
                                                                          45Item
      9A.(T)
                                                                          Controls
      and Procedures.
                                                                          45Item
      9B.
                                                                          Other
      Information.
                                                                          47Part
      IIIItem
      10.
                                                                          Directors,
      Executive Officers and Corporate Governance.
                                                                          47Item
      11.
                                                                          Executive
      Compensation.
                                                                          50Item
      12.
                                                                          Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.
                                                                          52Item
      13.
                                                                          Certain
      Relationships and Related Transactions, and Director
      Independence.
                                                                          53Item
      14.
                                                                          Principal
      Accountant Fees and Services.
                                                                          54Part
      IVItem
      15.
                                                                          Exhibits,
      Financial Statement Schedules.
                                                                          54








i




CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING INFORMATION





This report contains forward-looking
statements. These forward-looking statements are subject to known and unknown
risks, uncertainties and other factors which may cause actual results,
performance or achievements to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. These forward-looking statements were based on various factors and
were derived utilizing numerous assumptions and other factors that could cause
our actual results to differ materially from those in the forward-looking
statements. These factors include, but are not limited to, the risk of doing
business in the People's Republic of China ("PRC"), our ability to implement our
strategic initiatives, our access to sufficient capital, the effective
integration of our subsidiaries in the PRC into a U.S. public company structure,
economic, political and market conditions and fluctuations, government and
industry regulation, Chinese and global competition, and other factors. Most of
these factors are difficult to predict accurately and are generally beyond our
control. You should consider the areas of risk described in connection with any
forward-looking statements that may be made herein. Readers are cautioned not to
place undue reliance on these forward-looking statements and readers should
carefully review this report in its entirety, including the risks described in
"Item 1A. - Risk Factors". Except for our ongoing obligations to disclose
material information under the Federal securities laws, we undertake no
obligation to release publicly any revisions to any forward-looking statements,
to report events or to report the occurrence of unanticipated events. These
forward-looking statements speak only as of the date of this report, and you
should not rely on these statements without also considering the risks and
uncertainties associated with these statements and our business.





OTHER PERTINENT
INFORMATION





We maintain a web site atwww.lotuspharma.com. Informationon this website is not a part of this
annual report.





INDEX OF CERTAIN DEFINED TERMS USED IN
THIS REPORT





Unless specifically set forth to the
contrary, when usedin this
report the terms:





•"Lotus," "we," "us," "our," the "Company," and similar terms ref
 er to Lotus
Pharmaceuticals, Inc., a Nevada corporation formerly known as S.E. Asia Trading
Company, Inc., and its subsidiary,





•"Lotus
International" refers to
Lotus Pharmaceutical
International, Inc., a Nevada corporation and a subsidiary of
Lotus,





•"Lotus
Century" refers to Lotus
Century Pharmaceutical (Beijing) Technology co., Ltd., a wholly foreign-owned
enterprise (WFOE) Chinese company which is a subsidiary of Lotus,


ii





•"Liang
Fang" refers to Beijing
Liang Fang Pharmaceutical Co., Ltd., a Chinese limited liability company formed
on June 21, 2000 and an affiliate of En Zhe Jia,





•"En Zhe
Jia" refers to Beijing En
Zhe Jia Shi Pharmaceutical Co., Ltd., a Chinese limited liability company formed on
September 17, 1999 and an affiliate of Liang Fang,





•"Lotus
East" collectively refers
to Liang Fang and En Zhe Jia,





•"Consulting
Services Agreements" refers
to the Consulting Services Agreements dated September 20, 2006 between Lotus and Lotus
East.





•"Operating
Agreements" refers to the
Operating Agreements dated September 20, 2006 between Lotus, Lotus East and the
stockholders of Lotus East,





•"Equity
Pledge Agreements" refers
to the Equity Pledge Agreements dated September 20, 2006 between Lotus,
Lotus East and the stockholders of Lotus East,





•"Option
Agreements" refers to the
Option Agreements dated September 20, 2006 between Lotus, Lotus East and the
stockholders of Lotus East,





•"Proxy
Agreements" refersto the Proxy Agreements
dated September 20, 2006 between Lotus, Lotus East and the stockholders of Lotus
East,





•"Contractual
Arrangements" collectively
refers to the Consulting Services Agreements, Operating Agreements, Equity
Pledge Agreements, Option Agreements and the Proxy
Agreements,





•"China" or the "PRC" refers to the People's Republic of
China,





•"RMB" refers to the renminbi which is the
currency of mainland PRC of which the yuan is the principal
currency,





•"2007" generally refers to the
fiscal year ended December
31, 2007; and





•"2008" generally refers to the fiscal year
ending December 31, 2008.












PART
I





ITEM
1.  BUSINESS.





OVERVIEW





We operate, control and beneficially own
the pharmaceutical businessesin China of Lotus East under the
terms of the Contractual
Arrangements. Otherthan the Contractual Arrangements with
Lotus East, we do not have any businessor operations. Pursuant to the
Contractual Arrangements we provide businessconsulting and other general business
operation servicesto Lotus
East. Throughthese Contractual Arrangements, we have
the ability to control the dailyoperations and financial affairs of
Lotus East, appoint each of their seniorexecutives and approve all matters
requiring stockholder approval. As a resultof these Contractual Arrangements, which
enable us to control Lotus East, we areconsidered the primary beneficiary of
Lotus East. Accordingly, we consolidateLotus East's results, assets and
liabilities in our financial statements. Thecreditors of Lotus East, however, do not have recourse to any
assets we mayhave.





PRC
law currently places certain limitations on foreign ownership ofChinese companies. To comply with these
foreign ownership restrictions, weoperate our business in China through
the Contractual
Arrangements with LotusEast. The contractual relationship among
the above companies as follows:


4





Notwithstanding that Lotus, Liang Fang
and En Zhe Jia are separatelegal entities and the legal obligations
of the parties are governed by theContractual Arrangements, there is
commonality of control between Lotus andLotus East as set forth in the following
table:





Name
            Executive Officer/Director
      of Lotus
            Principal
              Stockholder
              of Lotus
            Stockholder of
              Liang Fang
            Stockholder of
              En Zhe
  JiaDr.Liu Zhong
Yi
            √
            √
            √
            √Mrs. Song Zhenghong1
            √
            √
            √
            √Wen Li Xian
            
            
            √





(1) Mrs. Song Zhenghong is the spouse of
Dr. Liu Zhong Yi.





Based in
Beijing, China, Lotus East is engaged in the production, trade and retailing of
pharmaceuticals, focusing on the development of innovative medicines and
investing in strategic growth to address various medical needs. Lotus East owns
and operates 10 drug stores throughout Beijing, China that sell Western and
traditional Chinese medications, lease medical treatment facilities to licensed
physicians, and generate revenues from the leasing of retail space to third
party vendors and the leasing of advertising locations at its retail
stores.




Our
principal executive offices are located at 16 Cheng Zhuang Road, Feng Tai
District, Beijing 100071 China and our telephone number is 86-10-63899868. Our
fiscal year end is December 31.





The Contractual Arrangements are
comprised of a series of agreements,including Consulting Services Agreements
and Operating Agreements, through whichwe have the right to advise, consult, manage and
operate Lotus East, and collectand own all of their respective net
profits. Additionally, under ProxyAgreements, the stockholders of Lotus
East have vested their voting control overLotus East to us. In order to
further reinforce our
rights to control andoperate Lotus East, these companies and
their stockholders have granted us,under Option Agreements, the exclusive
right and option to acquire all of theirequity interests in Lotus East,
alternatively, all of the assets of Lotus East.Further the Lotus East stockholders have
pledged all of their rights, titles andinterests in Lotus East to us under
Equity Pledge Agreements.





Under PRC laws, each of Lotus, Lotus
International, Liang Fang and EnZhe Jia is an independent legal person and none of them is
exposed toliabilities incurred by the other party.
Other than pursuant to the ContractualArrangements, Lotus East does not
transfer any other funds generated from theirrespective operations to
us.





5


On September 6, 2006, we entered into the following
ContractualArrangements:





Consulting Services Agreements. Pursuant
to the exclusive ConsultingServices Agreements we have the
exclusive right to provide to Lotus East generalpharmaceutical business operations
servicesas well as
consulting servicesrelated to the technological research
and development of pharmaceutical productsas well as general business operation
advice and strategic planning (the"Services"). Under these agreements, we
own the intellectual property rightsdeveloped or discovered through research
and development, in the course ofproviding the Services, or derived from
the provision of the Services. LotusEast is to pay us a quarterly consulting
service fees in RMB that is equal toLotus East's net profits, as defined, for such
quarter.





Operating Agreements. Pursuant to the
Operating Agreements we provideguidance and instructions on Lotus
East's daily operations, financial managementand employment issues. The stockholders
of Lotus East must designatethecandidates recommended by us as their
representatives on each of Lotus East'sBoard of Directors. We have the right to
appoint senior executives of LotusEast. In addition, we agreed to
guarantee Lotus East's performance under anyagreements or arrangements relating to Lotus East's business
arrangements withany third party. Lotus East, in return,
agreed to pledge its accounts receivableand all of its assets to us. Moreover,
Lotus East agreed that without our priorconsent, Lotus East would not
engagein any transaction
that could materiallyaffect the assets, liabilities, rights
or operations of Lotus East, including,without limitation, incurrence or
assumption of any indebtedness, sale orpurchase of any assets or rights,
incurrence of any encumbrance on any of itsassets or intellectual property rights
in favor of a third party or transfer ofany agreements relating to its business
operation to any third party. The termof these agreements is 10 years from
September 6, 2006 and may be extended onlyupon our written confirmation prior to
the expiration of the these agreements,with the extended term to be mutually
agreed upon by the parties.





Equity Pledge Agreements. Under the
Equity Pledge Agreements, thestockholders of Lotus East pledged all
of their equity interests
in Lotus Eastto us to guarantee Lotus East's
performance of its obligations under theConsulting Services Agreements. If Lotus
East or Lotus East's stockholdersbreaches its respective contractual
obligations, we, as pledgee, will beentitled to certain rights, including
the right to sell the pledged equityinterests. Lotus East's stockholders
also agreed that upon occurrence of anyevent of default, we will be granted an
exclusive, irrevocable power of attorneyto take actions in theplace and stead of Lotus East's
stockholders to carry outthe security provisions of the Equity
Pledge Agreements and take any action andexecute any instrument that we might
deem necessary or advisable to accomplishthe purposes of The Equity Pledge
Agreements. The
stockholders of Lotus Eastagreed not to dispose of the pledged
equity interests or take any actions thatwould prejudice our interest. The Equity
Pledge Agreements expire two yearsafter Lotus East's obligations under the
Consulting Services Agreements havebeen fulfilled.





Option Agreements. Under the Option
Agreements, the stockholders ofLotus East irrevocably granted us or our
designated person exclusive options topurchase, to the extent permitted under
PRC law, all or part of the equityinterests in Lotus East for the cost of
the initial contributions to theregistered capital or the minimum amount
of consideration permitted byapplicable PRC law. We, or our
designated person, has sole discretion to decidewhen to exercise the option,
whether in part or in full.
The term of theseagreements is 10 years from September 6,
2006 and may be extended prior to theirexpiration by written agreement of the
parties.




Proxy Agreements. Pursuant to the Proxy
Agreements, Lotus East'sstockholders agreed to irrevocably grant a person to
be designated by us withthe right to exercise Lotus East's
stockholders' voting rights and their otherrights, including the attendance at and
the voting of Lotus East's stockholders'shares at the stockholders'
meetings (or by written
consent in lieu of suchmeetings) in accordance with applicable
laws and their Articles of Association,including but not limited to the rights
to sell or transfer all or any of hisequity interests of Lotus East, and
appoint and vote for the
directors andChairman as the authorized
representative of the stockholders of Lotus East. Theterm of these Proxy Agreements is 10
years from September 6, 2006 and may beextended prior to their expiration by
written agreement of the parties.







6





LOTUS EAST





Based in Beijing, China, Liang Fang is
engaged in the production, tradeand retailing of pharmaceuticals,
focusing on the development of innovativemedicines and investing in strategic
growth to address various medical needs.


Liang Fang ownsand operates 10 drug stores throughout
Beijing, China that sellWestern and traditional Chinese
medications, lease medical treatment facilitiesto licensed physicians, and generate
revenues from the leasing of retail spaceto third party vendors and the
leasing of advertising
locations at its retailstores. En Zhe Jia is the sole
manufacturer for Liang Fang and maintainsfacilities for the production of
medicines, patented Chinese medicine, as wellas the research and production of other
new medicines.





Lotus East's business is composed of
three parts:





·
            manufacturing and distribution of
      pharmaceutical products, includingthe manufacture of pharmaceutical
      products for other distributors(OEM
      manufacturing),


·
            retailing of Western and
      traditional Chinese
      medications, andmedical treatment equipment
      through retail locations;
and


·
            research and development as
      outlined below:





MANUFACTURING AND DISTRIBUTION OF
PHARMACEUTICAL PRODUCTS





Lotus East's production enterprise is
located in the Chaoyang Districtof Beijing and covers a floor space of
approximately 50,000 square feet. Itpossesses liquid phase, gas phase,
spectrum, and mass spectrum equipment and a


variety of types of purification and
distilling equipment, all of which can beused for production and research and development of
biochemical medicines,Chinese traditional medicines, chemical
compound medicines, antibiotics andother new medicines. As one of the first
enterprises to be authenticated by theNational China Good Manufacturing
Practices (GMP), Lotus East
believes it has anadvanced automatic pharmacy product line
which is GMP authenticated undercertificate numbers C0849, C0850, D1645,
and G3452. Medicines produced by LotusEast include:





·
            material
      medicine,


·
            troches,


·
            capsules,


·
            granule medicaments;


·
            freeze-dried powder for
      injections,


·
            injections of small capacities,
      and


·
            eye
  drops.





Different production control zones are
used with separated airconditioning system according to
different production and control needs.Production and sale of its pharmaceuticals and wholesale
distribution of thirdparty manufactured pharmaceuticals is
Lotus East's largest and most profitablebusiness and accountsfor approximately88%and73% of our net revenues in2008 and2007, respectively. Undervarious manufacturing contracts, Lotus East
provides contract manufacturingservices for several drug companies
including the manufacture of product totheir
specifications.





Currently, Lotus East markets and sells
its products only in PRC. LotusEast's principal pharmaceutical manufactured
products include:





7








Valsartan





In 2000, Lotus East obtained approval
from the State Food and DrugAdministration (SFDA) of China to sell
Valsartan as a raw material and as acapsule (Maixin). Among its bestselling products, Valsartan
is a drug thattreats hypertension or high blood
pressure. This product is globally recognizedas the ideal anti-high blood pressure
medication by the medical industry due toits most stable and longest lasting
treatment resultsand
minimum side-effects.





High blood pressure adds to the workload
of the heart and arteries. Ifit continues for a long time, the heart
and arteries may not function properly.This can damage the blood vessels of the
brain, heart, and kidneys,resulting ina stroke, heart failure, or kidney
failure. High blood pressure may alsoincrease the risk of heart attacks.
These problems may be less likely to occurif blood pressure is controlled.
Valsartan works by blocking a substance in thebody that causes blood vessels to tighten. As a
result, Valsartan relaxes bloodvessels. This lowers blood pressure and
increases the supply of blood and oxygento the heart. Lotus East's goal is to
make Valsartan the number one prescribedbrand in its class of highblood pressure medications in the
PRC.





Lotus East holdscurrentmanufacturing rights to
produceValsartan. It estimates that there arecurrently 10 enterprises
producingsingleregent dosage and fixed-dose
combinations of Valsartan in China. Theforeignpharmacy Novartis Pharma sells Valsartan
under its brand name, Diovan. Accordingto clinical verification, the two
products, Maixin and Diovan, have the sameclinical effects. Lotus East’s currently holds approximately 20% of thetotal Chinamarketshare for Valsartan.Lotus Eastbelieves thatit will maintain its current market
share due to increasedbrand recognition andcontinued sales efforts. Lotus East also
believes that even if the Chinesegovernment does not take any measures to
protect these products,
otherenterprisesstill cannot replicate its productsinthe near futurebecause ittakesatleast two to three years toreplicate any orally taken
medicineand China SFDA has
not been encouragingfor
duplicated medicines bylimitingthe
approvals given to the new
applications for duplicated medicines. Evenif the marketdoes facefiercer competitionin the future, Lotus East believes its market will
berelatively mature and that its
production cost will be lower than those newly approvedproducts. Accordingly, it believes that its
sales revenue from Valsartan canstay relatively
stable.





Brimonidine
Tartrate Eyes Drops





Brimonidine Tartrate is a drug used to
constrict adrenaline receptors,an important step in treating glaucoma.
LotusEast sells
Brimonidine Tartrateeye drops under its brand name "Muxin".
The drug was first put into market inthe U.S. in 1998 and in August 2004,
Lotus East received the rights tomanufacture and release the drug in the
Chinese market. A fast and obviouscurative effect, very few side effects,
a very high exponent of cure and highendurement are prime features of the
drug. It will produce no harmful effects ofreducing blood pressure, resulting in
calmness and so on, much like diazepam.The imported product of its kind is Alphagan and is
produced by Allergan(Hangzhou) Pharmaceutical Co., Ltd.
According to clinical experiments ofPeople's Hospital of Peking University
and Tianjin Eye Hospital, Muxin andimported Alphagan have exactly the same
curative effect but the
side-effects ofMuxin are fewer than Alphagan. As a
result, Lotus East believes that its producthas a stronger competitive
advantage.





Lotus East holds manufacturing rights to
produce Brimonidine Tartratethrough August 2009. Lotus
Eastestimates that other
enterprises will not beable to replicate this product until
March 2010, as it believes it takes atleast 30 months to replicate an eye drop
medicine. Currently, Lotus East hasminimal competition and believes its
market share willincrease. However, itdoes anticipate lowersgross marginsprofits after 2010.





8








Levofloxacin
Lactate for Injection





Levofloxacin is a popular anti-bacterial
drug for the treatment ofmild, moderate, and severe infections
caused by susceptible trains of thedesignated microorganisms in the
conditions such as acute maxillary sinusitis,acute bacterial exacerbation of chronic
bronchitis, community-acquiredpneumonia, complicated and uncomplicated
skin and skin structure infections,complicated and uncomplicatedurinary tract infections,
and acutepyelonephritis. Lotus East received the
rights to manufacture and release thedrug in the Chinese market in 2005.Lotus Eastcurrently sells Levofloxacin Lactate
forInjection under its brand name "Junxin".
The importedproduct of its
kind ismanufactured by Japanese pharmaceutical
company, Daiichi Pharmaceutical Co.Levofloxacin is one of most widely use
antibiotics in China and Lotus Eastbelieves this product will remain
competitive through 2011.





Nicergoline
for Injection





Nicergoline for Injection is a national
medical insurance product. Itis an A-receptor blockage nerve system
blood-brain medicine with remarkablecurative effect. On the cerebral level,
it prompts a lowering of vascularresistance, an increase in arterial flow and stimulates the
use of oxygen andglucose. Nicergoline also improves blood
circulation in the lungs and limbs andhas been shown to inhibit blood platelet
aggregation. It is used to treat seniledementia, migraines of vascular
origin, transient ischemia,
platelethyper-aggregability and macular
degeneration. Lotus East received the rights tomanufacture this product in 2006 and
release the drug in the Chinese market in2007. The estimated patient base for
this product in China is approximately30,000,000 people and Lotus East
believes this product will remain competitivethrough 2011.Salesdecrease in 2008 but we expectfuture sales will remain stable at the
current levelas
2008.





Lotus East also acts as a wholesale
distributor to distribute
variouspharmaceutical products manufactured by
third party manufacturers.The third party manufactured products
are–





Product
Name
            Type of Distribution
      RightsOctreotide
      Acetate Injection Solution
            Exclusive
      Distribution RightsRecombinant
      Human Erythropoietin Injection
            Exclusive
      Distribution RightsRecombinant
      Human Granulocyte Colony Stimulating Factor Injection
            Exclusive
      Distribution RightsRecombinant
      Human Interleukin-2 for Injection
            Exclusive
      Distribution RightsCervus
      and Cucumis Polypeptide Injection
            Exclusive
      Distribution RightsPotassium
      Aspartate and Magnesium Aspartate for Injection
            Non-exclusive
      Distribution RightsDeproteinized
      Calfblood Extractives Injection
            Non-exclusive
      Distribution RightsCefotaxime
      Sodium For Injection
            Non-exclusive
      Distribution RightsNingxinyishen
      Koufuye
            Non-exclusive
      Distribution Rights





In 2008 and 2007, revenuesfrom wholesale distributionof ourfour principalproducts (Walsartan,Brimonidine Tartrate Eyes
Drops,Levofloxacin Lactate for Injection and Nicergoline for
Injection)manufactured by
Lotus Eastwereapproximately49%and28% of Lotus East'stotal salesrevenue, respectively.





With the implementation
in China of macro-economic policyand price controls by
the Chinese government, theoverallprofit margin of
medicinesin the industryshall
decrease.However, the rapid increase
in the disposable income, government-backed healthcare spending and the number
of elderly people in China in recent years have primarily resulted in an
increasing spending on
prescription and OTC medicines in China.








9





As of the date of this report, we cannot
estimate the effect of these economic policiesand increased spendings in Chinaon our results of
operations.





Technology
Transfer Agreement





On April
25, 2008 En Ze Jia entered into a Technology Transfer Agreement with Dong Guan
Kai Fa Biologicals Medicine LTD ("Dong Guan") pursuant to which Dong Guan agreed
to transfer the technology material, new medicine research and rights to the
Chinese patent of the anti-asthma new medicine R-BM to En Ze Jia on an exclusive
basis in exchange for a transfer technology fee of approximately $6,860,000 (RMB
48 million) to be paid at various intervals.  Under the terms of the
agreement, En Ze Jia is obligated to:





•
            complete
      the filing with the Chinese State Food and Drug Administration (SFDA) of
      the medicine's clinical research ratification
  document,


•
            complete
      the clinical research,


•
            complete
      the medicine's trial production,
and


•
            providing
      raw materials and formulation related documentation and apply for the new
      medicine certification and production
approval.





In
addition to the payment of the technology transfer fee, En Ze Jia is responsible
for paying all costs associated with its responsibility under the agreement
which are presently estimated at $2,286,000 (RMB 16 million).  Lotus
East intends to use its working capital to fund the project costs.





Dong Guan
is responsible for preparing and transferring the clinical research and
application documents as well as assisting En Ze Jia in the completing the
clinical research and applying for the new medicine certification and production
approval documents.





Under the terms of the agreement, the
technology transfer fee is to be paid upon the following schedule:





•           Approximately
$1,429,000 (RMB 10 million) is due by the 15th business day following the
receipt of the processing notice of the receipt of the clinical application and
all related material from SFDA is received,





•           Approximately
$1,144,000 (RMB 8 million) is due by the 10th business day after the receipt of
the medicine's clinical ratification document,





•           Approximately
$1,429,000 (RMB 10 million) is due by the 15th business day after the medicine's
Phase I clinical study is completed and ratification from the SFDA is obtained,
and





•           Approximately
$2,858,000 (RMB 20 million) is due by the 10th business day after the medicine's
Phase II clinical study is completed and ratification from the SFDA is
obtained.





En Ze Jia
paid Dong Guan a deposit of approximately $2,858,000 (RMB 20 million) which is
returned to En Ze Jia with 10 days after the transfer technology fee is
paid.  In the event Dong Guan should be unable to timely return the
deposit, it will pay En Ze Jia a late fee and En Ze Jia is entitled to damages
for Dong Guan's failure to timely return the deposit.





In addition to the technology transfer
fee, Dong Guan is entitled to annual payments equal to 3% of the product's
annual sales in the prior year beginning in following year after the medicine is
produced and marketed and continuing until August 2020, the expiration date of
the patent.  The agreement further requires En Ze Jia to complete
various stages of the process in accordance with an established schedule with
anticipates the introduction of the product to market during 2014.  En
Ze Jia, however, anticipates that the product will be launched in 2012 assuming
the approval of SFDA can be obtained.





10








The intellectual property arising from
the agreement will be jointly shared by the parties.  In addition, En
Ze Jia has guaranteed that both parties must jointly apply for related
government grants prior to when the new medicine is marketed.  Upon
receipt of the government grants En Ze Jia guaranteed that  the grant
monies will be shared equally by both parties.





The agreement can be terminated by Dong
Guan if En Ze Jia should fail to make any of the aforedescribed payments in
which event the patent rights would revert to Dong Guan and it is entitled to
transfer the project rights to a third party.





RETAIL DRUGSTORES





Lotus East owns and operates 10 drug
stores throughout many differentdistricts of Beijing,
including:





·
            Xin Zhong Tai
      Drugstore


·
            Long Ren Tang
      Drugstore


·
            Wan Shou Road
      Drugstore


·
            He Ping Li
      Drugstore


·
            Feng Lin Lu
      Zhou


·
            Youth Lake
      Drugstore


·
            Capital Airport
      Drugstore


·
            Young An Zhong Sheng
      Drugstore


·
            Cheng Zhuang Road
      Drugstore


·
            Feng Tai
      Drugstore





These 10 drug stores all offer in excessof 5,000 typesof Western andtraditional Chinese medications, and
medical treatment equipment.Thedrug stores attempt to compete according to
lower pricing and more efficientdistribution and management
practices.Lotus East hasapproximately 300 employees(90exclusive sales representatives, 65
retail store staff,60
product marketing specialists includingregistered pharmacists,45 administrative staff and40factory workers).





Through its retail operations, Lotus
East also generates revenuethrough the leasing of office space to
licensed physicians, the lease of storefront areas to various merchants, and the lease of advertising space
in theretail pharmacies.





DISTRIBUTION METHODS OF THE PRODUCTS OR
SERVICES AND LOTUS EAST'SCUSTOMERS





Currently, Lotus East sells drugs
throughover70 distributionagents and drug distribution companiesin China covering32 except Tibet, Taiwan,
Hong Kong, andMacauin the PRC. Lotus East works with
various distribution companies to distributeits products. The demand for new drugs
in China is substantial as the drugdistribution companies suffer from
very low profit margins
from the distributionof old generic drugs. Additionally,
Lotus East has a network of connections withhospitals in the Inner Mongolia and
surrounding areas which provide directaccess to hospitals in these areas.
Lotus East's drug products
are also soldthrough its retail drug
stores.





Lotus East recognizes the importance of
branding as well as packaging.All of its products bear a uniform brand
but it also brands and packages itsproducts with specialized designs to
differentiate the different
categories ofits products.







11





Lotus East conducts promotional
marketing activities to publicize andenhance the company's image as well as
to reinforce the recognition of its brandname, including:





·
            publishing advertisements andarticles in national
      as well asspecialized and provincialpharmaceuticsandBiotechnewspapersandmagazines, and in othermedia, including the
      Internet;





·
            participation in national
      meetings, seminars, symposiums,exhibitions for bio-pharmaceutical
      and other related
      industries;





·
            organizing cooperative promotional
      activities with distributors;
and





·
            Educational and seminar training
      sessions to physicians and pharmacists to introduce and explain our
      drugs.





·
            Establishmentof anover the counter department toresell variousretail pharmaceutical products to
      other third party pharmacies





Excluding customers in its retail
operations, Lotus East currently hasover 130 customers, including over 30 direct
customers in Beijing, Shanghai,Chongqing, GuangDong,Inner Mongolia, Ningxia, Henan, Hubei,
LiaoNing,HeiLongjiang, Guangxi, Jiangsu, Hebei,
Anhui, Yunnan, Sichuan, Shanxi provincesin the PRC. In 2008,Lotus East spent approximately$181,000on advertisingexpenses as compared to approximately
$2.6 millionin 2007.





AGREEMENT WITH WU LAN CHA BU EMERGENCY
HOSPITAL





On October 10, 2006, Lotus East entered
into a five-year loan agreementand contract with Wu Lan Cha Bu
Emergency Hospital whereby Lotus East agreed tolend to Wu Lan Cha Bu Emergency Hospital approximately
$4,377,000for theconstruction of a hospital ward in Inner
Mongolia, China. In exchange for theloan, Wu Lan Cha Bu Emergency Hospital
agreed that Lotus East would be theexclusive provider for all medicines and
disposable medical
treatment apparatusto it for a period of 20 years. In
October 2006, Dr. Liu Zhong Yi, our ChiefExecutive Officer and the CEO and
principal stockholder of Lotus East, loanedthese funds to Wu Lan Cha Bu Emergency
Hospital on behalf of Lotus East.Accordingly, on October 10, 2006 Lotus East
entered into an assignment agreementwhereby it assigned all of its rights,
obligations, and receipts under the loanagreement to Dr. Liu, except for the
rights to revenues from the sale of medicaland disposable medical treatment apparatus which will
remain with Lotus East. Ascompensation to Dr. Liu for accepting
the assignment under the loan agreementincluding all of the risks and
obligations and for Dr. Liu not accepting therights to revenues from the sale of
medical and disposable
medical treatmentapparatus which will remain with Lotus
East, Lotus East agreed to pay Dr. Liu anaggregate of approximately $1,313,000to be paid in five equal
annualinstallments of approximately
$263,000.On October 2006, we estimated the hospital construction project
will be completed by 2009. But there have been delays in this
construction project, so,
at this moment,we estimated it will not be completeduntil summer of 2010.
Accordingly, it is anticipated that Lotus East will begin generating revenue from the hospital
in late 2010.





COMPETITION





Vertically integrated pharmaceutical
operations are still at an earlystage of development in China due to
heavy state involvement in the past andLotus East believes that the
industry is fragmented.
Lotus East facescompetition from domestic drug research
and development companies and drugmanufacturing companies which are
growing rapidly. Its direct competitors aredomestic pharmaceutical companies and
new drug research and developmentinstitutes that have fairly strong
research anddevelopment
capabilities in newdrugs such as Beijing Venture Biopharma
Technology Co., Ltd., Fosun Group Co.,Ltd.,Zhuhai Lizhu andBeijing Nohua. LotusEast also faces competition of foreign
companies who
havestrong proprietary pipeline and strong
financial resources. These companies havesignificantly greater assets than Lotus
East and have a larger current marketshare. Lotus East believes its advantage
is its local concentration in researchanddevelopment, thelocal distribution network, and lower
prices.Lotus East believes that it has good
quality and technical manufacturing practices and generally has not experienced
any quality control issue.Lotus East attempts to focus more on
quality, and establishing
long-term goodcooperative relations with the Chinese
Academy of Medical Sciences and the ChinaAcademy of Traditional Chinese Medicine
and medicine test organizations. LotusEast believes that it is able to compete
as a result of its research
anddevelopment capability, extensive sales
network and lower prices. Other thanthese competitors, most of Lotus East's
other competitors produce only oneor two products.





12








RAW MATERIALS AND PRINCIPAL
SUPPLIERS





Lotus East designs, creates
prototypes and manufactures
its products atits manufacturing facilities located at
Beijing, PRC. Its principal rawmaterials include BrimonidineTartrate,Levofloxacin Lactate,
Nicergolineand
Valsartan. Theprices for these raw materials are
subject to market forces
largely beyond LotusEast's control, including energy costs,
organic chemical prices, market demand,and freight costs. The prices for these
raw materials have varied significantlyin the past and may vary significantly
in the future.





Lotus East relies on a combination of
trademark, copyright and tradesecret protection laws in PRC and other
jurisdictions, as well asconfidentiality procedures and
contractual provisions to protect ourintellectual property and its brand.
Lotus East intends to apply
for patentprotection of certain of its special
technologies to protect our coretechnologies. There are no assurances,
however, that if such applications aremade that the patents will be granted.
Lotus East also enters intoconfidentiality, non-compete and invention assignment
agreements with itsemployees and consultants and
nondisclosure agreements with third parties."Maixing" and "Liang Fang" are its
registered trademarks in the PRC.





RESEARCH AND
DEVELOPMENT





Lotus East places great
emphasis on product
research and developmentand it has established a research and
development center. Lotus East's researchand development team is comprised of
nine individuals who are focused ondiscovering new drugs as well as
developing generic and improved drugs based onexisting products already on the market
and traditional Chinese medicinalproducts. Lotus East also contracts
third party research and developmentinstitutes to conduct various research
and development projects on its behalf.From researchand development performed during and
prior to fiscal 2005, LotusEast has a product pipeline containing
approximately seven products in differentdosage forms which are ready for
commercialization in China for the treatment ofdiseases. Lotus East expectsto receive Chinese SFDA approvals on
those productsin the near future. Lotus East intends
to commercialize or license these drugsduring 2008 and 2009. In 2007, Lotus
East resumed its new drug research anddevelopment effort and started five new
researchand development
projects andthose projects are in different
development stages. Major projects currentlybeing undertaken at these centers focus
on the following:





13








Drug Name
              Target
      Treatment
              Status
  (A)Calcium
      Dibutyryl Adensine Monophosphate for Injection
              used
      to cure angina and acute myocardial infarction
              Pending
      final SFDA approvalGatifloxacin
      Lactate for Injection
              used
      for curing acute nasosinusitis, chronic bronchitis, pneumonia, gonorrhea,
      and rectum infection
              Pending
      final SFDA approvalSodium
      Aescinate for Injection
              use
      for curing hydrocephalus, swelling caused by wounds or surgery operation
      and for venous return disorder.
              Pending
      final SFDA approvalIsosorbide
      Mononitrate-Sustained Release Tablets
              used
      for preventing angina (chest pain) caused by heart
      disease.
              Pending
      SFDA approvalGliclazide-Controlled
      Release Tablets
              Used
      for control of hyperglycemia in gliclazide responsive diabetes mellitus of
      stable, mild, non-ketosis prone,maturity
      onset or adult type
              Pending
      SFDA approvalSalbutamol
      Sulfate-Controlled Release Tablets
              Used
      for the relief of bronchospasm in conditions such as asthma and chronic
      obstructive pulmonary disease
              Undergoing
      clinical studiesTotal
      Hawthorn Flavonoids-Sustained Release Tablets (TCM, patent
      product)
              Used
      to control high blood pressure
              In
      development stageDoxazosin-Controlled
      Release Tablets
              Used
      for curing benign prostatic hyperplasia
              In
      development stageNifedipine-Controlled
      Release Tablets
              used
      for curing hypertension and angina
              In
      development stageLovastatin-Controlled
      Release tablets
              used
      to hypolipidemic
              In
      development stageSimvastatin-Comtrolled
      Release tablets
              used
      to hypolipidemic
              In
      development stageVerapamil
      Hydrochloride-Controlled Release Tablets
              used
      for curing variant angina and unstable angina
              In
      development stageValsartan-Controlled
      Release Tablets
              Used
      for curing high blood pressure
              In
      development stage





(A) Subject to SFDA. Pending
Administrative Protection and approval.





GOVERNMENT APPROVAL AND
REGULATION





Lotus East's sales market is presently limited
to China. Lotus East issubject to the Drug Administration Law
of China, which governs the licensing,manufacturing, marketing and
distribution of pharmaceutical products in Chinaand sets penalties for violations ofthe law. Additionally,
Lotus East is alsosubject to various regulations and
permit systems by the Chinese government.





The Drug Administration Law of the PRC
governs Lotus East and itsproducts. The State Food & Drug
Administration of the PRC regulates andimplements drug laws. The State FDA has
granted Lotus East six governmentpermits for it to produce the following
products:





14








·
            Valsartan
      Capsules,





·
            the material of
      Valsartan,





·
            Levofloxacin Lactate for
      Injection,





·
            the material of Levofloxacin
      Lactate,





·
            Brimonidine Tartrate Eyes Drops
      with a density of 0.1, and





·
            Brimonidine Tartrate Eyes Drops
      with the density of 0.3.





No enterprise may start production at
its facilities until it receivesapproval from theprovincial, autonomous region
level, ormunicipality levelSFDAto begin operations. The
approvalprocess takes about two years: including
local SFDA approval, Local
SFDA assessment,State SFDA processing, state SFDA expert
valuation, clinical trial, finalapproval.





Lotus East hasthe requisite approval and licenses
from theBeijing
SFDAin order to operate
its production facilities.





COMPLIANCE WITH ENVIRONMENTAL
LAW





Lotus East complies with the
Environmental Protection Law of China andits local regulations. In compliance
with PRC environmental
regulations, LotusEast spentapproximately $0in 2008and approximately $170,000
in2007 oncompliance with environmental
regulations, principally for waste dischargeprocessing and dust
cleaning.





EMPLOYEES





We do not have anyemployees.As of March 31, 2009,Lotus East has 239employees, including 199 full time
employees and 40 part time employees. All ofthese employees are all located in the
PRC and who receive laborinsurance.These employees are organized into a
union under the laborlaws
of China and canbargain collectively with Lotus East.
Lotus East believes it maintains goodrelations with its
employees.





Lotus East is required to contribute a
portion of its employees' totalsalaries to the Chinese government's
social insurance funds,
including medicalinsurance, unemployment insurance and
job injuries insurance, and a housingassistance fund, in accordance with
relevant regulations. It expects the amountof its contribution to the government's
social insurance funds to increase inthe future as it expands its workforce
and operations.





CONSULTING ARRANGEMENT WITH CFO ONCALL,
INC.





In August 2006, we engaged CFO Oncall,
Inc., a U.S. based firmthatprovidesoutsourced chief financial
officer/controller services to publiccompanies,to assist us assembling our annual and
quarterly financialstatements, as well as to assist our
management in the preparation of ourfinancial statements. Under the terms of
the engagement, Mr. Adam Wasserman, aprincipal of CFO Oncall, Inc., serves as
our Chief Financial
Officer. We paythis firm on a monthly fixed fee. In2008 and2007, we paid CFO Oncall, Inc.$120,000 and$94,200 forits services, respectively.





HISTORY OF OUR
COMPANY





15








We were incorporated on January 28, 2004
in the State of Nevada as
S.E.Asia Trading Company, Inc. to sell
jewelry and home accessories.





On September 6, 2006, we entered into a
definitive Share ExchangeAgreement with Lotus International,
whereby we would acquire all of theoutstanding common stock of
Lotus International in
exchange for newly-issuedshares of our stock to Lotus
International's stockholders. Lotus Internationalwas incorporated under the laws the
State of Nevada on August 28, 2006 todevelop and market pharmaceutical
products in China. OnSeptember 28, 2006,Lotus International became our
wholly-owned subsidiary and Lotus International'sstockholders own the majority of our
voting stock. The acquisition of LotusInternational by us was accounted for as
a reverse merger because on apost-merger basis, the former stockholders of
Lotus International held amajority of our outstanding common stock
on a voting andfully-diluted basis.
Asa result, Lotus International is deemed
to be the acquirer for accountingpurposes.





We changed ourname to Lotus Pharmaceuticals, Inc. on
December 6, 2006.





In May 2007 we formed Lotus Century to
engage in the development ofinnovative medicines, medical technology
consulting and outsourcing services,and related training services. As of March31, 2009,it has not commencedoperations.





ITEM 1.A RISK
FACTORS





Investing
in our securities involves a great deal of risk. You should not invest in our
common stock unless you can afford to lose your entire investment. Careful
consideration should be made of the following factors as well as other
information included in this prospectus before deciding to purchase our common
stock. You should pay particular attention to the fact that we conduct all of
our operations in China and are governed by a legal and regulatory environment
that in some respects differs significantly from the environment that may
prevail in other countries. Our business, financial condition or results of
operations could be affected materially and adversely by any or all of these
risks.











RISKS
RELATING TOOUROVERALLBUSINESS
OPERATIONS





THE
SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK HAS A MANDATORY CONVERSION AND
WE MAY NOT HAVE SUFFICIENT FUNDS AVAILABLE TO PAY THE REDEMPTION
AMOUNTS.





Under the designations, rights and
preferences of the Series A Convertible Redeemable Preferred Stock at the option
of the holder for a period of 90 days beginning on February 25,
2010.  The redemption price which is equal to $0.87 per share plus any
accrued but unpaid dividends, must be paid in cash, in one lump sum within one
month from the end of the 90 day period.  Assuming that sufficient
funds are available to us to pay these redemption amounts, if one or more of the
holders of the Series A Convertible Redeemable Preferred Stock should elect
redemption of those shares, the payment of the redemption price will materially
and adversely impact our liquidity.  In addition, as described
elsewhere herein, we are dependent on Lotus East to both pay our management fees
on a current basis and to repay the amounts we have advanced that
company.  If for any reason those amounts should not have been
tendered and one or more of the Series A Convertible Redeemable Preferred Stock
holders should request redemption, it is possible we would not have sufficient
funds to pay the redemption amounts.





IN ORDER
TO COMPLY WITH PRC LAWS LIMITING FOREIGN OWNERSHIP OF CHINESE COMPANIES, WE
CONDUCT OUR PHARMACEUTICAL BUSINESS THROUGH LOTUS EAST BY MEANS OF THE
CONTRACTUAL ARRANGEMENTS. WE DO NOT HAVE ANY OPERATIONS OTHER THAN PURSUANT TO
THE CONTRACTUAL ARRANGEMENTS WITH LOTUS EAST. THE TERM OF THOSE CONTRACTUAL
ARRANGEMENTS IS ONLY FOR 10 YEARS AND THERE ARE NO ASSURANCES THOSE AGREEMENTS
WILL BE RENEWED. IF THE PRC GOVERNMENT DETERMINES THAT THE CONTRACTUAL
ARRANGEMENTS DO NOT COMPLY WITH APPLICABLE REGULATIONS, OUR BUSINESS COULD BE
ADVERSELY AFFECTED AND WE COULD BE FORCED TO CEASE OPERATIONS.





16













The PRC
government restricts foreign investment in pharmaceutical businesses in China.
Lotus East holds the licenses and approvals necessary to operate its
pharmaceutical business in China and through the Contractual Arrangements with
Lotus East and its stockholders we substantially control Lotus East. Neither
Lotus nor Lotus International, however, are engaged in any business or
operations other than pursuant to the terms of the various Contractual
Arrangements with Lotus East as described elsewhere in this prospectus. As such,
we are completely dependent on the Contractual Arrangements. We do not generate
any revenues and have no assets. All of Lotus East's assets and operations are
located in the PRC. As described in the financial statements included elsewhere
in this prospectus, the assets and liabilities at each of December 31, 2008 and
2007 and the results of operations for 2008 and 2007 are those of Lotus
East.





We cannot
assure you that we will be able to enforce these contracts. If we are unable to
enforce any legal rights we may have under these contracts or otherwise, our
ability to continue as a going concern is in jeopardy. In addition, the terms of
these contracts expire in September 2016 and there are no assurances these
agreements will be renewed. If the Contractual Arrangements are not renewed or
are significantly modified, unless we have expanded our business and operations,
of which there are no assurances, we will in all likelihood be forced to cease
our operations.





The
Contractual Arrangements are also subject to enforcement under the laws of the
PRC. Although we believe we comply with current PRC regulations, we cannot
assure you that the PRC government would agree that these operating arrangements
comply with PRC licensing, registration or other regulatory requirements, with
existing policies or with requirements or policies that may be adopted in the
future. If the PRC government determines that we do not comply with applicable
law, it could revoke Lotus East's business and operating licenses, require us to
discontinue or restrict our operations, restrict our right to collect revenues,
require us to restructure our operations, impose additional conditions or
requirements with which we may not be able to comply, impose restrictions on our
business operations or on our customers, or take other regulatory or enforcement
actions against us that could be harmful to our business.





OUR CONTRACTUAL ARRANGEMENTS WITH LOTUS
EAST AND THEIR RESPECTIVE STOCKHOLDERSMAY NOT BE AS EFFECTIVE IN PROVIDING
CONTROL OVER THESE ENTITIES AS DIRECTOWNERSHIP.





We have no equity ownership interest in
Lotus East and rely on theContractual Arrangements to control and
operate such businesses. TheseContractual Arrangements may not be as
effective in providing control over LotusEast as direct ownership. For example,
Lotus East could fail to take actionsrequired for our businesses
despite its contractual
obligation to do so. IfLotus East fails to perform under the
agreements with us, we may have to rely onlegal remedies under PRC law, which may
not be effective. In addition, we cannotassure you that the Lotus East
stockholders would always
act in our bestinterests.





CERTAIN OF OUR EXECUTIVE OFFICERS,
DIRECTORS AND PRINCIPAL STOCKHOLDERS ARE ALSOOFFICERS, DIRECTORS AND PRINCIPAL
STOCKHOLDERS OF LOTUS EAST. WE ARE NOTRECEIVING THE BENEFIT OF CERTAIN TERMS
OF THE CONTRACTUALARRANGEMENTS AND THEREARE NO ASSURANCES THAT THE CONFLICTS OF
INTEREST BETWEEN OBLIGATIONS TO OURCOMPANY AND OBLIGATIONS LOTUS EAST WILL
BE RESOLVED IN OUR FAVOR.





While pursuant to the Contractual
Arrangements we have the ability tocontrol the daily operations and financial affairs of Lotus East,
appoint eachof their senior executives and approve
all matters requiring approval by theirrespective members, these actions on our
behalf are determined by our Board ofDirectors. Dr. Liu, our CEO, and his wife Mrs. Zhenghong, are members of
ourBoard of Directors and principal
stockholders of our company and they are alsoofficers, directors and principal
stockholders of Lotus East. Conflicts ofinterests between their duties to our
company and Lotus East may arise. Dr. Luiand Mrs. Zhenghong each have a duty of
loyalty and care to us under Nevada lawwhen there are any potential conflicts
of interests between our company andLotus East. We cannot assure you,
however, that when conflicts of interestarise, Dr. Liu and or Mrs. Zhenghong will act completely
in our interests orthat conflicts of interests will be
resolved in our favor. In addition, Dr. Liuand/or Mrs. Zhenghong could violate
their legal duties by diverting businessopportunities from us to
others.





17








In addition, while the terms of the
Contractual Arrangements providethat we are to be paid quarterly service
fees equal to the net profit of LotusEast, such payments have not been
tendered to us and those funds are beingretained by Lotus East to fund their operations.At December 31, 2008 approximately $25
million is due to us by Lotus East which remains unpaid as of the date hereof.Although we have no
business and operations other than pursuantto the terms of the Contractual
Arrangements, we incur
operating expensesrelated to our public company reporting
requirements including legal andaccounting fees. There are no assurances
that these fees will be paid, orthatanyother conflicts of interest which may
arise between our company and LotusEastrelated to their obligation to pay the
amounts due us will be resolved inour favor.





WE HAVE LENT SUBSTANTIALLY ALL OF THE
NET PROCEEDS FROM OUR RECENTLY COMPLETEDFINANCINGS TO LOTUS EAST ON AN INTEREST
FREE, UNSECURED BASIS. IF THESE AMOUNTSARE NOT REPAID, OR IF LOTUS EAST DOES NOT BEGIN
PAYING THEIR QUARTERLY SERVICEFEES, IT IS POSSIBLE THAT WE WILL NOT
HAVE SUFFICIENT CAPITAL TO PAY OUROPERATING EXPENSES WHICH COULD RESULT IN
A REMOVAL OF OUR COMMON STOCK FROMQUOTATION ON THE OTC BULLETIN
BOARD.





In 2007, we sold $3,000,000 principal
amount 14% secured convertiblenotes ina private placement and we lentapproximately $2 million of
thoseproceeds to Lotus East for working
capital. In 2008, we received net proceedsfrom the sale of shares of our
Series A Convertible
Redeemable Preferred Stockof approximately $4.6 million. We used
approximately $2,576,557 of thoseproceeds to repay in full all of our
outstanding obligations under our 14%secured convertible notes. Of the
remaining proceeds, we lent approximately$1,600,000 to Lotus East. These loans
are in the form of unsecured, interestfree advances for use by Lotus East in
their operations including in theirresearch and development activities. We
do not have an understanding with LotusEast regarding the repayment of the amounts
advanced to that company. If thesefunds are not repaid, we may not have
sufficient capital to pay our operatingexpenses which could result in our
inability to remain current in our reportingobligations under Federal
securities laws. If we were
unable to remain currentin those requirements, our common stock
would be removed from quotation on theOTC Bulletin Board and our stockholders
would in all likelihood lose theirentire investment in our
company.





IF WE FAIL TO MAINTAIN THE ADEQUACY OF OUR INTERNAL
CONTROLS, OUR ABILITY TOPROVIDE ACCURATE FINANCIAL STATEMENTS
AND COMPLY WITH THE REQUIREMENTS OF THESARBANES-OXLEY ACT OF 2002 COULD BE
IMPAIRED, WHICH COULD CAUSE OUR STOCK PRICETO DECREASE
SUBSTANTIALLY.





Wehave committed limited
personnel and resources to the development ofthe external reporting
and compliance obligations that would be required of apublic company.
Recently, we have taken measures to address and improve ourfinancial reporting and
compliance
capabilities and we are in the process ofinstituting changes to
satisfy our obligations in connection with joining apublic company, when
and as such requirements become applicable to us. Prior totaking these measures,
we did not believe we had the resources and
capabilitiesto do so. We plan to
obtain additional financial and accounting resources tosupport and enhance our
ability to meet the requirements of being apubliccompany. We will need to
continue to improve our financial and managerialcontrols, reporting systems
and procedures, and documentation thereof. If ourfinancial and
managerial controls, reporting systems or procedures fail, we maynot be able to provide
accurate financial statements on a timely basis or complywith the
Sarbanes-Oxley Act of 2002 as it
applies to us. Any failure of ourinternal controls or
our ability to provide accurate financial statements couldcause the trading price
of our common stock to decrease substantially.We have implemented, or plan to
implement, the measures
described below under the supervision and guidance of our management to
remediate the above control deficiencies and to strengthen our internal controls
over financial reporting. Key elements of the remediation effort include, but
are not limited to,the following initiatives, which have
been implemented, or are in the process of implementation, as of the date of
filing of this Annual Report:





18





·
            We have increased efforts to
      enforce internal control procedures.  We have also reorganized
      the structure of our
      China financial department and clarified the responsibilities of each key
      personnel in order to increase communications and
      accountability.





·
            We have recruited and will
      continue to bring in additional qualified financial personnel for the
      accounting department
      to further strengthen our China financial reporting
      function.





·
            We continually review and improve
      our standardization of our monthly and quarterly data collection,
      analysis, and reconciliation procedures. To further improve the timeliness
      of data collection,
      we are selecting and will install new point of sale systems and enterprise
      resource planning systems for our wholesale and retail
      operations.





·
            We plan on significantly
      increasing the level of communication and interaction among our China
      management,
      independent auditors, our directors of the Board, and other external
      advisors..





·
            We are in the
      process of searching for qualified internal control consultants to help us
      be in compliance with internal control obligations, including Section
      404of the Sarbanes-Oxley Act
      of 2002. We also plan to
      dedicate sufficient resources to implement required internal control
      procedures.





If ourfinancial and managerial controls,
reporting systems or procedures fail, we maynot be able to provide accurate
financial statements on a
timely basis or complywith the Sarbanes-Oxley Act of 2002 as
it applies to us. Any failure of ourinternal controls or our ability to
provide accurate financial statements couldcause the trading price of our common
stock to decrease substantially.




RISKS RELATED TO LOTUS EAST'S
OPERATIONS





LOTUS EAST'S SUCCESS DEPENDS ON
COLLABORATIVE PARTNERS, LICENSEES AND OTHERTHIRD PARTIES OVER WHOM IT HAS LIMITED
CONTROL.





Due to the complexity of the process of
developingpharmaceuticals,Lotus East's core business depends on
arrangements with pharmaceuticalinstitutes, corporate and academic
collaborators, licensors, licensees andothers for the research, development,
clinical testing, technology rights,manufacturing, marketing and commercialization of its
products. It has oneresearch collaboration and outsources
other business functions. Its licenseagreements could obligate it to
diligently bring potential products to market,make milestone payments and royalties
that,in some instances,
could be


substantial, and incur the costs of
filing and prosecuting patent applications.There are no assurances that Lotus East
will be able to establish or maintaincollaborations that are important to its
business on favorable terms,or at all.





A number of risks arise from its
dependence on collaborative agreementswith third parties. Product development
and commercialization efforts could beadversely affected if any collaborative
partner:





19








·
            terminates or suspends its
      agreement with Lotus
      East;


·
            causes
    delays;


·
            fails to timely develop or
      manufacture in adequate quantities asubstance needed in order to
      conduct clinical trials;


·
            fails to adequately perform
      clinical trials;


·
            determines not to develop,
      manufacture or commercialize aproduct towhich it has rights;
      or


·
            otherwise fails to meet its
      contractual obligations.





Lotus East's collaborative partners
could pursue other technologies ordevelop alternative products that could
compete with the products it isdeveloping.





THE PROFITABILITY OF LOTUS EAST'S PRODUCTS
WILL DEPEND IN PART ON ITS ABILITY TOPROTECT PROPRIETARY RIGHTS AND OPERATE
WITHOUT INFRINGING THE PROPRIETARY RIGHTSOF OTHERS.





The profitability of Lotus East's
products will depend in part on itsability to obtain and maintainmanufacturing rights and preserve trade
secrets,and the period its intellectual property
remains protected. Lotus East must alsooperate without infringing the
proprietary rights of third parties and withoutthird parties circumventing its rights. The patent positions
of pharmaceuticaland biotechnology enterprises, including
Lotus East, are uncertain and involvecomplex legal and factual questions for
which important legal principles arelargely unresolved. The biotechnology
patent situation outside
the U.S. isuncertain, is currently undergoing
review and revision in many countries, andmay not protect Lotus East's
intellectual property rights to the same extent asthe laws of the U.S. Because patent
applications are maintained insecrecy insome cases, Lotus East cannot be certain
that it or its licensors are the firstcreators of inventions described in our
pending patent applications or patentsor the first to file patent applications
for such inventions.





Most of LotusEast's drug products have been approved
by the PRC's Foodand Drug Administration (SFDA) but have
not received patent protection. Forinstance, Valsartan, one of Lotus East's
most profitable products, is producedby other companies in China, including
Novartis. If Novartis or
any othercompany were to obtain patent protection
for Valsartan in China, or for any ofLotus East's other drug products, it
would have a material adverse effect on itsrevenue.





Other companies may independently
develop similar products
and designaround any patented products Lotus East
develops. We cannot assure you that:





·
            any of Lotus East's patent
      applications will result in the issuanceof
  patents;


·
            Lotus East will develop patentable
      products;


·
            the manufacturing rights
      Lotus East has been
      issued will provide itwith any competitive
      advantages;


·
            the patents of others will not
      impede Lotus East's ability to dobusiness;
  or


·
            third parties will not be able to
      circumvent Lotus East'smanufacturing
      rights.








There are no assurancesthat Lotus East will be able to
meaningfullyprotect its trade secrets. We cannot
assure you that any of Lotus East'sexisting confidentiality agreements with
employees, consultants, advisors orcollaborators will provide meaningful
protection for its trade
secrets, know-howor other proprietary information in the
event of any unauthorized use ordisclosure. Collaborators, advisors or
consultants may dispute the ownership ofproprietary rights to Lotus East's
products, for example by asserting that theydeveloped the product
independently.





20








LOTUS EAST MAY ENCOUNTER DIFFICULTIES IN
MANUFACTURING ITS PRODUCTS.





Before Lotus East's products can be
profitable, they must be producedin commercial quantities in a
cost-effective manufacturing process thatcomplieswith regulatory requirements, including
GMP, production and quality controlregulations. If Lotus East cannot
arrange for or maintain commercial-scalemanufacturing on acceptable terms, or if
there are delays or difficulties in themanufacturing process, it may not be able to conduct
clinical trials, obtainregulatory approval or meet demand for
its products. Production of Lotus East'sproducts could require raw materials
which are scarce or which can be obtainedonly from a limited number of
sources. If Lotus East is
unable to obtainadequate supplies of such raw materials,
the development, regulatory approvaland marketing of its products could be
delayed.





LOTUS EAST COULD NEED MORE CLINICAL
TRIALS OR TAKE MORE TIME TO COMPLETE ITSCLINICAL TRIALS THAN WE HAVEPLANNED.





Clinical trials vary in design by
factors including dosage, end points,length, and controls. Lotus East may
need to conduct a series of trials todemonstrate the safety and efficacy of
its products. The results of these trialsmay not demonstrate safety or efficacy
sufficiently for regulatory authoritiesto approve Lotus East's products.
Further, the actual schedules for its clinicaltrials could vary dramatically from the
forecasted schedules due to factorsincluding changes in trial design, conflicts with the
schedules of participatingclinicians and clinical institutions,
and changes affecting product supplies forclinical trials.





Lotus East relies on collaborators,
including academic institutions,governmentalagencies and clinical research
organizations, to conduct,supervise, monitor and design some or
all aspects of clinical trials involvingour products. Since these trials depend
on governmental participation andfunding, Lotus East has less control
over their timing and
design than trials itsponsors. Delays in or failure to
commence or complete any planned clinicaltrials could delay the ultimate
timelines for Lotus East product releases.





LOTUS EAST MAY NOT BE ABLE TO OBTAIN THE
REGULATORY APPROVALS OR CLEARANCES THATARE NECESSARY TO COMMERCIALIZE ITS
PRODUCTS.





The PRC imposes significant statutory
and regulatory obligations uponthe manufacture and sale of
pharmaceutical products. It typically has a lengthyapproval process in which it
examinespre-clinical and
clinical data and thefacilities in which the product is
manufactured. Regulatory submissions mustmeet complex criteria to demonstrate the
safety and efficacy of the ultimateproducts. Addressing these criteria
requires considerable datacollection,verification and analysis. Lotus East
may spend time and money preparingregulatory submissions or applications
without assurances as to whether theywill be approved on a timely basis or at
all.





Lotus East's product candidates,
someof which are currently
in theearly stages of development, will
require significant additional development andpre-clinical and clinical testing prior
to their commercialization. These stepsand the process of obtaining required
approvals and clearances can be costly andtime-consuming. If Lotus East's
potential products are not successfullydeveloped, cannot be proven to be safe
and effective through clinical trials, ordo not receive applicable regulatory
approvals and clearances, or if there aredelaysin the process:





·
            the commercialization of Lotus
      East's products could be adverselyaffected;


·
            any competitive advantages of the
      products could be diminished;
and


·
            revenues or collaborative
      milestones from the products could bereduced or
      delayed.





21








Governmental and regulatory authorities
may approve a product candidatefor fewer indications or narrower
circumstances than requested or may conditionapproval on the performance of
post-marketing studies for a productcandidate.Even if a product receivesregulatory approval and clearance, it
may laterexhibit adverse side effects that limit
or prevent its widespread use or thatforce Lotus East to withdraw the product
from the market.





Any marketed product and its
manufacturer will continue to besubjectto strict regulation after approval.
Results of post-marketing programs maylimit or expand the further marketing of
products. Unforeseen problems with anapproved product or any violation of
regulations could result in restrictions onthe product, including its withdrawal from the
market and possible civilactions.





In manufacturing Lotus East's products
it is required to comply withapplicable good manufacturing practices
regulations, which include requirementsrelating to quality control and
quality assurance, as well
as the maintenance ofrecords and documentation. If Lotus East
cannot comply with regulatoryrequirements, including applicable good
manufacturing practice requirements, itmay not be allowed to develop or market
the product candidates. If
Lotus Eastfails to comply with applicable
regulatory requirements at any stage during theregulatory process, it may be subject to
sanctions, including fines, productrecalls or seizures, injunctions,
refusal of regulatory agencies to reviewpending market approval applications or
supplements to approve applications,total or partial suspension of
production, civil penalties, withdrawals ofpreviously approved marketing
applications and criminal prosecution.





COMPETITORS MAY DEVELOP AND MARKET
PHARMACEUTICAL PRODUCTS
THAT ARE LESSEXPENSIVE, MORE EFFECTIVE OR SAFER,
MAKING LOTUS EAST'S PRODUCTS OBSOLETE ORUNCOMPETITIVE.





Some of Lotus East's competitors and
potential competitors have greaterproduct development capabilities and
financial, scientific,
marketing and humanresources than it does. Technological
competition from pharmaceutical companiesand biotechnology companies is intense
and is expected to increase. Othercompanies have developed technologies
that could be the basis for competitiveproducts. Some of these products have an
entirely different approach or means ofaccomplishing the desired curative
effect than products Lotus East isdeveloping. Alternative products may be
developed that are more effective, workfaster and are less costlythan its products. Competitors may
succeed indeveloping products earlier than Lotus
East, obtaining approvals and clearancesfor such products more rapidly than it,
or developing products that are moreeffective than those of Lotus East. In
addition, other forms of
treatment may becompetitive with its products. Over
time, Lotus East's products may becomeobsolete or
uncompetitive.





LOTUS EAST'S OPERATIONS AND THE USE OF
ITS PRODUCTS COULD SUBJECT IT TO DAMAGESRELATING TO INJURIES OR ACCIDENTAL
CONTAMINATION.





Lotus East's research and development
processes involve the controlleduse of hazardous materials. It is
subject to central government, provincial andlocal laws and regulations governing the
use, manufacture, storage, handling anddisposal of suchmaterials and waste products. The risk
of accidentalcontamination or injury from handling
and disposing of such materials cannot becompletely eliminated. In the event of
an accident involving hazardousmaterials, Lotus East could be held
liable for resulting
damages. Lotus East isnot insured with respect to this
liability. Such liability could exceed itsresources.





IF LOTUS EAST WERE SUCCESSFULLY SUED FOR
PRODUCT LIABILITY, IT COULD FACESUBSTANTIAL LIABILITIES THAT MAY EXCEED
ITS RESOURCES.





22








Lotus Eastmay be held liable if any product it
develops, or anyproduct which causes injury or is found
unsuitable during product testing,manufacturing, marketing, sale or use.
These risks are inherent in thedevelopment of pharmaceutical products.
Lotus East doesnot have
productliability insurance. If Lotus East
choose to obtain product liability insurancebut cannot obtain sufficient insurance
coverage at an acceptable cost orotherwise protect against potential
product liability claims, thecommercialization of products that it develops may be
prevented or inhibited. Ifit is sued for any injury caused by its
products, Lotus East's liability couldexceed its total
assets.





LOTUS EAST HAS LIMITED BUSINESS
INSURANCE COVERAGE.





The insurance industry in China is
still at an early stage
ofdevelopment. Insurance companies in
China offer limited business insuranceproducts. Lotus East does not have any
business liability or disruptioninsurance coverage for its operations in
China. Any business disruption,litigationor natural disaster may result in our
incurring substantial costs andthe diversion of its
resources.





LOTUS EAST'S SUCCESS DEPENDS ON
ATTRACTING AND RETAINING QUALIFIED PERSONNEL.





Lotus East depends on a core management
and scientific team. Althoughmost of these personnel are founders and
stockholders of Lotus East, there canbe no assurance that it can be
successful in retaining them. The unavailability


or departure of such key personnel may
seriously disrupt and harm itsoperations, business and the
implementation of its
business strategy and plans.Lotus East's future success depends in
large part on its continued ability toattract and retain other highly
qualified scientific, technical and managementpersonnel, as well as personnel with
expertise inclinical
testing andgovernment regulation. It faces
competition for personnel from other companies,universities, public and private
research institutions, government entities andother organizations. If Lotus East's
recruitment and retention efforts areunsuccessful, its business operations
could suffer.




RISKS RELATED TO DOING BUSINESS IN
CHINA





BOTH OUR COMPANY AND LOTUS EAST MAY BE
ADVERSELY AFFECTED BY COMPLEXITY,UNCERTAINTIES AND CHANGES IN PRC
REGULATION OF PHARMACEUTICAL BUSINESS ANDCOMPANIES, INCLUDING LIMITATIONS ON OUR
ABILITY TO OWN KEY ASSETS.





The PRC government regulates the
pharmaceutical industry includingforeign ownership of, and the licensing
and permit requirements pertaining to,companies in the pharmaceutical industry. These laws and
regulations are


relatively new and evolving, and their
interpretation and enforcement involvesignificant uncertainty. As a result, in
certain circumstances it may bedifficult to determine what actions or
omissions may be deemed to
be a violation


of applicable laws and regulations.
Issues, risks and uncertainties relating toPRC government regulation of the
pharmaceutical industry include the following:





·
            we only have contractual control
      over Lotus East. We do not own itdueto the restriction of foreign
      investment in Chinese businesses;
and





·
            uncertainties relating to the
      regulation of the pharmaceuticalbusiness in China, including
      evolving licensing practices, means that permits,licenses or operations at our
      company may besubject to challenge. This maydisrupt Lotus East's business, or
      subject it to sanctions, requirements toincrease capital or other
      conditions or enforcement, or compromiseenforceability of related
      contractual arrangements, or have other harmfuleffectson
  it.





23








The interpretation and application of
existing PRC laws, regulationsand policies and possible new laws,
regulations or policies have createdsubstantial uncertainties regarding the
legality of existing and future foreign


investments in, and the businesses and activities of,
pharmaceutical businessesin China, including our
business.





ADVERSE CHANGES IN ECONOMIC AND
POLITICAL POLICIES OF THE PRC GOVERNMENT COULDHAVE A MATERIAL ADVERSE EFFECT ON THE
OVERALL ECONOMIC GROWTH OF CHINA, WHICHCOULD ADVERSELY AFFECT LOTUS EAST'S
BUSINESS.





All of Lotus East's business operations
are conducted in China.Accordingly, our results of operations,
financial condition and prospects aresubject to a significant degree to
economic, political andlegal developments
in


China. China's economy differs from the
economies of most developed countries inmany respects, including with respect
to:





·
            the amount of government
      involvement,





·
            level of
      development,





·
            growth
  rate,





·
            control of foreign exchange,
      and





·
            allocation of
      resources.





While the PRC economy has experienced
significant growth in the past 20years, growth has been uneven across
different regions and among variouseconomic sectors of China. The PRC
government has implemented various measuresto encourage economic development and
guide the allocation of resources. Some ofthese measures benefit the overall PRC
economy, but may also have a negativeeffect on us. For example, our financial
condition and results of operations maybe adversely affected by government control over
capital investments or changesin tax regulations that are applicable
to Lotus East. Since early 2004, the PRCgovernment has implemented certain
measures to control the pace of economicgrowth. Such measures may cause adecrease in the level of
economic activity inChina, which in turn could adversely
affect our results of operations andfinancial condition.





IF PRC LAW WERE TO PHASE OUT THE
PREFERENTIAL TAX BENEFITS CURRENTLY BEINGEXTENDED TO FOREIGN INVESTED
ENTERPRISES AND "NEW OR
HIGH-TECHNOLOGYENTERPRISES" LOCATED IN A HIGH-TECH
ZONE, LOTUS EAST WOULD HAVE TO PAY MORETAXES, WHICH COULD HAVE A ATERIAL AND
ADVERSE EFFECT ON OUR FINANCIAL CONDITIONAND RESULTS OF
OPERATIONS





Under PRC laws and regulations, aforeign invested enterprise
may enjoypreferential tax benefits if it is
registered in a high-tech zone and alsoqualifies as "new or high-technology
enterprise". As a foreign investedenterprise as well as a certified "new
or high-technology enterprise" located ina high-tech zone in Beijing: Lotus East
is registered in the Liangxiang EconomicTech Development Zone and is entitled to
an exemption from enterprise income taxuntil December 12, 2008. If the PRC law
were to phase out preferential taxbenefitscurrently granted to "new orhigh-technology enterprises"
andtechnology consulting services, we would
be subject to the standard statutorytax rate, which currently is25%, and we would be unable to obtain
business taxrefunds for our provision of
technology consulting
services. Loss of thesepreferential tax treatments could have a
material and adverse effect on ourfinancial condition and results of
operations.





24








UNCERTAINTIES WITH RESPECT TO THE PRC
LEGAL SYSTEM COULD ADVERSELY AFFECT US.





We conduct our business through the
Contractual Arrangements with LotusEast. Our operations in China are
governed by PRC laws and regulations. We aregenerally subject to laws and
regulations applicable to foreign investments inChina and, in particular, lawsapplicable to wholly
foreign-owned enterprises.The PRC legal system is based on written
statutes. Prior court decisions may becited for reference but have limited
precedential value.





Since 1979, PRC legislation and
regulations have significantly enhancedthe protections afforded to various
forms of foreign investments in China.However, China has not developed a fully
integrated legal system and recently enacted laws and regulations may not
sufficiently cover all aspects of economicactivities in China. In particular, because these
laws and regulations arerelatively new, and because of the
limited volume of published decisions andtheir nonbinding nature, the
interpretation and enforcement of these laws andregulations involve uncertainties. Inaddition, the PRC legal
system is based inpart on government policies and internal
rules (some of which are not publishedon a timely basis or at all) that may
have a retroactive effect. As a result, wemay not be aware of our violation of
these policiesand rules
until some timeafter the violation. In addition, any
litigation in China may be protracted andresult in substantial costs and
diversion of resources and management attention.





YOU MAY EXPERIENCE DIFFICULTIES IN
EFFECTING SERVICE OF LEGAL PROCESS, ENFORCINGFOREIGN JUDGMENTS OR BRINGING ORIGINAL
ACTIONS IN CHINA BASED ON UNITED STATESOR OTHER FOREIGN LAWS AGAINST US OR OUR
MANAGEMENT.





All of Lotus East's assets are located
outside the United States andall of its current operations
areconducted in China.
Moreover, the majority ofour directors and officers are nationals
or residents of China. All or asubstantial portion of the assets of
these persons are located outside theUnited States. As a result, it may be
difficult for our stockholders to effectservice of process within the United
States upon these persons. In addition,there is uncertainty as to whether the
courts of China would recognize orenforce judgments of U.S. courts
obtained against us or such officers and/or directorspredicated upon the civil liability
provisions of the securities lawof the United States or any state
thereof, or be competent to hear originalactions brought in China against us or
such persons predicated upon thesecurities laws of the United States
orany state
thereof.





GOVERNMENTAL CONTROL OF CURRENCY
CONVERSION MAY ADVERSELY AFFECT OUR COMPANY.





The PRC government imposes controls on
the convertibility of RMB intoforeign currencies and, in certain
cases, the remittance of currency out ofChina. Lotus East receives all of its
revenues in RMB. Under our currentstructure, our income is restricted to
payments under the ContractualArrangements with Lotus East. Shortages
in the availability of foreign currencymay restrict the ability of LotusEast to remit sufficient
foreign currency topay the monthly fees due us, or
otherwise satisfy their foreign currencydenominated obligations. As such, we may
not be able to receive all amounts dueto us from Lotus East under the
Contractual Arrangements.Under existing PRCforeign exchange regulations, payments
of current account items, includingprofit distributions, interest payments
and expenditures from trade-relatedtransactions, can be made in foreign
currencies without prior approval from thePRC State Administration of Foreign Exchange
by complying with certainprocedural requirements. However,
approval from appropriate governmentauthorities is required where RMB is to
be converted into foreign currency andremitted out of China to pay capital
expenses such as the
repayment of bankloans denominated in foreign
currencies.





25








The PRC government may also at its
discretion restrict access in thefuture to foreign currencies for current
account transactions. If the foreignexchange control systemprevents Lotus East from obtaining
sufficient foreigncurrency to satisfy its currency
demands, we may not have sufficient fundsavailable to pay our obligations as they
become due.





FLUCTUATION IN THE VALUE OF RMB MAY HAVE
A MATERIAL ADVERSE EFFECT ON YOURINVESTMENT.





The value of RMB against the U.S. dollar
and other currencies mayfluctuate and is affected by, among
other things, changes in political andeconomic conditions. All of Lotus East's
financial assets and its revenues andcosts are denominated in RMB. We rely entirely on
fees paid to us by Lotus East.Any significant fluctuation in value of
RMB may materially and adversely affectour cash flows, revenues, earnings and
financial position, and the value of theconsulting fees payable tous by Lotus East. For example, an
appreciation of RMBagainst the U.S. dollar would make any
new RMB denominated investments orexpenditures more costly to Lotus East,
to the extent that it might need toconvert U.S. dollars into RMB for such
purposes. Anappreciation
of RMB againstthe U.S. dollar would also result in
foreign currency translation losses forfinancial reporting purposes when we
translate our U.S. dollar denominatedfinancial assets into RMB, as RMB is our
reporting currency.





WE FACE RISKSRELATED TO HEALTH EPIDEMICS AND OTHER
OUTBREAKS.





Lotus East's business could be adversely
affected by the effects ofSARS or another epidemic or outbreak.
China reported a number of cases of SARSin April 2004. Any prolonged recurrence
of SARS or other adverse
public healthdevelopments in China may have a
material adverse effect on Lotus East'sbusiness operations. For instance,
health or other government regulationsadopted in response may require
temporary closure of Lotus East's productionfacilities or of its offices. Such
closures would severely disrupt its businessoperations and adversely affect our
results of operations. Lotus East has notadopted any written preventive measures
or contingency plans to combat anyfuture outbreak of SARS or any other
epidemic.




RISKS RELATED TO HOLDING OUR
SECURITIES





OUR CORPORATE ACTIONS ARE SUBSTANTIALLY
CONTROLLED BY OUR MANAGEMENT.





Our executive officers and directors own
approximately 62% of ouroutstanding common stock and
approximately 55% of voting control. Thesestockholders, acting individually or as
a group, could exert substantialinfluence over matters such as electing
directors and approving mergers or otherbusiness combination transactions. In
addition, because of the percentage ofownership and voting concentration in
these principal stockholders, elections ofour board of directors will generally be
within the control of thesestockholders. It would be difficult for
our stockholders to propose and haveapproved proposals not supported by management. There
can be no assurances thatmatters voted upon by our officers and
directors in their capacity asstockholders will be viewed favorably by
all stockholders of our company.





THE ELIMINATION OF MONETARY LIABILITY
AGAINST OUR DIRECTORS AND
OFFICERS UNDERNEVADA LAW AND THE EXISTENCE OF
INDEMNIFICATION RIGHTS TO OUR DIRECTORS ANDOFFICERS MAY RESULT IN SUBSTANTIAL
EXPENDITURES BY US MAY DISCOURAGE LAWSUITSAGAINST OUR DIRECTORS AND/OR
OFFICERS.






26





Our articles of incorporation do not contain any specific
provisionsthat eliminate the liability of our
directors for monetary damages to ourcompany and stockholders, however we are
prepared to give such indemnificationto our directors and officers to the
extent provided by Nevada
law. Theseindemnification obligations could result
in our company incurring substantialexpenditures to cover the cost of
settlement or damage awards against directorsand officers, which we may be unable to
recoup. These provisions and resultantcosts may also discourage our company from
bringing a lawsuit against directorsand officers for breaches of their
fiduciary duties, and may similarlydiscourage the filing of derivative
litigation by our stockholders against ourdirectors and officers eventhough such actions, if successful,
might otherwisebenefit our company and
stockholders.





WE MAY HAVE DIFFICULTY ESTABLISHING
ADEQUATE MANAGEMENT, LEGAL AND FINANCIALCONTROLS IN THE PRC.





PRC companies have historically not
adopted a Western style ofmanagement and financial reporting concepts
and practices, which includes strongcorporate governance, internal controls
and, database, financial and othercontrol systems. As a result, we may
experience difficulty in establishingmanagement, legal and financial controls, collecting financial data
andpreparing financial statements, books of
account and corporate records andinstituting business practices that meet
Western standards. Therefore, we may,in turn, experience difficulties in
implementing and maintaining adequateinternal controls as required under
Section 404 of the Sarbanes-Oxley Act of2002. Any failure on our part may result
in significant deficiencies or materialweaknesses in our internal controls
which could impact the reliability of ourfinancial statements which could have a
materially adverse effect on ourbusiness.





THE EXERCISE OF OUTSTANDING WARRANTS,
THE ISSUANCE OF SHARES OF OUR COMMON STOCKAS INTEREST ON THE OUTSTANDING NOTES AND
THE POSSIBLE CONVERSION OF THOSEOUTSTANDING NOTES WILL BE DILUTIVE TO OUR EXISTING
STOCKHOLDERS.





At March 31, 2009,we had43,377,932shares of our common stock
issuedand outstanding and the following
securities which are convertible orexercisable into shares of our common
stock were outstanding:





·
            5,747,118 shares of our common stock
      issuable upon the possibleconversion of the Series A
      Convertible Redeemable Preferred
Stock;





·
            up to an additional
      919,544shares of our common stock which
      we mayissue the Series A Convertible
      Redeemable Preferred Stockholders as dividendpayments;
    and





·
            5,166,999of our common stock issuable upon
      the exercise of commonstock purchase warrants with anaverageexercise price of $1.13per
  share.





The issuance of the shares as dividend
payment, the exercise of thewarrants and/orthe conversion of the Series A
Convertible Redeemable PreferredStock may materially adversely affect
the market price of our common stock andwill have a dilutive effect on our
existing stockholders.





CERTAIN
OF OUR OUTSTANDING WARRANTS CONTAIN CASHLESS EXERCISE PROVISIONS WHICH MEANS WE
WILL NOT RECEIVE ANY CASH PROCEEDS UPON THEIR EXERCISE.


27





In
February 2007 and February 2008, we issued five year common stock purchase
warrants to purchase an aggregate of 4,373,553 shares of our common stock with
current exercise prices ranging from $0.87 to $1.20 per share in connection with
the sales of our 14% secured convertible notes and the shares of our Series A
Convertible Redeemable Preferred Stock.  All of these warrants are
exercisable on a cashless basis at any time when there is not an effective
registration statement covering the shares of our common stock underlying the
warrants which means that the holders, rather than paying the exercise price in
cash, may surrender a number of warrants equal to the exercise price of the
warrants being exercised. The utilization of this cashless exercise feature will
deprive us of additional capital which might otherwise be obtained if the
warrants did not contain a cashless feature.





WE HAVE NOT VOLUNTARILY IMPLEMENTED
VARIOUS CORPORATE
GOVERNANCE MEASURES, INTHE ABSENCE OF WHICH, STOCKHOLDERS MAY
HAVE MORE LIMITED PROTECTIONS AGAINSTINTERESTED DIRECTOR TRANSACTIONS,
CONFLICTS OF INTEREST AND SIMILAR MATTERS.





Recent Federal legislation, including
the Sarbanes-Oxley Act of
2002,has resulted in the adoption of various
corporate governance measures designedto promote the integrity of the
corporate management and the securities markets.Some of these measures have been adopted
in response to legal requirements.Others have been adopted by companies in
response to the requirements ofnational securities exchanges, such as
the NYSE or the NASDAQ Stock Market, onwhich their securities are listed. Among
the corporate governance measures thatare required under the rulesof national securities exchanges are
those thataddress board of directors'
independence, audit committee oversight, and theadoption of a code of ethics. We have
not adopted a code of ethics nor have weadopted any of these other corporate
governance measures and,
since oursecurities are not yet listed on a
national securities exchange, we were notrequired to do so. We have not adopted
corporate governance measures such as anaudit or other independent committees of
our board of directors. If we expandour board membership in future periods
to include additional independentdirectors, we may seek to establish an
audit and other committees of our boardof directors. It is possible that if we
were to adopt some or all of thesecorporate governance
measures, stockholders
would benefit from somewhat greaterassurances that internal corporate
decisions were being made by disinteresteddirectors and that policies had been
implemented to define responsible conduct.For example, in the absence of audit,
nominating and compensation
committeescomprised of at least a majority of
independent directors, decisions concerningmatters such as compensation packages to
our senior officers and recommendationsfor director nominees may be made by a
majority of directors whohave aninterest in the outcome of the matters
being decided. Prospective investorsshould bear in mind our current lack of
corporate governance measures informulating their investment
decisions.





WE MAY BE EXPOSED TO POTENTIAL RISKS
RELATING TO OUR INTERNAL
CONTROLS OVERFINANCIAL REPORTING AND OUR ABILITY TO
HAVE THOSE CONTROLS ATTESTED TO BY OURINDEPENDENT
AUDITORS.





As directed by Section 404 of the
Sarbanes-Oxley Act of 2002 ("SOX404"), the Securities and Exchange
Commission adopted rules requiringsmallbusiness issuers, such as our company,
to include a report of management on thecompany's internal controls over
financial reporting in their annual reports forfiscal years ending on or after December
15, 2007. Such report is containedlater in thisannual report under Item 9A(T) Controls
and Procedures. Inaddition, unless the pending one year
delay proposed by the SEC is adopted, forour fiscal year ending December 31,
2009the independent registered
publicaccounting firm auditing our financial
statements must also attest
to and reporton management's assessment of the
effectiveness of our internal controls overfinancial reporting as well as the
operating effectiveness of our internalcontrols. In the event we are unable to
receive a positive attestation from ourindependent auditors with respect to our
internal controls, investors and othersmay lose confidence in the reliability
of our financial statements and ourability to obtain financing as needed
could suffer.


28





BECAUSE OUR STOCK CURRENTLY
TRADES BELOW $5.00 PER
SHARE, AND IS QUOTED ON THEOTC BULLETIN BOARD, OUR STOCK IS
CONSIDERED A "PENNY STOCK" WHICH CAN ADVERSELYAFFECT ITS
LIQUIDITY.





As the trading price of our common stock
is less than $5.00 per share,our common stock is considered a "penny stock," and trading in
our common stockis subject to the requirements of Rule
15g-9 under the Securities Exchange Actof 1934. Under this rule, broker/dealers
who recommend low-priced securities topersons other than established customersand accredited investors
must satisfyspecial sales practice requirements. The
broker/dealer must make anindividualized written suitability
determination for the purchaser and receivethe purchaser's written consent prior to
the transaction.





SEC regulations also require additional disclosure
in connection withany trades involving a "penny stock,"
including the delivery, prior to any pennystock transaction, of a disclosure
schedule explaining the penny stock marketand its associated risks. These
requirements severely limit
the liquidity ofsecurities in the secondary market
because few broker or dealers are likely toundertake these compliance activities.
In addition to the applicability of thepenny stock rules, other risks
associated with trading in penny stocks couldalso be price fluctuations and the lack
of a liquid market.





ITEM 1B.
UNRESOLVED STAFF COMMENTS.





Not applicable to a smaller reporting
company.





ITEM 2.
PROPERTIES.





Our principal executive offices are
located Liang Fang's headquarterswhich are provided to us at no
cost.





Lotus East leases all of its office and
retail locations. Lease termsare generally one to 20 years, with
renewal options. All of its leases providefor a fixed annual rent. Lotus East
intends to continue to lease all of itsleases.





Lotus East has the following properties
leased in Beijing, China:





Property
      Location
              (District
      of Beijing, China)
            Area
      (sq. ft)
            Lease
      Expiration Period
            PurposeFengtai
      District
            4,413
            August
      31, 2009
            Liang
      Fang warehouseFengtai
      District
            11,345
            December
      31, 2009
            Liang
      Fang headquartersFengtai
      District
            12,917
            July
      3, 2019
            Retail
      - Xinzhong Taita PharmacyFengtai
      District
            2,067
            December
      31, 2009
            Retail
      - Nangong PharmacyFengtai
      District
            2,153
            December
      31, 2010
            Retail
      - Chenzhuang Rd. PharmacyHaidian
      District
            3,660
            December
      31, 2009
            Retail
      - Wanshou Rd. PharmacyDongcheng
      District
            2,153
            May
      31, 2009
            Retail
      - Qingnianhu PharmacyDongcheng
      District
            807
            Month-to-Month
            Retail
      - Hepingli PharmacyChaoyang
      District
            1,550
            December
      31, 2011
            Retail
      - Capital Airport PharmacyChaoyang
      District
            2,691
            Month-to-Month
      (related party)
            Retail
      - Fenglinlvzhou PharmacyFangshan
      District
            1,615
            December
      31, 2010
            Retail
      - Yonganzhongshen PharmacyLiujia
      Village
            2,153
            October
      9, 2010
            Retail
      PharmacyChaoyan
      District
            72,118
            Property
      Owned by Lotus
            En
      Zhe Jia Shi production and manufacturing
  facility





29





On June
3, 2008 Liang Fang entered into an agreement with Cha You Qian Qi Economy
Commission, a governmental agency (“Cha You”) related to the construction of a
pharmaceutical plant in Cha You’s Cha Ha Er Industrial Garden
District.  The new facility, which will be comprised approximately
40,000 square meters situated on 600 MU of land (approximately 400,200 square
meters), will be used to expand Liang Fang’s current manufacturing capacity. The
new facility, which will manufacture medical injection products, including 0.9%
physiological saline injection, hydroxyethyl starch 130/0.4 injection and
hydroxyethyl starch 200/0.5 injection, Qiang Yi Ji starch, a medical corn starch
commonly known as O-2-hydeoxyethyl starch, dextran and additional
pharmaceuticals, will require a total investment of RMB 623.66 million, or
approximately $90.99 million. It anticipated that construction will begin on the
project in September 2008 and that it will take between 12 to 30 months to
complete the facility.





Included
in the total cost of the project is land cost of RMB 223.66 million
(approximately $32.63 million) which is paid to Cha You. Other components of the
project include construction costs of approximately RMB 120 million
(approximately $17.51 million), costs associated with the various production
lines estimated at RMB 230 million (approximately $33.56 million) and working
capital of approximately RMB 50 million (approximately $7.29
million).





Liang
Fang intends to use its present working capital together with bank loans and
government grants to fund the project. The funds are required to be invested
over the next 18 months under a specified schedule ending in December 2010. As
of December 31, 2008, Liang Fang has paid about RMB 226.5 million (approximately
$33 million) of the total investment. Liang Fang, however, has not secured
either the bank loans or government grants and does not have sufficient working
capital to complete this project without securing substantial funds from those
third party sources.




Under the
terms of the agreement, Cha You agreed to abate fees associated with water
resources, waste and other relative supplies for a period of 30 years and agreed
to ensure that the land use tax to be paid by Liang Fang after it begins normal
production will be at the lowest tax rate imposed for five years. Once the
project is completed, for a period of eight years the local reserved portion of
the imposed corporation income tax will be returned to Liang Fang. Liang Fang is
required to commence construction by September 3, 2008. If for any reason Liang
Fang should fail to begin construction within 90 days from the date of the
agreement, Cha You has the right to restore the land use rights to it and Liang
Fang will forfeit any funds invested to date. In addition, Liang Fang is
prohibited from changing the land use designation. We commenced the construction
in August 2008 and we completed the payment for land use right of RMB 223.66
million (approximately $32.63 million) in February 2009.







ITEM
3.  LEGAL PROCEEDINGS.





We are not a party to any pending legal
proceedings.





ITEM 4.  SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS.





None.




PART
II





ITEM
5.  MARKET FOR REGISTRANT'S COMMON EQUITY; RELATED STOCKHOLDERMATTERSANDISSUER PURCHASE OF EQUITY
SECURITIES.


30





MARKET PRICE OF AND DIVIDENDS ON COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS





Our common stock is quoted on the OTCBB under
the symbol LTUS. Thereported high and low sales prices for
the common stock as reported on the OTCBBare shown below for the periods
indicated. The quotations reflect inter-dealerprices, without retail mark-up,
markdown or commission, and
may not representactual transactions.





High
                    LowFiscal
      2007First
      quarter ended March 31, 2007
                    $3.50
                    $1.50Second
      quarter ended June 30, 2007
                    $3.30
                    $1.50Third
      quarter ended September 30, 2007
                    $2.45
                    $1.20Fourth
      quarter ended December 31, 2007
                    $1.60
                    $0.90Fiscal
      2008First
      quarter ended March 31, 2008
                    $1.24
                    $0.54Second
      quarter ended June 30, 2008
                    $1.30
                    $0.59Third
      quarter ended September 30, 2008
                    $0.80
                    $0.30Fourth
      quarter ended December 31, 2008
                    $0.44
                    $0.16Fiscal
      2009First
      quarter ended March 31, 2009
                    $0.38
                    $0.13




On March
31, 2009, the last sale price of our common stock as reported on the OTCBB was
$0.30. As of March 31, 2009, there were approximately 63 record owners of our
common stock.





DIVIDENDPOLICY





We have
not paid cash dividends on our common stock since we became public through a
reverse merger. We intend to keep future earnings to finance the expansion of
our business, and we do not anticipate that any cash dividends will be paid in
the foreseeable future. We rely on dividends from Lotus East for our funds and
PRC regulations may limit the amount of funds distributed to us from Lotus East,
which will affect our ability to declare any dividends. See “Risk Factors -
Risks Related to Doing Business in the PRC” – Lotus East re subject to
restrictions on paying dividends and making other payments to us” and
“Governmental control of currency conversion may affect the value of your
investment.”





Our
future payment of dividends will depend on our earnings, capital requirements,
expansion plans, financial condition and relevant factors that our board of
directors may deem relevant. Our retained earnings limits our ability to pay
dividends.





Payment ofdividends will be within the sole
discretion of our Board of
Directors, subjectto the limitations in the designations,
rights and preferences of our Series APreferred Stock, and will depend, among
other factors, upon our earnings,capital requirements and our
operating and financial
condition.





Pursuant to the designations, rights and
preferences of our Series APreferred Stock each share pays a
mandatory dividend at an annual rate of 8.00%,compounded annually, of the sum
of





·
            $0.87 per share (subject to
      appropriate adjustment in the event of any stockdividend, stock split, combination
      or other similarrecapitalization affecting such
      shares), plus





·
            an amount equal to any dividend
      that has accumulated through suchdate on a share of Series A
      Preferred Stock has not paid in fullthat are payable in
      respect of such
      share, whether or not suchdividends are
      declared.


31





Dividend payments are to be made in
additional shares of Series APreferred Stock on February 25 of each
year.





The terms of the Series A Preferred
Stock prohibit us from declaring orpaying dividends on our common stock as long as
the Series A Preferred Stock isoutstanding.





RECENT SALES OF UNREGISTERED
SECURITIES





None.





ITEM 6. SELECTED
FINANCIAL DATA.





Not applicable to a smaller reporting
company.








ITEM
7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTSOF OPERATIONS.





Overview





We
operate, control and beneficially own the pharmaceutical businesses in China of
Lotus East under the terms of the Contractual Arrangements. Other than the
Contractual Arrangements with Lotus East, we do not have any business or
operations. Pursuant to the Contractual Arrangements we provide business
consulting and other general business operation services to Lotus East. Through
these Contractual Arrangements, we have the ability to control the daily
operations and financial affairs of Lotus East, appoint each of their senior
executives and approve all matters requiring stockholder approval. As a result
of these Contractual Arrangements, which enable us to control Lotus East, we are
considered the primary beneficiary of Lotus East. Accordingly, we consolidate
Lotus East's results, assets and liabilities in our financial statements. The
creditors of Lotus East, however, do not have recourse to any assets we may
have.





PRC law
currently places certain limitations on foreign ownership of Chinese companies.
To comply with these foreign ownership restrictions, we operate our business in
China through the Contractual Arrangements with Lotus East. The contractual
relationship among the above companies as follows:










Based in
Beijing, China, Lotus East is engaged in the production, trade and retailing of
pharmaceuticals, focusing on the development of innovative medicines and
investing in strategic growth to address various medical needs. Lotus East owns
and operates 10 drug stores throughout Beijing, China that sell Western and
traditional Chinese medications, lease medical treatment facilities to licensed
physicians, and generate revenues from the leasing of retail space to third
party vendors and the leasing of advertising locations at its retail
stores.





32


When used
in this section, and except as may be set forth otherwise, the terms "we," "us,"
"ours," and similar terms includes Lotus and its subsidiary Lotus International
as well as Lotus East.




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES





Our
discussion and analysis of our financial condition and results of operations are
based on our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities and expenses.
On an ongoing basis, we evaluate our estimates and judgments, including those
related to accrued expenses, fair valuation of stock related to stock-based
compensation and income taxes. We based our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.




REVENUE
RECOGNITION





Product
sales are generally recognized when title to the product has transferred to
customers in accordance with the terms of the sale. The Company recognizes
revenue in accordance with the Securities and Exchange Commission’s (SEC) Staff
Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial
Statements” as amended by SAB No. 104 (together,
“SAB 104”), and Statement of Financial Accounting Standards (SFAS)
No. 48 “Revenue
Recognition When Right of Return Exists.”SAB 104 states that
revenue should not be recognized until it is realized or realizable and earned.
In general, the Company records revenue when persuasive evidence of an
arrangement exists, services have been rendered or product delivery has
occurred, the sales price to the customer is fixed or determinable, and
collectability is reasonably assured.




SFAS No. 48 states
that revenue from sales transactions where the buyer has the right to return the
product shall be recognized at the time of sale only if the seller’s price to
the buyer is substantially fixed or determinable at the date of sale, the buyer
has paid the seller, or the buyer is obligated to pay the seller and the
obligation is not contingent on resale of the product, the buyer’s obligation to
the seller would not be changed in the event of theft or physical destruction or
damage of the product, the buyer acquiring the product for resale has economic
substance apart from that provided by the seller, the seller does not have
significant obligations for future performance to directly bring about resale of
the product by the buyer, and the amount of future returns can be
reasonably estimated.




The
Company’s net product revenues represent total product revenues less allowances
for returns.





PRODUCT
RETURNS





The
Company accounts for sales returns in accordance with Statements of Financial
Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of
Return Exists, by establishing an accrual in an amount equal to its
estimate of sales recorded for which the related products are expected to be
returned. The Company determines the estimate of the sales return accrual
primarily based on 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. In general, for
wholesale sales, the Company provides credit for product returns that are
returned six months prior to and up to six months after the product expiration
date. Upon sale, the Company estimates an allowance for future product returns.
The Company provides additional reserves for contemporaneous events that were
not known and knowable at the time of shipment. In order to reasonably estimate
future returns, the Company analyzed both quantitative and qualitative
information including, but not limited to, actual return rates, the level of
product manufactured by the Company, the level of product in the distribution
channel, expected shelf life of the product, current and projected product
demand, the introduction of new or generic products that may erode current
demand, and general economic and industry wide indicators. The Company also
utilizes the guidance provided in SAB 104 in establishing its return
estimates.





OTHER
REVENUE





Other
revenues consist of (i) rental income received for the lease of retail space to
various retail merchants; (ii) advertising revenues from the lease of counter
space at our retail locations; (iii) rental income from the lease of retail
space to licensed medical practitioners; and (iv) revenues received by us for
research and development projects. We recognize revenues upon performance of
such funded research. We recognize revenues from leasing of space as earned from
contracting third parties. Revenues received in advance are reflected as
deferred revenue on the accompanying balance sheets. Additionally, we receive
income from the sale of developed drug formulas. Income from the sale of drug
formulas are recognized upon performance of all of our obligations under the
respective sales contract and are included in other income on the accompanying
consolidated statement of operations.


33





ACCOUNTS
RECEIVABLE





Accounts
receivable are carried at original invoice amount less an estimate made for
doubtful receivables based on a review of all outstanding amounts on a monthly
basis. Management judgment and estimates are made in connection with
establishing the allowance for doubtful accounts. Specifically, we analyze the
aging of accounts receivable balances, historical bad debts, customer
concentrations, customer credit-worthiness, current economic trends and changes
in our customer payment terms. Significant changes in customer concentration or
payment terms, deterioration of customer credit-worthiness or weakening in
economic trends could have a significant impact on the collectability of
receivables and our operating results. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required.





INVENTORIES





Inventories
are stated at the lower of cost or market with cost determined under the moving
average method. Inventory consists of finished capsules, liquids, finished oral
suspension powder and other western and traditional Chinese medicines and
medical equipment. At least on a quarterly basis, we review our inventory levels
and write down inventory that has become obsolete or has a cost basis in excess
of its expected net realizable value or is in excess of expected requirements.
Inventory levels are evaluated by management relative to product demand,
remaining shelf life, future marketing plans and other factors, and reserves for
obsolete and slow-moving inventories are recorded for amounts which may not be
realizable.





PROPERTY
AND EQUIPMENT





Property
and equipment are carried at cost. The cost of repairs and maintenance is
expensed 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. In accordance with Statement of Financial
Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets", we examine the possibility of decreases in the value of
fixed assets when events or changes in circumstances reflect the fact that their
recorded value may not be recoverable.





Depreciation
is calculated on a straight-line basis over the estimated useful lives of the
assets. The useful lives for property and equipment are as follows:





Buildings
      and leasehold improvement
              
              
              20
      to 40 yearsManufacturing
      equipment
              
              
              10
      to 15 yearsOffice
      equipment and furniture
              
              
              5
      to 8 years





INCOME
TAXES





Taxes are
calculated in accordance with taxation principles currently effective in the
United States and PRC. We account for income taxes using the liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. 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 as income in the
period that includes the enactment date. A valuation allowance is provided for
the amount of deferred tax assets that, based on available evidence, are not
expected to be realized.





RECENT
ACCOUNTING PRONOUNCEMENTS





34


In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities, Including an Amendment of FASB
Statement No.115", under which entities will now be permitted to measure many
financial instruments and certain other assets and liabilities at fair value on
an instrument-by-instrument basis. This Statement is effective as of the
beginning of an entity's first fiscal year that begins after November 15, 2007.
Early adoption is permitted as of the beginning of a fiscal year that begins on
or before November 15, 2007, provided the entity also elects to apply the
provisions of SFAS 157. The adoption of SFAS 159 did not have a material impact
on our financial statements.





In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141R, Business Combinations (SFAS 141R) and Statement of Financial Accounting
Standards No. 160, Accounting and Reporting of Non-controlling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). These
two standards must be adopted in conjunction with each other on a prospective
basis. The most significant changes to business combination accounting pursuant
to SFAS 141R and SFAS 160 are the following: (a) recognize, with certain
exceptions, 100 percent of the fair values of assets acquired, liabilities
assumed and non-controlling interests in acquisitions of less than a 100 percent
controlling interest when the acquisition constitutes a change in control of the
acquired entity, (b) acquirers' shares issued in consideration for a business
combination will be measured at fair value on the closing date, not the
announcement date, (c) recognize contingent consideration arrangements at their
acquisition date fair values, with subsequent changes in fair value generally
reflected in earnings, (d) the expensing of all transaction costs as incurred
and most restructuring costs, (e) recognition of pre-acquisition loss and gain
contingencies at their acquisition date fair values, with certain exceptions,
(f) capitalization of acquired in-process research and development rather than
expense recognition, (g) earn-out arrangements may be required to be re-measured
at fair value and (h) recognize changes that result from a business combination
transaction in an acquirer's existing income tax valuation allowances and tax
uncertainty accruals as adjustments to income tax expense. Should we decide to
enter into future business combinations, these new standards will significantly
affect our accounting for future business combinations following adoption on
January 1, 2009.





In March
2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments
and Hedging Activities-- an amendment of FASB Statement No. 133" ("FAS 161").
FAS 161 changes the disclosure requirements for derivative instruments and
hedging activities. Entities are required to provide enhanced disclosures about
(a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under Statement 133 and
its related interpretations, and (c) how derivative instruments and related
hedged items affect an entity's financial position, financial performance, and
cash flows. The guidance in FAS 161 is effective for financial statements issued
for fiscal years and interim periods beginning after November 15, 2008, with
early application encouraged. This Statement encourages, but does not require,
comparative disclosures for earlier periods at initial adoption. The adoption of
SFAS 161 did not have a material impact on our financial
statements.





In May
2008, the Financial Accounting Standards Board (FASB”) issued FASB Staff
Position (FSP”) APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement) . FSP APB 14-1 clarifies
that convertible debt instruments that may be settled in cash upon either
mandatory or optional conversion (including partial cash settlement) are not
addressed by paragraph 12 of APB Opinion No. 14,Accounting for Convertible Debt and
Debt issued with Stock Purchase Warrants . Additionally, FSP APB 14-1
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. We will adopt FSP APB 14-1 beginning in the first quarter of
fiscal 2010, and this standard must be applied on a retrospective basis. We are
evaluating the impact the adoption of FSP APB 14-1 will have on our consolidated
financial position and results of operations.





In May
2008, the FASB issued Statement of Financial Accounting Standards (SFAS”) No.
162,The Hierarchy of
Generally Accepted Accounting Principles . This standard is intended to
improve financial reporting by identifying a consistent framework, or hierarchy,
for selecting accounting principles to be used in preparing financial statements
that are presented in conformity with generally accepted accounting principles
in the United States for non-governmental entities. SFAS No. 162 is effective 60
days following approval by the U.S. Securities and Exchange Commission (SEC”) of
the Public Company Accounting Oversight Board’s amendments to AU Section
411,The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles . We
do not expect SFAS No. 162 to have a material impact on the preparation of our
consolidated financial statements.


35





On June
16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities”
to address the question of whether instruments granted in share-based payment
transactions are participating securities prior to vesting. The FSP determines
that unvested share-based payment awards that contain rights to dividend
payments should be included in earnings per share calculations. The guidance
will be effective for fiscal years beginning after December 15, 2008. We are
currently evaluating the requirements of (FSP) No. EITF 03-6-1.




On October 10, 2008, the FASB issued FSP
157-3, “Determining the Fair
Value of a FinancialAsset When the
Market for That Asset Is Not Active,”which clarifies the application of SFAS
157 in a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market forthat financial
asset is not active. FSP 157-3 became effective on October 10, 2008, and its
adoption did not have a material impact on our financial position or
results.





In January 2009, the FASB issued FSP
EITF 99-20-1, “Amendments
to the Impairment Guidance
of EITF Issue No. 99-20, “Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets”. FSP EITF 99-20-1 changes the
impairment model included within EITF 99-20 to be more consistent with the impairment model of SFAS No. 115.
FSPEITF 99-20-1
achieves this by amending the impairment model in EITF 99-20 to remove its
exclusive reliance on “market participant”estimates of future cash flows used in
determining fair value. Changing the cashflows used to analyze
other-than-temporary impairment from the “market participant”view to a holder’s estimate of whether there has been a
“probable”adverse change in estimated cash flows
allows companies to apply reasonable judgment in assessing whether an other-than-temporary impairment has
occurred. The adoption of FSP EITF 99-20-1 did not have a material impact on our
consolidated financial statements.





Results
of Operations





Year
Ended December 31, 2008 compared to Year Ended December 31, 2007





Total
Net Revenues





Total
revenues for the year ended December 31, 2008 were $73,803,029 as compared to
total revenues of $56,873,115 for the year ended December 31, 2007, an increase
of $16,929,914 or approximately 29.77% comparable period in 2007. For the year
ended December 31, 2008 and 2007, net revenues consisted of the
following:





2008
                    
                    
                    2007Wholesale
                    
                    $
                    65,264,281
                    
                    
                    $
                    41,651,106Retail
                    
                    
                    2,837,257
                    
                    
                    
                    3,471,960Other
      revenues
                    
                    
                    5,701,491
                    
                    
                    
                    11,750,049Total
      net revenues
                    
                    $
                    73,803,029
                    
                    
                    $
                    56,873,115








36





For
      the year ended December 31, 2008, wholesale revenues increased by
      $23,613,175or 56.69%. The significant increase in tangible product
      revenues is mainly attributed to strong sales in Brimonidine Tartrate Eye
      Drops and third party manufactured drugs included Recombinant Human
      Granulocyte Colony, Recombinant Human Interleukin-2 for Injection,
      Recombinant Human Erythropoietin Injection, Deproteinized Calfblood
      Extractives Injection, Octreotide Acetate Injection, Cervus and Cucumis
      and Polypeptide Injection Cefrotaxime Sodium for Injection. The increase
      in revenue was offset by the decrease in sales in Levofloxacin Lactate for
      Injection and Valsartan Capsules. The significant increased sales in
      Brimonidine Tartrate Eye Drops were primarily due to our strong sales
      effort on promoting this drug. In late 2007, we obtained exclusive
      distribution rights from a third party Beijing based pharmaceutical
      company for four drugs: Octreotide Acetate Injection, Recombinant Human
      Erythropoietin Injection, Recombinant Human Granulocyte Colony-stimulating
      Factor Injection, and Recombinant Human Interleukin-2 for Injection. In
      2008, we obtained exclusive distribution rights for Cervus and Cucumis
      Polypeptide Injection. Additionally, we also strengthen our relationships
      with the several large drug manufacturers in 2008.  As a result,
      we experienced a significant increase in our third party manufactured drug
      sales during the year ended December 31, 2008. As majority of our
      wholesale products are prescription drugs that are in demand by patients
      in China, we believe the demand for our wholesale products will not be
      impacted by the overall softening economy.  We expect the sales
      will continue to have steady growth in our fiscal year of
  2009.For
      the year ended December 31, 2008, retail revenues decreased by $634,703 or
      18.28%. The decrease is primarily attributable to the slowdown in economy
      growth and the impact from 2008 Olympic held in Beijing.  The
      slowdown in the economy growth resulted in less non-essential health
      supplements being purchases. The Company also experienced a reduction in
      the sale of higher priced drugs in 2008. As a result, the Company
      generated less per store revenue. Additionally, during the 2008 Olympics,
      the Beijing government restricted the city traffic and limited local roads
      used by locals. Consequentially, the Company’s retail stores received less
      visits from its customers. We expect our retail revenue will slightly
      increase in our fiscal year of 2009.For
      the year ended December 31, 2008, other revenues decreased by $6,048,558
      or 51.48%. The decrease in other revenues is attributed to the
      following:





2008
                    
                    
                    2007Leasing
      revenues
                    
                    $
                    779,346
                    
                    
                    $
                    859,288Third-party
      manufacturing
                    
                    
                    4,465,965
                    
                    
                    
                    9,482,572Advertising
      revenues
                    
                    
                    230
                    
                    
                    
                    601,335Research
      and development and lab testing services
                    
                    
                    455,950
                    
                    
                    
                    806,854Total
      other revenues
                    
                    $
                    5,701,491
                    
                    
                    $
                    11,750,049




We
      sublease certain portion our retail stores and counter spaces to various
      other vendors and generate leasing revenue. The leasing revenue remained
      materially consistent with prior year same period. The slight decrease was
      primarily due to less counter space being leased to third parties due to
      less demand for our counter spaces during the year ended December 31,
      2008. We expect our leasing revenue to remain flat in our fiscal
      2009.





For
      third-party manufacturing, customers supply the raw materials and we are
      paid a fee for manufacturing their products. We had less large
      manufacturing contracts during the year ended December 31, 2008 as the
      demand for the third-party manufacturing decreased as compared to the same
      period in 2007. Several of our historical, large third party manufacturing
      customers have built their own facilities and started manufacturing
      products on their own in 2008 and we were unable to find new customers to
      replace them. As a result, our third-party manufacturing revenue
      decreased. We anticipate the third-party manufacturing revenue will
      continue to decrease for the fiscal 2009 as we do not expect to have new
      customers with large third party manufacturing contracts.A
      large advertisement contract whereby we receive approximately $50,000 per
      month for the lease of counter and other space at our retail locations
      ended in December 2007. Accordingly, our advertising revenues decreased
      during the year ended December 31, 2008 as compared to the same period in
      2007. As the local government tightens the advertising rules and
      regulations in the pharmaceutical industry, we do not anticipate signing
      similar advertisement contracts in the near future.We
      performed research and development and lab testing projects for various
      third parties and performed drug testing and analysis. We preformed less
      R&D testing services and drug testing and analysis work for third
      parties during the year ended December 31, 2008 as compared to the same
      period in 2007. Some of our historical customers for these services were
      able to find other companies that provide similar R&D and lab testing
      serves at a lower price and decided not to use our services in 2008. We
      expect the revenue from R&D and lab testing will maintain at its
      current level with minimal growth in the fiscal year of
  2009.





37





Cost
of Sales





Cost of
sales includes raw materials, packing materials, direct labor, manufacturing
costs, which includes allocated portion of overhead expenses such as Labor fee,
utilities and depreciation directly related to product production, and related
taxes. For the year ended December 31, 2008, cost of sales amounted to
$40,440,088 or approximately 54.79% of total net revenues as compared to cost of
sales of $33,678,963 or approximately 59.22% of total net revenues for the year
ended December 31, 2007. The decrease in cost of sales as a percentage of total
net revenue was primarily due to better purchase pricing management and more
efficient production cost controls.





Gross
Profit





Gross
profit for the year ended December 31, 2008 was $33,362,941 or 45.21% of total
net revenues, as compared to $23,194,152 or 40.78% of total net revenues for the
year ended December 31, 2007. The increase in gross profit was attributable to
the decrease in cost of sales as a percentage of revenue. The decrease in cost
of sales as a percentage of revenue was primarily contributed to better managed
raw material and third party manufactured finished goods purchase prices.
Although we recognized higher than average gross profits during the year ended
December 31, 2008, there could be no assurance that we will continue to
recognize similar gross profit margin in the future.





Operating
Expenses





Total
operating expenses for the year ended December 31, 2008 were $18,292,997, an
increase of $6,407,138 or 53.91% from total operating expenses in the year
ended December 31, 2007 of $11,885,859. This increase included the
following:





For the
year ended December 31, 2008, selling expenses amounted to $14,902,646 as
compared to $6,460,206 for the year ended December 31, 2007, an increase of
$8,442,440 or 130.68% from the comparable period in fiscal 2007. This increase
is primarily attributable to an increase of approximately $5.6 million in
commission paid to our sales representatives on sales generated to provide
greater incentives; we increased the sales commission percentage in
2008.  Additionally, we paid bonuses to our collection personnel of
approximately $2.5 million to improve our collections on accounts receivables
and cash flows. In order to generate sufficient cash to meet our near term
capital commitments such as new manufacture plant construction project and
acquiring Chinese Class I drug patent, management adopted a high commission and
bonuses policy to incentivize our sales and collection personnel’s
performance.  As a result, the significant increase in the selling
expenses negatively impacted of our net income. Management has modified its
sales and collection incentive policy and reduced the sales commission
percentage and collection bonuses in 2009 as the Company’s near term capital
requirement has been met.  Although we currently expect the selling
expenses as a percentage of revenue will decrease, we cannot guarantee that we
will not reinforce the high sales and collection incentive policy and increase
the selling expenses as a percentage of revenue to meet future working capital
needs.





For the
year ended December 31, 2008, research and development costs amounted to
$1,200,194 as compared to $2,411,651 for the year ended December 31, 2007, a
decrease of $1,211,457 or 50.23%from the comparable period in 2007. In late
2007, we entered into several research and development agreements with third
parties for the design, research and development of designated pharmaceutical
projects. We fulfilled these research and development agreements on June 30,
2008. We did not enter into any new research and development agreement in the
last half fiscal year of 2008. As a result, expenses related to those research
and development projects decreased during the year ended December 31, 2008. As
we have a number of new drugs that are either under development or waiting for
approval, we do not expect to enter into additional research and development
agreements that will incur material research and development costs in the near
future.





For the
year ended December 31, 2008, general and administrative expenses were $
2,190,157 as compared to $3,014,002 for the year ended December 31, 2007, a
decrease of $823,845 or 27.33% from the comparable period in fiscal
2007.  These changes are summarized below:




38





For the Year
      ended
                  December
31,2008
                
                
                2007Salaries and related
      benefits
                
                $
                1,411,256
                
                
                $
                1,457,501Depreciation
                
                
                16,868
                
                
                
                10,550Amortization
                
                
                151,723
                
                
                
                140,471Rent
                
                
                210,954
                
                
                
                242,856Travel and
      entertainment
                
                
                57,525
                
                
                
                284,357Professional
      fees
                
                
                521,519
                
                
                
                250,472Bad debt
      recovery
                
                
                (575,781
                )
                
                
                -Other
                
                
                396,092
                
                
                
                627,795Total
                
                $
                2,190,157
                
                
                $
                3,014,002





The
changes in these expenses from the year ended December 31, 2008 as compared to
the year ended December 31, 2007 included the following:


·
                                        Salaries and related benefits decreased $46,245 or 3.17% primarily
      due to a decrease in bonuses paid to administrative personnel. The bonuses
      paid in 2007 were paid to several key employees and management and
      determined by meeting various individuals’ as well as overall Company’s
      operational goals. As we continue our efforts to control corporate
      spending, starting in 2008, we no longer provided certain benefits that
      were provided to employees in the 2007 including insurance, car allowances
      and other fringe benefits. As a result, the salaries and related benefits
      costs decreased accordingly·
                                        Depreciation on our fixed assets increased by $6,318 or
      approximately 59.89% which is primarily attributable to the purchase of
      new equipment in 2008.·
                                        Amortization of our intangible assets increased by $11,252 or
      approximately 8.01% which is primarily attributable to the purchase of new
      intangible asset used in our office in fiscal year of
  2008.·
                                        Bad
      debt recovery income increased $575,781 or 100% primarily due to our
      strong effort on accounts receivable collection.·
                                        Rent decreased by $31,902 or
      approximately 13.14% which primarily reflects our ability to renegotiate a
      portion of our leases at reduced rent rates on a short term
  basis.·
                                        Travel
      and entertainment expenses decreased by $226,832 or 79.77% as a result of
      corporate spending control effort.·
                                        Professional
      fees increased $271,047 or 108.21% due to increase in investor relation
      professional fees, legal expenses related to February 2008 financing and a
      stock based compensations paid to a technology consultant  for
      consulting services provided to the Company.·
                                        Other
      general and administrative expenses, which includes utilities, office
      supplies and training and other office expenses decreased by $231,703 or
      approximately 36.91% reflecting efforts at reducing non-sales related
      corporate training and other activities as well as stricter controls on
      corporate spending.


Income
from Operations





We
reported income from operations of $15,069,944 for the year ended December 31,
2008 as compared to income from operations of $11,308,293 for the year ended
December 31, 2007, an increase of $3,761,651 or approximately
33.26%.


39





Other
Expense





For the
year ended December 31, 2008, total other expense amounted to $2,279,296 as
compared to other expense of $91,165 for the year ended December 31, 2007, an
increase of $2,188,131 or 2400.19% from the comparable period in 2007. This
change is primarily attributable to:




·
            For
      the year ended December 31, 2008, we do not receive any forgiveness of
      business and value-added taxes from local government as compared to
      $2,160,795 forgiveness of business of business and valued-added taxes
      received from local government for the year ended December 31, 2007. In
      2007, the Chinese local government granted Lotus East special tax waivers
      to exempt and release business and value added taxes. The PRC local
      government has provided various incentives to local companies in order to
      encourage economic development. Such incentives include reduced tax rates
      and other measures. The tax waivers were provided on a non-recurring
      basis. We do not expect to receive the forgiveness of taxes in
      2009.·
            For
      the year ended December 31, 2008, our debt issuance cost amounted to
      $361,436 as compared to $205,379 for the year ended December 31, 2007, an
      increase of $156,057 or approximately 75.98%, due to our February 2008
      financing.·
            For
      the year ended December 31, 2008, we recorded registration rights
      penalties of $650 related to the late filing of our registration statement
      on Form SB-2 as compared to $110,000 for the year ended December 31, 2007,
      a decrease of $109,350 or 99.41%.·
            For
      the year ended December 31, 2008, interest expense was $1,929,836 as
      compared to $2,038,735 for the year ended December 31, 2007, a decrease of
      $108,899 or 5.34% which is primarily attributable to the amortization of
      debt discount on our 2007 financing which was fully amortized earlier in
      2008 and the annual interest rate on our 2007 financing was larger than
      the annual interest rate on our 2008
financing.




NET
INCOME, OTHER COMPREHENSIVE INCOME AND COMPREHENSIVE INCOME





As a
result of these factors, we reported net income of $12,790,648 for the year
ended December 31, 2008 as compared to net income of $11,217,128 for the year
ended December 31, 2007. This translates to basic and diluted net income per
common share of $0.30, $0.27 and $0.27, $0.26 for the year ended December 31,
2008 and 2007, respectively.





During
the year ended December 31, 2008, our unrealized gain on foreign currency
translation of $2,247,686, an increase of $767,334, or approximately 51.83%,
from the same period in 2007. We report in U.S. dollars, but the functional
currency of Lotus East is the RMB. Translation adjustments result from the
process of translating the local currency financial statements into U.S.
dollars, with the average translation rates applied to our income statement of
6.96225 RMB to $1.00 during the year ended December 31, 2008. As a result of
this non-cash gain, we reported comprehensive income of $15,038,334 for the year
ended December 31, 2008 as compared to $12,697,480 for the same period in
2007.





LIQUIDITY ANDCAPITAL RESOURCES





Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its obligations and otherwise operate on an ongoing
basis.





At
December 31, 2008, we had a cash balance of $1,278,808. These funds are located
in financial institutions located as follows:





China
                  
                  $
                  1,277,649USA
                  
                  
                  1,159Total
                  
                  $
                  1,278,808





40


Our
working capital position decreased $20,229,954 to $ 4,422,183 at December
31, 2008 from $24,652,137 at December 31, 2007. This decrease in working capital
is primarily attributable to a decrease in cash of approximately $3.28 million,
a decrease in accounts receivable net of allowance of approximately $14.30
million, a decrease in prepaid expenses and other assets of approximately $0.89
million, a decrease in convertible debt net of debt discount of approximately
$2.56 million, an increase in other receivable-related party of approximately
$2.03 million, an increase in inventories net of reserve for obsolete inventory
of approximately $0.38 million, an increase in deferred debt issuance costs of
approximately $0.37 million, an increase in accounts payable and accrued
expenses of approximately $1.41 million, an increase in tax payable of
approximately $4.44 million  and an increase in due to related parties
of approximately of $1.27 million.





At
December 31, 2008, our accounts receivable, net of allowance for doubtful
accounts, was $6,132,912 as compared to $20,430,827 at December 31, 2007, a
decrease of $14,297,915. The decrease was primarily due to our strong collection
effort which significantly improved our accounts receivable aging days. We
expect our accounts receivable will maintain at the current level; in addition
to our continuous collection effort, we have started to provide our customers
discounted sales price on our products if they pay for the products within a
certain short time period.





At
December 31, 2008, we maintained an allowance for doubtful accounts on accounts
receivable balances of $0 as compared to $548,083 at December 31, 2007, a
decrease of $548,083 reflects our best estimate of probable losses. In
determining the allowance for doubtful accounts, our management reviews our
accounts receivable aging as well as the facts and circumstances of specific
customers which may indicate the collection of specific amounts are at
risk.  Our terms of sale generally require payment within two to four
months, we believe that our terms of sale are customary among our competitors
for a company in our size within our industry.  As described elsewhere
herein, in 2008 we began paying a bonus to certain employees who are involved in
the collection of accounts receivable to generate sufficient cash to meet our
near term capital commitments such as new manufacture plant construction project
and acquiring Chinese Class I drug patent.  At December 31, 2008,
these bonuses totaled $2.5 million. We also occasionally offer established
customers longer payment terms on new products as an incentive to purchase these
products, which has served to further increase the average days outstanding for
accounts receivable. As the market for these new products is established, we
will discontinue offering this sales incentive. Occasionally we will request a
customer to prepay an order prior to shipment.





At
December 31, 2008, our inventories of raw materials, work in progress, packaging
materials, finished goods and reserve for obsolete inventories totaled
$3,787,802, an increase of approximately $0.38 million, or 11.06%, from December
31, 2007. Included in this change was an increase of $79,154 in finished goods
and an increase of $571,981 in raw materials offset by decreases in packaging
materials of $36,867, work in progress of $279,759 and inventories reserve of
$42,554 and there is an exchange rate effect in fiscal year of 2008 about
reverse for obsolete inventories of $2,855. We expect to maintain slight higher
raw materials and finished goods inventory levels to accommodate for anticipated
future sales growth and productions.





At
December 31, 2008, we have another receivable-related party of $2,027,954 as
compared to $0 at December 31, 2007, a increase of $2,027,954. The increase was
due to a wire transfer fund from the Company account to our CEO, Zhongyi Liu,
personal account in order to form a subsidiary in Inner Mongolia, China. In
December 2008, in connection with the new plant facility in Cha Ha Er Industrial
Garden District in Inner Mongolia, the Company planned to form a new subsidiary
in Inner Mongolia. In preparation for the register capital of the originally
planned new entity, on December 25, 2008, the Company transferred $2,027,954 to
the Company’s CEO to register for the new entity. The Company subsequently
determined forming an Inner Mongolia new entity was not necessary and the money
was returned to the Company on January 5, 2009.





At
December 31, 2008, we have a prepaid expenses and other assets of $121,274 as
compared to $1,009,382 at December 31, 2007, a decrease of $888,108. The
decrease was primarily due to the completion of our research and development
contracts which were recorded as a prepayment of approximately $1,009,000 in
fiscal 2007 and we did not make similar research and development contract
prepayments in 2008.





At
December 31, 2008, we have a deferred debt cost of $464,411 as compared to
$29,340 at December 31, 2007, an increase of $ 435,071. The increase was
primarily attributed to the issuance of the series A convertible redeemable
preferred stock and warrants to purchase 2,873,553 shares of the company’s
common stock. We recorded a total deferred debt cost of $796,133 to be amortized
over the term of our purchase agreement.


41





At
December 31, 2008, we have a deposit on patent of $2,917,919 to acquire a new
Chinese Class I anti-asthma medicine drug patent in accordance with a technology
transfer agreement the Company entered into in April 2008.





At December 31, 2008, we
have an installment on intangible assets of $38,175,134 to acquire the foregoing
Chinese Class I drug patent, another drug certificate and intellectual property
right- Yipubishan in accordance with a new drug certificate and intellectual
property right transfer contract we entered into on December 2, 2008 and land
use right in Inner Mongolia. In accordance with the agreement we entered into in
June 2008, we recorded an installment on land use right of $32,631,088 for the
amounts paid to a local government agency in Cha You to acquire a long-term
interest to utilize certain land to construct a new manufacture facility. We did
not have these installments at December 31, 2007.





At
December 31, 2008, we have a convertible debt, net of debt discount of $0 as
compared to $2,561,645 at December 31, 2007, a decrease of $2,561,645. Because
we repaid in full all of our outstanding obligations under the 14% Secured
Convertible Notes due February 2008.





At
December 31, 2008, we have an accounts payable and accrued expenses of
$2,170,165 as compared to $764,491 at December 31, 2007, an increase of
$1,405,674. The increase was primarily attributed to the increase in payables
for construction in progress for our new facility in Inner
Mongolia.





At
December 31, 2008, we have a taxes payable of $5,015,908 as compared to $572,200
at December 31, 2007. The amounts are related to accrued but unpaid value added
taxes and other related taxes for the year ended December 31, 2008. The increase
in the taxes payable is primarily due to increase in our revenues and we did not
receive any forgiveness of taxes from local government during the year ended
December 31, 2008 and the tax payment timing differences.





Our
balance sheet at December 31, 2008, also reflects a balance due to related
parties of $2,113,914 which was a working capital advances made to us by our
president, vice-president and an officer of the Company and a Board member as
well as an amount payable of approximately $1,051,450 related to an assignment
agreement as discussed elsewhere in this report. These advances are non-interest
bearing and are due on demand. We are currently repaying these balances as
operating cash become available.





At
December 31, 2008, we have a series A convertible redeemable preferred stock of
$3,652,341 as compared to $0 at December 31, 2007. The increase is due to our
private financing in February 25, 2008.





Our
balance sheet at December 31, 2008 also reflects notes payable to related
parties of approximately $5 million due on December 30, 2015 which is a working
capital loan made to us by the Company’s Chief Executive Officer, two employees
of the Company and a Board member. These loans bear a variable annual interest
at 80% of current bank rate and are unsecured. During the year ended December
31, 2008, we did not repay any portion of these loan balances.





The
changes in asset and liabilities discussed above is based on a comparison of
amounts on our balance sheets at December 31, 2008 and December 31, 2007 and
does necessarily reflect changes in assets and liabilities reflected on our cash
flow statement, which we use the average foreign exchange rate during the period
to calculate these changes.





Net cash
provided by operating activities for the year ended December 31, 2008 was
$37,394,084 as compared to net cash used in operating activities of $850,455 for
the year ended December 31, 2007. For the year ended December 31, 2008, net cash
provided by operating activities was attributable primarily to a decrease in
accounts receivable of $16,001,384, a decrease in prepaid expenses and other
current assets of $939,654, an increase in accounts payable and accrued expenses
of $1,360,568, an increase in taxes payable of $4,336,947,  and the
add back of net income of $12,790,648, depreciation and amortization of
$634,347, amortization of deferred debt issuance costs of $361,062, amortization
of debt discount of $208,355, amortization of discount on convertible redeemable
preferred stock of $962,604, amortization of prepaid expense attributable to
warrants of $163,338, stock based compensation of $318,551 and warrant repricing
of $74,593 offset by a decrease in allowance for doubtful accounts of $575,781,
an increase in inventories of $145,910 and a decrease in advances from customers
of $36,276. Net cash used in operating activities for the year ended December
31, 2007 was $850,455. For the year ended December 31, 2007, net cash used in
operating activities was attributable primarily to our net income of
$11,217,128, the add back of depreciation and amortization of $564,607,
amortization of deferred debt issuance costs of $205,379, amortization of debt
discount of $1,458,484, stock issued for compensation of $ 284,200 and an
increase in value-added taxes payable of $608,526 and an increase in unearned
revenue of $71,402  offset by an decrease in allowance for doubtful
accounts of $2,385,354, a forgiveness of income and value-added taxes of
$2,160,795, an increase in accounts receivable of $9,764,076, an increase in
inventories of $58,942, an increase of prepaid expenses and other current assets
of $714,013 and a decrease in advances from customers of
$204,267.


42





Net cash
used in investing activities for the year ended December 31, 2008 amounted to
$41,901,488. For the year ended December 31, 2008, net cash used in investing
activities was attributable to the deposit on patent right of $2,872,635, the
installments on intangible assets of $ 37,582,678, the purchase of intangible
asset of $7,756 and the purchase of property and equipment of $1,438,419. Net
cash used in investing activities for the year ended December 31, 2007 was
$381,772 and was attributable to the purchase of property and
equipment.





Net cash
provided by financing activities was $980,937 for the year ended December 31,
2008 and was attributable to the receipt of net proceeds of $5,000,000 from our
private financing and proceeds from related party advances of $ 965,986 offset
by payments on convertible debt of $2,520,000, debt issuance costs of $468,568
and repayments of related party advances of $1,996,481. Net cash provided by
financing activities was $3,472,102 for the year ended December 31, 2007 and was
primarily attributable to the receipt of net proceeds of $2,950,000 from our
debt financing and the collections from related party advances of $1,061,009
offset by payments on related party advances and notes of $307,381 and the
payment of debt issuance costs of $231,526.





We
reported a net decrease in cash for the year ended December 31, 2008 of
$3,279,149 as compared to a net increase in cash of $2,468,801for the year ended
December 31, 2007.




In 2007,
we lent approximately $2 million of the net proceeds received from the sale of
$3 million principal amount convertible debt to Lotus East, which they used as
working capital. These advances are unsecured and interest free. During the
first quarter of 2008, we used a portion of the proceeds from the sale of equity
to satisfy these notes, lent Lotus East an additional $1.6 million and retained
the balance to fund our operating expenses. We have no operations other than the
Contractual Arrangements with Lotus East and, accordingly, we are dependent upon
the quarterly service fees due us to provide cash to pay our operating expenses.
Such payments have not been tendered to us and those funds are being retained by
Lotus East to fund their operations. At December 31, 2008, Lotus East owned us
approximately $ 23.7 million for such fees and we do not know when such funds
will be paid to us. Our CEO is also the CEO and principal shareholder of Lotus
East. Accordingly, we are solely reliant upon his judgment to ensure that the
funds advanced to Lotus East are repaid to us. If these funds should not be
repaid, or if Lotus East should continue to withhold payment of the quarterly
service fee due us under the Contractual Arrangement, it is possible that we
will not have sufficient funds to pay our operating expenses in future
periods.




Other
than our existing cash we presently have no other alternative source of working
capital. We believe that our working capital may not be sufficient to fund our
current operations for the next 12 months unless Lotus East pays us the amounts
due to us. Lotus East has historically funded its capital expenditures from
their working capital and has advised us that they believe this capital is
sufficient for their current needs. Lotus East has unpaid contractual
commitments for approximately $62.7 million related to a Technology Transfer
Agreement and the construction of the new manufacturing
facility.  While it intends to fund the costs associated with the
Technology Transfer Agreement and a portion of the construction of the new
manufacturing facility with its existing working capital, it is dependent upon
the continued growth of its operations and prompt payment of outstanding
accounts receivables by its customers to ensure that it has sufficient cash for
these commitments. In addition, its ability to fully fund the costs associated
with the new manufacturing facility is materially dependent upon its ability to
secured bank financing and/or government grants. As the banking industry is
tightening the credit/lending policy, we expect the bank financing will become
more challenging and the time to obtain the bank funding might be longer than
expected. Although the Chinese government has recently announced an economic
simulation plan, there is no guarantee that we will successfully be awarded the
government grant. As it has no firm commitments for either, while its management
believes the company will be successful in securing the necessary funding
through its increasing revenue, quicker collections on receivables, current
discussions with various commercial banks there are no assurances the funding
will be available in the amounts or at the time required to meet Liang Fang's
commitment.  In the event Lotus East is not successful in obtaining
the funds it needs for the Technology Transfer Agreement, it is possible that it
could default under the terms of the agreement and forfeit any funds paid to
date.  If Lotus East is not successful in obtaining all of the funding
necessary to complete the construction of the new facility, it would lose the
approximately $33,813,000 spent to date, including the $32,631,000 for the
deposit on the land use rights which is non-refundable.


43





However,
the ability of Lotus East to raise any significant capital to expand their
operations is very limited. We believe that it is in our best long term
interests to assist Lotus East in their growth plans. Accordingly, it is likely
that we will seek to raise working capital not only for our operating expense
but to provide capital to Lotus East for these projects as well as providing
working capital necessary for its ongoing operations and obligations. No
assurances can be given that we will be successful in obtaining additional
capital, or that such capital will be available in terms acceptable to our
company, particularly given the current conditions in the capital markets. If we
are unable to raise capital as necessary for our operations, and we were no
longer able to timely file our reports with the Securities and Exchange
Commission, our common stock would be removed from quotation on the OTC Bulletin
Board. In this event, the ability of our stockholders to liquidate their
investment in our company would be adversely impacted and it is possible that an
event of default would occur under various agreements we are a party to with the
purchases of our Series A Convertible Redeemable Preferred Stock and common
stock purchase warrants.





Contractual
Obligations and Off-Balance Sheet Arrangements




Contractual
Obligations




We have
certain fixed contractual obligations and commitments that include future
estimated payments. Changes in our business needs, cancellation provisions,
changing interest rates, and other factors may result in actual payments
differing from the estimates. We cannot provide certainty regarding the timing
and amounts of payments. We have presented below a summary of the most
significant assumptions used in our determination of amounts presented in the
tables, in order to assist in the review of this information within the context
of our consolidated financial position, results of operations, and cash flows.
The total of contractual obligations and commitments does not include any
payments made by us.




The
following tables summarize our contractual obligations as of December 31, 2008,
and the effect these obligations are expected to have on our liquidity and cash
flows in future periods.







Payments
      Due by PeriodTotal
                                                  
                                                  Less than
                                                    1
      year
                                                  
                                                  1-3
                                                    Years
                                                  
                                                  3-5
                                                    Years
                                                  
                                                  5 Years
+Contractual Obligations:Series
      A convertible redeemable preferred stock
                                                  
                                                  $
                                                  5,466,667
                                                  
                                                  
                                                  $
                                                  5,400,000
                                                  
                                                  
                                                  $
                                                  66,667
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -Related
      Parties Indebtedness
                                                  
                                                  
                                                  6,106,901
                                                  
                                                  
                                                  
                                                  525,225
                                                  
                                                  
                                                  
                                                  525,225
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  5,056,451Patent
      Purchase Obligations
                                                  
                                                  
                                                  4,376,878
                                                  
                                                  
                                                  
                                                  1,458,959
                                                  
                                                  
                                                  
                                                  2,917,919
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Construction
      Obligations
                                                  
                                                  
                                                  58,358,379
                                                  
                                                  
                                                  
                                                  8,753,757
                                                  
                                                  
                                                  
                                                  49,604,622
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Intellectual
      Rights Purchase Obligations
                                                  
                                                  
                                                  4,960,462
                                                  
                                                  
                                                  
                                                  4,960,462
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Total
      Contractual Obligations:
                                                  
                                                  $
                                                  79,269,287
                                                  
                                                  
                                                  $
                                                  21,098,403
                                                  
                                                  
                                                  $
                                                  53,114,433
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  5,056,451





Off-balance
Sheet Arrangements





As of the
date of this report, we do not have any off-balance sheet arrangements that have
or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that are
material to investors, however we have agreed to guarantee loans for Lotus East,
if required. As of the date of this report, we have not entered into any
guarantee arrangements with Lotus East. The term "off-balance sheet arrangement"
generally means any transaction, agreement or other contractual arrangement to
which an entity unconsolidated with us is a party, under which we have: (i) any
obligation arising under a guarantee contract, derivative instrument or variable
interest; or (ii) a retained or contingent interest in assets transferred to
such entity or similar arrangement that serves as credit, liquidity or market
risk support for such assets.


44





ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not applicable to smaller
reporting
companies.





ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA.





Please see our financial statements
beginning on page F-1 of thisannual report.





ITEM
9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
ANDFINANCIAL DISCLOSURE.FINANCIAL
DISCLOSURE.





None.





ITEM 9A(T).
CONTROLS AND PROCEDURES.





Our
management does not expect that our disclosure controls or our internal controls
over financial reporting will prevent all error and fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, but no
absolute, assurance that the objectives of a control system are met. Further,
any control system reflects limitations on resources, and the benefits of a
control system must be considered relative to its costs. These limitations also
include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people or by management override of a control. A design of a control
system is also based upon certain assumptions about potential future conditions;
over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be
detected.





Evaluation of Disclosure Controlsand
Procedures





Disclosure controls and procedures refer
to controls and other procedures designed to ensure that information required to
be disclosed in the reports we file or submit under the Securities Exchange Act
is recorded, processed, summarized andreported within the time periods
specified in the rules and forms of the SEC and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required
disclosure.




As required by Rule 13a-15(e) and
15d-15(e) under the Securities Exchange Actof 1934, our management has carried out an
evaluation, with the participation and under the supervision of our Chief
Executive Officer and our
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2008.  As discussed
in more detail below, our Chief Executive Officer and our Chief Financial
Officer concluded that our disclosure controls and procedures
are ineffective as of December 31, 2008, due to material weaknesses that we
identified in internal control over financial reporting.





Report of Management on Internal Control
over Financial Reporting





Our
management
is responsible for establishing and maintaining adequateinternal control over
financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the
Securities Exchange Act. Our management is also required toassess and report on
the effectiveness ofour internal control
over financialreporting in accordance
with Section 404 of the Sarbanes-Oxley Act of 2002("Section 404").
Management assessed the effectiveness of our internal controlover financial
reporting
as of December 31, 2008. In making thisassessment,
weused the criteria set
forth by the Committee of Sponsoring Organizations of theTreadway Commission
(COSO) in Internal Control - Integrated Framework.In its assessment of the effectiveness
of internal control over financial reporting as ofDecember 31, 2008, our management
determined that the material weaknesses below existed.  A material
weakness is a deficiency, or a combination of deficiencies, in internal control
over financial reporting such that there is a reasonable possibility thatamaterial misstatement of the annual or
interim financial statements will not be prevented or detected in a timely
basis.A
significant deficiency is a deficiency, or acombination of
deficiencies, in internal control over financial reporting thatis lesssevere than a material
weakness, yet important enough to merit attentionby those responsible
for oversight of the company's financial reporting.The following material weaknesses have
been identified and included in our management’s assessment as of December 31, 2008:


45





1.
            We did not maintain effective
      control over the period-end closing process.Due to the insufficient number of
      qualified resources, we were unable to timely and accurately complete our
      work needed to close our books and prepare financialstatements in accordance with
      accounting principles generally accepted in the United States of America.
      This control deficiency resulted inasignificantnumberof audit adjustments to our 2008
      financial statements.  In addition, this control deficiency
      could result in a
      material misstatement to annual or interim financial statements that would
      not be prevented or detected.  Accordingly, management
      determined that this control deficiency constitutes a material
      weakness.





2.
            Multiple material
      adjustmentswere made
      as a result of audit procedures performed, which is a material weakness.
      Management has concluded that the controls over the period-end financial
      reporting process were not operating effectively. Specifically, controls
      were not effective to ensure that significant accounting
      estimates and other adjustments were appropriately reviewed, analyzed, and
      monitored on a timely basis.





3.
            Significant capital expenditures
      were discussed and approved at management meetings at which some directors
      of theboard of
      directors attended but no formal board approval procedure were followed,
      which is a significant
deficiency.





Remediation Measures of Material
Weaknesses





We have implemented, or plan to
implement, the measures described below under the supervision and guidance of our management to
remediate the above control deficiencies and to strengthen our internal controls
over financial reporting. Key elements of the remediation effort include, but
are not limited to, the following initiatives, which have been implemented, or are in the process of
implementation, as of the date of filing of this Annual
Report:





1.
            We have increased efforts to
      enforce internal control procedures.  We have also reorganized
      the structure of our China financial department andclarified the responsibilities of
      each key personnel in order to increase communications and
      accountability.




2.
            We have recruited and will
      continue to bring in additional qualified financial personnel for the
      accounting department to further strengthen our China financial reporting
      function.




3.
            We continually review and improve
      our standardization of our monthly and quarterly data collection,
      analysis, and reconciliation procedures. To further improve the timeliness
      of data collection, we are selecting and will install new
      point of sale systems and enterprise resource planning systems for our
      wholesale and retail
operations.




4.
            We plan on significantly
      increasing the level of communication and interaction among our China
      management, independent auditors, our directors of
      the Board, and other external
advisors..




5.
            We are in the process of searching
      for qualified internal control consultants to help us be in compliance
      with internal control obligations, including Section 404. We also
      plan to dedicate
      sufficient resources to implement required internal control
      procedures.








46


We believe that the foregoing steps will
remediate the materialweaknesses identified above, and we will
continue to monitor the effectivenessof these steps and make any changes that our management deems
appropriate. Dueto the nature of these material
weaknesses in our internal control overfinancial reporting, there is more than
a remote likelihood that misstatementswhich could be material to our annual or
interimfinancial
statements couldoccur that would not be prevented or
detected.





Because of its inherent limitations,
internal control over financialreporting may not prevent or detect
misstatements. Projections of any evaluationof effectiveness to future
periods are subject to the
risk that controls maybecome inadequate because of changes in
conditions, or that the degree ofcompliance with the policies and
procedures may deteriorate.





Auditor Attestation





This annual report does not include an
attestationreport of
ourregistered public accounting firm
regarding internal control over financialreporting. Management's report was not
subject to attestation by our registeredpublic accounting firm pursuant to
temporary rules of the Securities andExchange Commission that permit us to provide only
management's report in thisannual report.





Changes in Internal Control over
Financial Reporting





Except as described
above,there have been no changes in our
internal control over financialreporting during our fourthfiscal quarter that has materially
affected, or isreasonably likely to materially affect,
our internal control over financialreporting.





ITEM 9B. OTHER
INFORMATION.





None.




PART
III





ITEM 10.
DIRECTORS, EXECUTIVEOFFICERS AND CORPORATE
GOVERNANCE





DIRECTORS AND EXECUTIVE
OFFICERS





The following individuals serve as our
executive officers and membersof our Board of
Directors:





Name
                
                Age
                
                Positions
    held:Dr. Liu Zhong
      Yi
                
                48
                
                Chief Executive
      Officer,President,
      and Chairman of the Board of DirectorsAdam
    Wasserman
                
                44
                
                Chief Financial
      OfficerDr. Ian
    Ashley
                
                39
                
                SecretaryMs. Li Ping
                
                47
                
                DirectorMr. Liu Jin
                
                72
                
                DirectorMs. Xian
    Xuemei
                
                39
                
                DirectorMrs. Song
      Zhenghong
                
                42
                
                Director





DR. LIU ZHONG YI. Dr. Lui has served
asChairman of the Board and
ChiefExecutive Officer of Lotus since
September 2006 and he has also served in thosepositions at Lotus International since
founding that company in
August 2006. Dr.Liu is also the Chairman, Deputy Chief
Physician and founder of Liang Fang andfounder and General Manager of En Zhe
Jia Shi.. As a researcher and medicalstudent, Dr. Liu excelled in the
development of many new drugs in wide use inChina today. While working for the
Chinese Government in 1992, he establishedthe Research Center of Space Flight
Biological Engineering Technology, andcontinued his renowned research related
to incretion diseases. Four years later,entering the privatesector and invigorated by burgeoning
capitalism in China,Dr. Liu started his first pharmaceutical
company in Beijing. He earned hisMaster's Degree in
Endocrinology from Beijing Xiehe Medical School,after doing his undergraduate studies
inInner Mongolia Medicine College in Inner Mongolia,
China He is a majoritystockholder in each of Liang Fang and En
Zhe Jia and the spouse of Mrs. SongZhenghong.


47





ADAM WASSERMAN. Mr. Wasserman has served
as Chief Financial Officer forLotus since October 2006under the terms of the consulting
agreement with hisfirm, CFO Oncall, Inc. Mr. Wasserman
devotes approximately 20% of his time toour company. Since November 1999, Mr.
Wasserman has been CEO of CFO Oncall,Inc., a Weston, Florida based provider
of consultant accounting
servicesspecializing in financial reporting,
budgeting and planning, mergers and acquisitions, audit preparation
services, accounting, automated systems, bankingrelations and internal controls. Mr.
Wasserman has also served as the chieffinancial officer of Transax International
Limited since May 2005, Gold Horse International, Inc. since July 2007 and
China Wind Systems, Inc. since March2008. Mr. Wasserman has also served as
the chief financial officer ofExplorations Group Inc. (January2002 until December 2005)
Colmena Corp. (May2003 until June 2004) and Genesis
Pharmaceuticals Enterprises, Inc. (October2001 until October 2007), all client
companies of CFO Oncall, Inc. From June1991 to November 1999 he was Senior
Audit Manager at American
Express Tax andBusiness Services, in Fort Lauderdale,
Florida where his responsibilitiesincluded supervising, training and
evaluating senior staff members, work paperreview, auditing, maintaining positive
client relations, preparation of taxreturns and preparation of financial
statements and the related footnotes. FromSeptember 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, managementconsulting, systems design, staff
instruction, and recruiting. Mr. Wassermanholds a Bachelor of Administration from
the State University of New York atAlbany. He is a CPA (New York) and a
member of The American
Institute ofCertified Public Accountants and is a
director, the treasurer and an executiveboard member of Gold Coast Venture
Capital Association.





DR. IAN ASHLEY. Dr. Ashley has been a
member of our Board of Directorssince September 2006 anda member of Lotus International's Board
of Directorssince August 2006. Previously he worked
for Merck & Co in 1990 in Researchand Development with focus on
hypertension and calcium channel blockers. He isABEM Board Certified in Emergency
Medicine afterfinishing a
residency inEmergency Medicine at Loma Linda
University Medical Center in SouthernCalifornia. Since 2002, Dr. Ashley has
served as Attending Physician atProvidence Hospital in Waco, Texas. Dr.
Ashley graduated Summa Cum Laude withdegrees in Chemistry and Biochemistry from
Oberlin College before graduatingfrom Baylor College of Medicine in
Houston, Texas in 1996.





MS.LI PING. Ms. Li has been a member of our
Board of Directors sinceSeptember 2006 and a member of Lotus
International's Board of
Directors sinceAugust 2006. Ms. Li served as salesman
and deputy manager of the salesdepartment of Beijing Dongcheng Medicine
Wholesale Company from 1984 to 1999.Since 2000, she served as director of
Liang Fang and is responsible for medicineand clinic promotions. Ms. Li graduated
from the Beijing Medical School,apothecary.





LIU JIN. Mr. Liu has been a member of
our Board of Directors sinceSeptember 2006 and a member of Lotus
International's Board of Directors sinceAugust 2006.Mr. Liu served as an accountant for the
Finance Bureau ofLiangcheng County from 1958 to1970 and
the as accountant and accountant generalfor Finance Bureau of Chayouqiqnqi of
Inner Mongolia. Since 2000, Mr. Liu hasserved as a director of Liang Fang and
has been responsible for
production costcontrol. Mr. Liu graduated from the
Middling Finance School of Wulanchabu Cityof Inner Mongolia in
1958.


48





XIAN XUEMEI. Ms. Xian has been a member
of our Board of Directors sinceDecember 2006. Ms. Xian served as clinical pharmacist of Chengdu
SpaceflightHospital from 1997 to 2000. Since 2001,
she has been working with Liang Fang andis responsible for medical quality
inspections. Ms. Xian graduated from theSchool of Pharmacy, West China
University of Medical
Sciences with a bachelor'sdegree in 1996 with excellent academic
results.





SONG ZHENGHONG. Mrs. Song has been a
member of our Board of Directorssince September 2006 and a member of
Lotus International's Board of Directorssince August 2006. Since 1991, Mrs. Song has been a teacher,
assistant teacherand senior teacher at Yungang Second
Middle School in Fengtai, Beijing. She is aminority stockholder in each of Liang
Fang and En Zhe Jia and the wife of Dr.Liu.





There are no family
relationships between any
of the executive officersand directors, except as set forth
above. Each director is elected at our annualmeeting of stockholders and holds office
until the next annual meeting ofstockholders, or until his successor is
elected and qualified.





COMPLIANCE WITH SECTION 16(A) OF THE
EXCHANGE ACT





Based solely upon a review of Forms 3
and 4 and amendments theretofurnished to us under Rule 16a-3(d) of
the Securities Exchange Act
during 2008and Forms 5 and
amendments thereto furnished to us withrespect to 2008, as wellas any written representation from a
reporting person that no Form 5 isrequired, we are not aware that any
officer, director or 10% or greaterstockholder failed to file on a timely
basis, as disclosed in the aforementionedForms,reports required by Section 16(a) of
the Securities Exchange Act during2008, except as follows:





·
            Dr. Liu Zhong Yi did not timely
      file on one occasion the receipt of30,000 shares of our common stock
      issued as compensation for hisservices as a
      director,





·
            Dr. Ian Ashley did not timely file
      on one occasion the receipt of30,000 shares of our common stock
      issued as compensation for hisservices as a
      director,





·
            Ms. Li Ping did not timely file on
      one occasion the receipt of30,000 shares of our common stock
      issued as
      compensation for hisservices as a
      director,





·
            Mr. Liu Jin did not timely file on
      one occasion the receipt of30,000 shares of our common stock
      issued as compensation for hisservices as a
      director,





·
            Ms. Caeli Widger did not timely
      file on one occasion
      the receipt of30,000 shares of our common stock
      issued as compensation for herservices as a
      director,





·
            Ms. Xian Xuemei did not timely
      file on one occasion the receipt of30,000 shares of our common stock
      issued as compensation for herservices as a director,
  and





·
            Mrs. Song Zhenghong did not timely
      file on one occasion the receiptof 30,000 shares of our common
      stock issued as compensation for herservices as a
      director.





These
delinquent reports have not been filed as of the date of this
report.


49





CODE OF ETHICS





On
February 1, 2006 our Board of Directors adopted a Financial Code of Ethics which
applies to our Chief Executive Officer, Chief Financial Officer and members of
our financial department. We will provide a copy, without charge, to any person
desiring a copy of the Financial Code of Ethics, by written request to 16 Cheng
Zhuang Road, Feng Tai District, Beijing 100071, People’s Republic of China.
Attention: Corporate Secretary. In addition, we have filed a copy of the
Financial Code of Ethics with the Securities and Exchange Commission as an
exhibit to this report.





COMMITTEES OF THE BOARD OF
DIRECTORS





Our Board of Directors has not
established any committees, including anAudit Committee, a Compensation
Committee or a Nominating Committee, anycommittee performing a similar function.
The functions of those committees arebeing undertaken by the entire board as
a whole.





We do not have a policy regarding the
consideration of any directorcandidates which may be recommended by
our stockholders, including
the minimumqualifications for director candidates,
nor has our Board of Directorsestablished a process for identifying
and evaluating director nominees. We havenot adopted a policy regarding the
handling of any potential recommendation ofdirector candidates by our stockholders,
including the procedures to befollowed. Our Board has not considered
or adopted any of these policies as wehave never received a recommendation
from any stockholder for any candidate toserve on our Board of Directors. Given our relative size and lack
of directorsand officers insurance coverage, we do
not anticipate that any of ourstockholders will make such a
recommendation in the near future. While therehave been no nominations of additional
directors proposed, in the
event such aproposal is made, all members of our
Board will participate in the considerationof director
nominees.





None of our directors is an "audit
committee financial expert" withinthe meaning of Item 401(e) of Regulation
S-B. Ingeneral, an "audit
committeefinancial expert" is an individual
member of the audit committee or Board ofDirectors who:





·
            understands generally accepted
      accounting principles and financialstatements,


·
            is able to assess the general
      application of such principles inconnection with accounting for
      estimates, accruals and
reserves,


·
            has experience preparing,
      auditing, analyzing or evaluatingfinancial statements comparable to
      the breadth and complexity to ourfinancial
      statements,


·
            understands internal controls
      over financial
      reporting, and


·
            understands audit committee
      functions.





Since the closing of the share exchange
with Lotus International, wehave relied upon the personal
relationships of our CEO to attract individuals toour Board of Directors. While we
would prefer that one or
more of our directorsbe an audit committee financial expert,
the individuals whom we have been ableto attract to our Board do not have the
requisite professional backgrounds. Itis our intent to expand our Board of Directors during
2009to include additionalindependent directors as well as one or
more directors who are considered auditcommittee financial experts. At that
time we intent to establish an AuditCommittee of our Board of Directors. Our
securities are not quoted on anexchange, however, that has requirements
that a majority of our Board members beindependent and we are not currently
otherwise subject to any law, rule orregulation requiring that all or any
portion of our Board of Directors include"independent" directors,nor are we required to establish or
maintain an AuditCommittee or other committee of our
Board of Directors.





ITEM 11.
EXECUTIVE COMPENSATION.


50





The following table summarizes all
compensation recorded by us in thelast completed fiscal year forour principal executive
officer, each otherexecutive officer serving as such whose
annual compensation exceeded $100,000,and up to two additional individuals for
whom disclosure would have been made inthis table but for the fact that the
individual wasnot serving
as an executiveofficer ofour company at December 31,
2008. The value
attributable to anyoption awards is computed in accordance
with FAS 123R.





SUMMARY COMPENSATION
  TABLEName
      and principal position
                                    (a)
                                  Year
                                    (b)
                                  Salary
                                    ($)
                                    (c)
                                  Bonus
                                    ($)
                                    (d)
                                  Stock
                                    Awards
                                    ($)
                                    (e)
                                  Option
                                    Awards
                                    ($)
                                    (f)
                                  Non-Equity
      Incentive Plan Compensation ($)
                                    (g)
                                  Nonqualified
      Deferred Compensation Earnings ($)
                                    (h)
                                  All
                                    Other
      Compensation
                                    ($)
                                    (i)
                                  Total
                                    ($)
                                    (j)Liu Zhong Yi(1)
                                  2008
                                    2007
                                  180,000
                                    150,000
                                  0
                                    0
                                  0
                                    0
                                  0
                                    0
                                  0
                                    0
                                  0
                                    0
                                  0
                                    50,000
                                  180,000
                                    200,000Adam
      Wasserman (2)
                                  2008
                                    2007
                                  50,000
                                    50,000
                                  0
                                    0
                                  0
                                    0
                                  0
                                    0
                                  0
                                    0
                                  0
                                    0
                                  70,000
                                    44,200
                                  120,000
                                    94,200





(1) Dr. Liu has served as our Chief
Executive Officer and President sinceSeptember 28, 2006.Dr. Liu’s othercompensation for 2008 and 2007 was $0 and $50,000,
respectively. Dr. Liu’s other compensation includes fees paid
for his car allowance and personal expenses.Compensation amounts reflected for
Dr.Liu for each of 2007and 2008exclude anypayments to himfor his services as a director orpursuant to the
termsof the assignment agreement entered into
between Dr. Liu and Lotus East inOctober 2006 in conjunction with the
loan agreement and contract with Wu Lan ChaBu Emergency Hospital. SeeDirector Compensation below andItem 13. Certain
Relationships and RelatedTransactions,and Director
Independence.





(2)
Compensation for Adam Wasserman was paid to CFO Oncall, Inc., a company where
Mr. Wasserman serves as chief executive officer.





HOW DR.LIU'S COMPENSATION IS
DETERMINED





We currently have no employment
agreements with any of our executiveofficers, nor any compensatory plans or
arrangements resulting from theresignation, retirement or any other
termination of any of our executiveofficers, from a change-in-control, or
from a change in any executive officer'sresponsibilities following a
change-in-control. Aportion ofcompensation
paid to Dr. Liuas reflected in the foregoing table is
paid by Lotus East. Dr. Liu is theprincipalowner of the Lotus East companies and
the amount of compensation paidto him is within his sole
discretion.





OUTSTANDING EQUITY AWARDS AT FISCAL YEAR
END





The following table provides information
concerning unexercisedoptions, stock that has not vested and
equity incentive plan awards for eachnamed executive officer outstanding as of December 31,
2008:





OPTION
      AWARDS
                                STOCK
      AWARDSName
                                Number
      of securities underlying unexercised options(#)
exercisable
                                Number
      of securities underlying unexercised options(#)
    unexercisable
                                Equity
      incentive plan awards: Number of securities underlying unexercised
      unearned options(#)
                                Option
      exercise price($)
                                Option
      expiration date
                                Number
      of shares or units of stock that have not vested (#)
                                Market
      value of shares or units of stock that have not vested ($)
                                Equity
      incentive plan awards: Number of unearned shares, units or other rights
      that have not vested (#)
                                Equity
      incentive plan awards: Market or payout value of unearned shares, units or
      other rights that have not vested (#)(a)
                                (b)
                                (c)
                                (d)
                                (e)
                                (f)
                                (g)
                                (h)
                                (i)
                                (j)Dr.
      Liu Zhong
      Yi
                                0
                                0
                                0
                                0
                                0
                                0
                                0
                                0
                                0Adam
                                  Wasserman
                                0
                                0
                                0
                                0
                                0
                                0
                                0
                                0
                                0





51


DIRECTOR COMPENSATION





The following table provides information
concerning the compensation ofmembers of our Board of Directors for
each of their services as a
directorfor2008. The value attributable to any option
awards is computed in accordance with


FAS 123R.





Director
      CompensationName
                      Fees
      earned or paid in cash ($)
                      Stock
      awards ($)
                      Option
      awards ($)
                      Non-equity
      incentive plan compensation ($)
                      Nonqualified
      deferred compensation earnings ($)
                      All
      other compensation ($)
                      Total
      ($)(a)
                      (b)
                      (c)
                      (d)
                      (e)
                      (f)
                      (g)
                      (h)Liu
      Zhong Yi
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000Dr.
      Ian Ashley
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000Li
      Ping
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000Liu
      Jin
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000Caeli
      Widger
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000Xian
      Xuemei
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000Song
      Zhenghong
                      0
                      30,000
                      0
                      0
                      0
                      0
                      30,000





ITEM 12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND


RELATED STOCKHOLDER
MATTERS.





At March 31, 2009we had 43,377,932shares of common stock and5,747,118shares of Series A ConvertibleRedeemable Preferred Stock
issued andoutstanding. Each share of common stock
entitles the holder to one vote and each


of the Series A Convertible Redeemable
Preferred Stock entitles the holder to anumber of votes equal to the number of
shares into whichthe
Series AConvertible Redeemable Preferred Stock
is then convertible vote at any meetingof our stockholders. Presently, the
Series A Convertible Redeemable PreferredStock is convertible on a one for one
basis. The holders of the common stock andtheSeries A Convertible Redeemable
Preferred Stock vote together on all matterssubmitted to a vote of our stockholders,
except that they are not entitled tovote in the election of our directors.
The following table sets forthinformationknown to us as of March 31, 2009relating to the beneficialownership of shares of our voting
securities by:





·
            each person who is known by us to
      be the beneficial owner of morethan five percent of our
      outstanding voting stock;


·
            each
    director;


·
            eachnamedexecutive officer;
      and


·
            allnamedexecutive officers and directors
      as a group.





Unless otherwise indicated, the business
address of each person listedis in care of Boca Corporate Plaza, 16
Cheng Zhuang Road, Feng Tai DistrictBeijing 100071 People's Republic of
China. The percentages in
the table havebeen calculated on the basis of treating
as outstanding for a particular person,all shares of our common stock
outstanding on that date and all shares of ourcommon stock issuable to that holder in
the event of exercise of outstandingoptions, warrants, rights or conversion
privileges owned by that person at thatdate which are exercisable within 60
days of that date. Except as otherwiseindicated, the persons listed below have
sole voting and investment power withrespect to all shares of stock owned by them, except to
the extent that powermay be shared with a
spouse.


52








Amount
      and Nature of Beneficial OwnershipCommon
      Stock
                          Series
      A Convertible
                            Redeemable
      Preferred StockName
                          #
      of Shares
                          %
      of Class
                          #
      of Shares
                          %
      of Class
                          %
      of VoteDr.
      Liu Zhong Yi (1)
                          19,689,191
                          45.4%
                          0
                          n/a
                          40.1%Adam
      Wasserman (2)
                          171,490
                          *
                          0
                          n/a
                          *Dr.
      Ian Ashley
                          34,483
                          *
                          0
                          n/a
                          *Li
      Ping
                          64,483
                          *
                          0
                          n/a
                          *Liu
      Jin
                          64,483
                          *
                          0
                          n/a
                          *Caeli
      Widger
                          34,483
                          *
                          0
                          n/a
                          *Xian
      Xuemei
                          64,483
                          *
                          0
                          n/a
                          *Song
      Zhenghong
                          6,772,483
                          15.6%
                          0
                          n/a
                          13.8%All
      officers and directors as a group (nine persons) (1),
                          26,895,579
                          62.0%
                          0
                          n/a
                          54.7%





*
represents less than 1%





(1) Includes 7,500,000shares of our common stock which are
subject to the termsof the Escrow Agreement entered into in February 2008 in
conjunction with thesale our Series A Convertible Redeemable
Preferred Stock described earlier inthis annual report.





(2) Mr. Wasserman's address is 1643
Royal Grove Way, Weston, Florida 33327.





ITEM 13. CERTAIN
RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTORINDEPENDENCE.





Dr. Liu leases Lotus East a 249 square
meter retail space for no chargeon a month-to-month
basis.





On October 10, 2006, Lotus East entered
into a five-year loan agreementand contract with Wu Lan Cha Bu Emergency
Hospital whereby Lotus East agreed tolend to Wu Lan Cha Bu Emergency Hospital
approximately $4,377,000for theconstruction of a hospital ward in Inner
Mongolia, China. In exchange for theloan, Wu Lan Cha Bu Emergency
Hospital agreed that Lotus
East would be theexclusive provider for all medicines and
disposable medical treatment apparatusto it for a period of 20 years. In
October 2006, Dr. Liu Zhong Yi, our ChiefExecutive Officer and the CEO and
principal stockholder of
Lotus East, loanedthese funds to Wu Lan Cha Bu Emergency
Hospital on behalf of Lotus East.Accordingly, on October 10, 2006 Lotus
East entered into an assignment agreementwhereby it assigned all of its rights,
obligations, and receipts under the loanagreement to Dr. Liu, except for the
rights to revenues from the sale of medicaland disposable medical treatment
apparatus which will remain with Lotus East. Ascompensation to Dr. Liu for accepting
the assignment under the loan agreementincluding all ofthe risks and obligations and for Dr.
Liu not accepting therights to revenues from the sale of
medical and disposable medical treatmentapparatus which will remain with Lotus
East, Lotus East agreed to pay Dr. Liu anaggregate of approximately $1,313,000to be paid in five equal
annualinstallments of approximately
$263,000. During 2008 and 2007 Dr. Liu was paid$0 and$ 194,709, respectively,under the terms of this
agreement.Dr. Liu agreed to allow the Company
deferred the installments in 2008 to ease the burden on Company’s working capital needs.Our financial statementsas December 31, 2008 include $26,261 for
the 2008 installments which is reflected in current portion of due to related
parties in balance sheet.





In 2007, we sold $3,000,000
principal amount 14%
secured convertiblenotes in a private placement and we lent
approximately $2 million of thoseproceeds to Lotus East for working
capital. In 2008 we received net proceedsfrom the sale of shares of our Series A
Convertible Redeemable Preferred Stockof approximately $4.6 million. We usedapproximately $2,576,557 of
thoseproceeds to repay in full all of our
outstanding obligations under our 14%secured convertible notes. Of the
remaining proceeds, we lent approximately$1,600,000 to LotusEast. These loans are in the form of an
unsecured, interestfree advances for use by Lotus East in
their operations including in theirresearch and development activities. We
do not have an understanding with LotusEast regarding the repayment of the
amounts advanced to that
company.


53





DIRECTOR
INDEPENDENCE





Our Board of Directors has determined
that directors Dr.Ian Ashley, and Caeli Widger are
independent directors within The NASDAQ StockMarket's director independence standards
pursuant to Marketplace
Rule 4200.





ITEM
      14.
            PRINCIPAL ACCOUNTING FEES AND
      SERVICES.




The following table sets forth the fees
billed by our principal independent accountants for each of our last two fiscal
years for the categories of services indicated.





YearsEnded December
      31,Category
                                
                                2008
                                
                                
                                2007Audit
      Fees1
                                
                                $
                                77,000
                                
                                
                                $
                                75,000Audit Related
      Fees2
                                
                                
                                22,500
                                
                                
                                
                                17,400Tax
      Fees3
                                
                                
                                0
                                
                                
                                
                                0All Other Fees4
                                
                                
                                0
                                
                                
                                
                                0Total
                                
                                $
                                99,500
                                
                                
                                $
                                92,400







1
            Consists of fees billed for the
      auditof our annual
      financial statements, review of our Form 10-K and services that are
      normally provided by the accountant in connection with year-end statutory
      and regulatory filings or
engagements.




2
            Consists of fees billed for the
      review of our quarterlyfinancial statements, review of
      our forms 10-Q/10-QSB and 8-K and services that are normally provided by
      the accountant in connection with non year end statutory and regulatory
      filings on engagements.





3
            Consists of professional services
      rendered by a company
      aligned with our principal accountant for tax compliance, tax advice and
      tax planning.




4
            The services provided by our
      accountants within this category consisted of advice and other services
      relating to SEC matters, registration statement review, accounting issues and client
      conferences.





Our Board
of Directors has adopted a procedure for pre-approval of all fees charged by our
independent auditors.  Under the procedure, the Board approves the
engagement letter with respect to audit, tax and review services. Other fees are
subject to pre-approval by the Board, or, in the period between meetings, by a
designated member of Board. Any such approval by the designated member is
disclosed to the entire Board at the next meeting. The audit and tax fees paid
to the auditors with respect to fiscal year 2008 were pre-approved by the entire
Board of Directors.





ITEM 15. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES.


54





Exhibit
      No.
            Description2.3
            Share Exchange Agreement between
      S.E. Asia Trading Company, Inc., SEAA Stockholders and Lotus
      Pharmaceutical International, Inc. and the Lotus Pharmaceutical
      International, Inc. Stockholders dated September 6, 2006
      (1)3.1
            Certificate of Amendment effective
      December 14, 2006 (5)3.2
            Charter of S.E. Asia Trading
      Company,Inc. as
      filed with the State of Nevada (2)3.3
            Bylaws
  (2)3.4
            Certificate
      of Designation of the Relative Rights and Preferences of the Series A
      Convertible Redeemable Preferred Stock (8)4.1
            Form of Warrant
      (6)4.2
            Form of Series A Convertible
      RedeemablePreferred Stock
      Certificate (8)10.1
            Equity Pledge Agreement between
      Lotus Pharmaceutical International, Inc. and Liang Fang Pharmaceutical
      Co., Ltd. and Liang Fang’s Majority Stockholders dated
      September 6, 2006 (3)10.2
            Operating Agreement between
      Lotus Pharmaceutical
      International, Inc., and Liang Fang, Liang Fang’s Majority Stockholders dated
      September 6, 2006 (3)10.3
            Proxy Agreement between Lotus
      Pharmaceutical International, Inc., Liang Fang, and Liang Fang s Majority
      Stockholders dated September 6, 2006
    (3)10.4
            Option Agreement between Lotus
      Pharmaceutical International, Inc. and Liang Fang, Liang Fang Majority
      Stockholders dated September 6, 2006 (3)10.5
            Equity Pledge Agreement between
      Lotus Pharmaceutical International, Inc. and En Zhe Jia Shi Pharmaceutical Co., Ltd. and
      En Zhe Jia Shi’s Majority Stockholders dated
      September 6, 2006 (3)10.6
            Operating Agreement between Lotus
      Pharmaceutical International, Inc., and En Zhe Jia Shi, En Zhe Jia
      Shi’s Majority Stockholders dated
      September 6,2006
      (3)10.7
            Proxy Agreement between Lotus
      Pharmaceutical International, Inc., En Zhe Jia Shi, and En Zhe Jia
      Shi’s Majority Stockholders dated
      September 6, 2006 (3)10.8
            Option Agreement between Lotus
      Pharmaceutical International, Inc. and En Zhe Jia Shi, En Zhe Jia Shi’s Majority Stockholders dated
      September 6, 2006 (3)10.9
            Consulting Services Agreement
      between Lotus Pharmaceutical International, Inc. and Liang Fang
      Pharmaceutical Co., Ltd. dated September 6, 2006
  (3)10.10
            Consulting Services
      Agreement between
      Lotus Pharmaceutical International, Inc., En Zhe Jia Shi Pharmaceutical
      Co., Ltd. dated September 6, 2006 (3)10.11
            Letter of Resignation by Mr.
      Thomas Miller to the Board of Directors of S.E. Asia Trading Company
      (3)10.12
            General Partnership Agreement between Genesis
      Equity Partners, LLC and Liang Fang Pharmaceutical, Ltd. dated March 15,
      2006. (3)10.13
            Lease Agreement between Beijing
      Aoshikai Peace Lane Shopping Center and Liang Fang Pharmaceutical Co. Ltd.
      dated June 1, 2002. (3)10.14
            Lease Agreement between Beijing
      Aoshikai Peace Lane Shopping Center and Liang Fang Pharmaceutical Co. Ltd.
      dated June 1, 2005. (3)10.15
            Lease Agreement between Beijing
      Fengtai District Retired Officer Management Agency of General Logistics of
      P.L.A. andLiang Fang
      Pharmaceutical Co. Ltd. dated September 15, 2003.
    (3)10.16
            Lease Agreement between Beijing
      Fengtai District 2ndSanatorium of General Logistics
      of P.L.A. and Liang Fang Pharmaceutical Co. Ltd. dated April 1, 2003.
      (3)10.17
            Lease Agreement between Beijing Qiji Investment and
      Management Center and Liang Fang Pharmaceutical Co. Ltd. dated October 10,
      2005. (3)10.18
            Lease Agreement between Beijing
      South Palace Marketing Center and Liang Fang Pharmaceutical Co. Ltd. dated
      January 1, 2006. (3)10.19
            Lease Agreement between Beijing
      Xingfa Food Shop and Liang Fang Pharmaceutical Co. Ltd. dated January 1,
      2006. (3)10.20
            Lease Agreement between
      Construction and Repair Agency of Haiying Group and Liang Fang
      Pharmaceutical Co. Ltd. dated December 31, 2000.
  (3)10.21
            Lease Agreement between Liu
      Zhongyi and Liang Fang Pharmaceutical Co. Ltd. Dated December 15, 2001.
      (3)10.22
            Lease Agreement between Real
      Estate Management Agency of General Logistics of P.L.A. and Drugstore
      (Wanshou Round Branch) of Liang Fang Pharmaceutical Co.
      Ltd. dated September 1, 2004. (3)10.23
            Loan Agreement between Beijing En
      Ze Jia Shi Pharmaceutical Co., Ltd. and Liu Zhongyi dated December 31,
      2005. (3)


55





10.24
            Loan Agreement between Beijing En
      Ze Jia Shi Pharmaceutical Co.,Ltd. and Ma Zhaozhao dated
      December 31, 2005. (3)10.25
            Loan Agreement between Beijing En
      Ze Jia Shi Pharmaceutical Co., Ltd. and Song Guo an dated December 31,
      2005. (3)10.26
            Loan Agreement between Beijing En
      Ze Jia Shi Pharmaceutical Co., Ltd. and Song Zhenghong dated December 31,
      2005. (3)10.27
            Loan Agreement between Beijing En
      Ze Jia Shi Pharmaceutical Co., Ltd. and Zehng Guixin dated December 31,
      2005. (3)10.28
            Letter Agreement among S.E. Asia
      Trading Company, Inc., Lynn Management, LLC and Dynacap Holdings Limited LLC dated
      September 13, 2006. (3)10.29
            Bill of Sale between S.E. Asia
      Trading Company, Inc. and Charles Smith dated September 25, 2006.
      (3)10.30
            Loan Agreement among Beijing Liang
      Fang Pharmaceutical Co., Ltd. and Wu Lan Cha Bu Emergency Hospital (English version)
      (7)10.31
            Loan Agreement among Beijing Liang
      Fang Pharmaceutical Co., Ltd. and Wu Lan Cha Bu Emergency Hospital
      (Chinese version) (7)10.32
            Contract among Wu Lan Cha Bu
      Emergency Hospital Center and Beijing Liang Fang Pharmaceutical Co., Ltd. dated
      October 10, 2006 (English version) (7)10.33
            Contract among Wu Lan Cha Bu
      Emergency Hospital Center and Beijing Liang Fang Pharmaceutical Co., Ltd.
      dated October 10, 2006 (Chinese version) (7)10.34
            Assignment agreement
      among Beijing Liang
      Fang Pharmaceuticals Co., Ltd. and Dr. Liu Zhong Yi dated October 10, 2006
      (English version) (7)10.35
            Assignment agreement among Beijing
      Liang Fang Pharmaceuticals Co., Ltd. and Dr. Liu Zhong Yi dated October
      10, 2006 (Chinese version) (7)10.36
            Convertible
      Redeemable Preferred Share and Warrant Purchase Agreement dated February
      25, 2008 by and among Lotus Pharmaceuticals, Inc., its founders Dr. Liu
      Zhong Yi and Mrs. Song Zhenghong, and certain accredited investors
      (6)10.37
            Form
      of Escrow Agreement (6)10.38
            Form
      of Closing Escrow Agreement (6)10.39
            English
      translation of Technology Transfer Agreement dated April 25, 2008 by and
      between Bei Jing En Ze Jia Shi Pharmaceuticals LTD and Dong Guan Kai Fa
      Biologicals Medicine LTD (9)10.40
            English
      translation of Agreement dated June 3, 2008 by and between Beijing Liang
      Fang Pharmaceutical Co., Ltd., a Chinese limited liability company, and
      Cha You Qian Qi Economy Commission. (10)10.41
            Yipubishan
      New Drug Certificate and Intellectual Property Right Transfer Contract
      (12)14.1
            Lotus
      Pharmaceuticals, Inc. Code of Business Conduct and Ethics
    (11)21.1
            Subsidiaries of the company
      (7)31.1
            Rule
      13a-14(a)/ 15d-14(a) Certification of Chief Executive Officer
      ***31.2
            Rule
      13a-14(a)/ 15d-14(a) Certification of Chief Financial Officer
      *32.1
            Section
      1350 Certification of Chief Executive Officer *32.2
            Section
      1350 Certification of Chief Financial Officer
*





(1)
            Incorporated by reference from the
      Current Report on Form 8-K filed on September 7,
  2006.(2)
            Incorporated by reference from the
      registration statement on Form SB-1, SEC File No. 333-118898, filed on
      September 10, 2004, as amended.(3)
            Incorporated by reference from the
      Current Report on Form 8-K filed on October 5,
  2006.(4)
            Incorporated by reference from the
      Current Report on Form 8-K filed on November 13,
    2006.(5)
            Incorporated by reference from the
      Current Report on Form 8-K filed on December 19,
    2006.(6)
            Incorporated by reference from the
      Current Report on Form 8-K filed on February 26,
      2008.(7)
            Incorporated by reference from the
      Annual Report on Form 10-KSB for the fiscal year ended December 31,
      2006.(8)
            Incorporated by reference from the
      Current Report on Form 8-K/A as filed on February 29,
      2008.(9)
            Incorporated byreference from the Current Report
      on Form 8-K as filed onMay 30, 2008.(10)
            Incorporated by reference from the
      Current Report on Form 8-K as filed on July 17,
    2008.(11)
            Incorporated by reference from the
      Current Report on FormS-1as filed onMay 13, 2008.(12)
            Incorporated by reference from the
      Current Reporton
      Form 8-K as filed on February 18, 2009.





56


SIGNATURES





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 in the capacities and on the dates
indicated.


LOTUS PHARMACEUTICALS,
      INC.April 15, 2009
                By:
                /s/ Zhong Yi
      LiuZhong Yi Liu, Chief Executive
      Officer and Director




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





Signature
                  
                  Title
                  
                  Date/s/Liu Zhong
Yi
                  
                  Chief Executive Officer and
      Director
                  
                  April15, 2009Liu Zhong
Yi/s/ Adam
      Wasserman
                  
                  Chief Financial Officer, principal
      accounting officer
                  
                  April 15, 2009Adam
    WassermanIan
      Ashley
                  
                  Director
                  
                  April 15, 2009Ian Ashley/s/ Ms.Li Ping
                  
                  Director
                  
                  April 15, 2009Ms.Li Ping/s/ Mr.Liu Jin
                  
                  Director
                  
                  April 15, 2009Mr.Liu Jin/s/ Ms.Xian Xuemei
                  
                  Director
                  
                  April 15, 2009Ms.Xian Xuemei/s/ Ms.Song
    Zhenghong
                  
                  Director
                  
                  April 15, 2009Ms.Song
    Zhenghong





57









LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES


CONSOLIDATED
FINANCIAL STATEMENTS


December
31, 2008 and 2007











LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES


INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008 and 2007





CONTENTS




Report
      of Independent Registered Public Accounting Firm
                F-2Consolidated
      Financial Statements:Consolidated
      Balance Sheets
                F-3Consolidated
      Statements of Operations
                F-4Consolidated
      Statements of Cash Flows
                F-5Consolidated
      Statements of Shareholders’ Equity
                F-6Notes
      to Consolidated Financial Statements
                F-7
      to F-28











REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors


Lotus
Pharmaceuticals, Inc. and Subsidiaries


Beijing,
China





We have audited the accompanying
consolidated balance sheets of Lotus Pharmaceuticals, Inc. and Subsidiaries as
of December 31, 2008 and 2007 and the related consolidated statements of
operations, changes in shareholders' equity, and cash flows for the years ended
December 31, 2008 and 2007.  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 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 purposes of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit includes examining on a test basis, evidence supporting the amount 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 statement
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 Lotus
Pharmaceuticals, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the
results of their operations and their cash flows for the years ended December
31, 2008 and 2007, in conformity with accounting principles generally accepted
in the United States of America.








/s/ Sherb & Co.,
LLP


Certified Public
Accountants




New York,
New York


March 17,
2009





F-2





LOTUS PHARMACEUTICALS, INC. AND
      SUBSIDIARIESCONSOLIDATED
      BALANCE SHEETS





December
      31,2008
                        
                        
                        2007ASSETSCURRENT
      ASSETS:Cash
                        
                        $
                        1,278,808
                        
                        
                        $
                        4,557,957Accounts
      receivable, net of allowance for doubtful accounts
                        
                        
                        6,132,912
                        
                        
                        
                        20,430,827Other
      receivable
                        
                        
                        15,757
                        
                        
                        
                        -Other
      receivable-related party
                        
                        
                        2,027,954
                        
                        
                        
                        -Inventories,
      net of reserve for obsolete inventory
                        
                        
                        3,787,802
                        
                        
                        
                        3,410,739Prepaid
      expenses and other assets
                        
                        
                        121,274
                        
                        
                        
                        1,009,382Deferred
      debt costs
                        
                        
                        398,067
                        
                        
                        
                        29,340Total
      Current Assets
                        
                        
                        13,762,574
                        
                        
                        
                        29,438,245PROPERTY
      AND EQUIPMENT - Net
                        
                        
                        7,554,817
                        
                        
                        
                        6,169,966OTHER
      ASSETSDeposit
      on patent license
                        
                        
                        2,917,919
                        
                        
                        
                        -Installments
      on intangible assets
                        
                        
                        38,175,134
                        
                        
                        
                        -Intangible
      assets, net of accumulated amortization
                        
                        
                        1,231,730
                        
                        
                        
                        1,291,322Deferred
      debt costs
                        
                        
                        66,344
                        
                        
                        
                        -Total
      Assets
                        
                        $
                        63,708,518
                        
                        
                        $
                        36,899,533LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Convertible
      debt, net of debt discount
                        
                        $
                        -
                        
                        
                        $
                        2,561,645Accounts
      payable and accrued expenses
                        
                        
                        2,170,165
                        
                        
                        
                        764,491Taxes
      Payable
                        
                        
                        5,015,908
                        
                        
                        
                        572,200Advances
      from customers
                        
                        
                        -
                        
                        
                        
                        34,531Unearned
      revenue
                        
                        
                        565,629
                        
                        
                        
                        530,063Due
      to related parties
                        
                        
                        1,588,689
                        
                        
                        
                        323,178Total
      Current Liabilities
                        
                        
                        9,340,391
                        
                        
                        
                        4,786,108LONG-TERM
      LIABILITIES:Due
      to related parties
                        
                        
                        525,225
                        
                        
                        
                        738,300Notes
      payable - related parties
                        
                        
                        5,056,451
                        
                        
                        
                        4,738,508Series
      A convertible redeemable preferred stock, $.001 par value; 10,000,000
      sharesauthorized;
      5,747,118 and -0- shares issued and outstanding at December 31,
      2008and
      2007, respectively, net
                        
                        
                        3,652,341
                        
                        
                        
                        -Total
      Liabilities
                        
                        
                        18,574,408
                        
                        
                        
                        10,262,916SHAREHOLDERS'
      EQUITY:Common
      stock ($.001 par value; 200,000,000 shares authorized;42,420,239
      and 41,794,200 shares issued and outstandingat
      December 31, 2008 and 2007, respectively)
                        
                        
                        42,420
                        
                        
                        
                        41,794Additional
      paid-in capital
                        
                        
                        11,554,381
                        
                        
                        
                        8,095,848Statutory
      reserves
                        
                        
                        3,750,529
                        
                        
                        
                        2,161,505Retained
      earnings
                        
                        
                        25,557,537
                        
                        
                        
                        14,355,913Other
      comprehensive gain - cumulative foreign currency translation
      adjustment
                        
                        
                        4,229,243
                        
                        
                        
                        1,981,557Total
      Shareholders' Equity
                        
                        
                        45,134,110
                        
                        
                        
                        26,636,617Total
      Liabilities and Shareholders' Equity
                        
                        $
                        63,708,518
                        
                        
                        $
                        36,899,533





See
      notes to consolidated financial
statements





F-3





LOTUS
      PHARMACEUTICALS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF OPERATIONS





For
      the Years EndedDecember
      31,2008
                  
                  
                  2007NET
      REVENUES:Wholesale
                  
                  $
                  65,264,281
                  
                  
                  $
                  41,651,106Retail
                  
                  
                  2,837,257
                  
                  
                  
                  3,471,960Other
      revenues
                  
                  
                  5,701,491
                  
                  
                  
                  11,750,049Total
      Net Revenues
                  
                  
                  73,803,029
                  
                  
                  
                  56,873,115COST
      OF SALES
                  
                  
                  40,440,088
                  
                  
                  
                  33,678,963GROSS
      PROFIT
                  
                  
                  33,362,941
                  
                  
                  
                  23,194,152OPERATING
      EXPENSES:Selling
      expenses
                  
                  
                  14,902,646
                  
                  
                  
                  6,460,206Research
      and development
                  
                  
                  1,200,194
                  
                  
                  
                  2,411,651General
      and administrative
                  
                  
                  2,190,157
                  
                  
                  
                  3,014,002Total
      Operating Expenses
                  
                  
                  18,292,997
                  
                  
                  
                  11,885,859INCOME
      FROM OPERATIONS
                  
                  
                  15,069,944
                  
                  
                  
                  11,308,293OTHER
      INCOME (EXPENSE):Forgiveness
      of business and value-added taxes
                  
                  
                  -
                  
                  
                  
                  2,160,795Debt
      issuance costs
                  
                  
                  (361,436
                  )
                  
                  
                  (205,379
                  )Registration
      rights penalty
                  
                  
                  (650
                  )
                  
                  
                  (110,000
                  )Interest
      income
                  
                  
                  12,626
                  
                  
                  
                  102,154Interest
      expense
                  
                  
                  (1,929,836
                  )
                  
                  
                  (2,038,735
                  )Total
      Other Income (Expense)
                  
                  
                  (2,279,296
                  )
                  
                  
                  (91,165
                  )INCOME
      BEFORE INCOME TAXES
                  
                  
                  12,790,648
                  
                  
                  
                  11,217,128INCOME
      TAXES
                  
                  
                  -
                  
                  
                  
                  -NET
      INCOME
                  
                  $
                  12,790,648
                  
                  
                  $
                  11,217,128COMPREHENSIVE
      INCOME:NET
      INCOME
                  
                  
                  12,790,648
                  
                  
                  
                  11,217,128OTHER
      COMPREHENSIVE INCOME:Unrealized
      foreign currency translation gain
                  
                  
                  2,247,686
                  
                  
                  
                  1,480,352COMPREHENSIVE
      INCOME
                  
                  $
                  15,038,334
                  
                  
                  $
                  12,697,480NET
      INCOME PER COMMON SHARE:Basic
                  
                  $
                  0.30
                  
                  
                  $
                  0.27Diluted
                  
                  $
                  0.27
                  
                  
                  $
                  0.26WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:Basic
                  
                  
                  42,307,762
                  
                  
                  
                  41,417,434Diluted
                  
                  
                  48,054,880
                  
                  
                  
                  43,861,106





See
      notes to consolidated financial
statements





F-4





LOTUS
      PHARMACEUTICALS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWS





For
      the Years EndedDecember
      31,2008
                  
                  
                  2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                  
                  $
                  12,790,648
                  
                  
                  $
                  11,217,128Adjustments
      to reconcile net income from operations to net cashprovided
      by (used in) operating activities:Depreciation
      and amortization
                  
                  
                  634,347
                  
                  
                  
                  564,607Amortization
      of deferred debt issuance costs
                  
                  
                  361,062
                  
                  
                  
                  205,379Interest
      expense
                  
                  
                  1,170,959
                  
                  
                  
                  1,458,484Amortization
      of prepaid expense attributable to warrants
                  
                  
                  163,338
                  
                  
                  
                  -Stock
      based compensation
                  
                  
                  318,551
                  
                  
                  
                  284,200Warrant
      repricing
                  
                  
                  74,593
                  
                  
                  
                  -(Decrease)
      increase in allowance for doubtful accounts
                  
                  
                  (575,781
                  )
                  
                  
                  (2,385,354
                  )Forgiveness
      of income and value-added taxes
                  
                  
                  -
                  
                  
                  
                  (2,160,795
                  )Changes
      in assets and liabilities:Accounts
      receivable
                  
                  
                  16,001,384
                  
                  
                  
                  (9,764,076
                  )Inventories
                  
                  
                  (145,910
                  )
                  
                  
                  (58,942
                  )Prepaid
      expenses and other current assets
                  
                  
                  939,654
                  
                  
                  
                  (714,013
                  )Accounts
      payable and accrued expenses
                  
                  
                  1,360,568
                  
                  
                  
                  27,266Taxes
      payable
                  
                  
                  4,336,947
                  
                  
                  
                  608,526Unearned
      revenue
                  
                  
                  -
                  
                  
                  
                  71,402Advances
      from customers
                  
                  
                  (36,276
                  )
                  
                  
                  (204,267
                  )NET
      CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
                  
                  
                  37,394,084
                  
                  
                  
                  (850,455
                  )CASH
      FLOWS FROM INVESTING ACTIVITIES:Deposit
      on patent right
                  
                  
                  (2,872,635
                  )
                  
                  
                  -Installment
      on intangible assets
                  
                  
                  (37,582,678
                  )
                  
                  
                  -Purchase
      of intangible asset
                  
                  
                  (7,756
                  )
                  
                  
                  -Purchase
      of property and equipment
                  
                  
                  (1,438,419
                  )
                  
                  
                  (381,772
                  )NET
      CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
                  
                  
                  (41,901,488
                  )
                  
                  
                  (381,772
                  )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      proceeds (payments) from convertible debt
                  
                  
                  (2,520,000
                  )
                  
                  
                  2,950,000Proceeds
      from sale of convertible redeemable peferred stocks
                  
                  
                  5,000,000
                  
                  
                  
                  -Payment
      of debt issuance costs
                  
                  
                  (468,568
                  )
                  
                  
                  (231,526
                  )Proceeds
      from related party advances
                  
                  
                  965,986
                  
                  
                  
                  1,061,009Repayments
      of related party advances
                  
                  
                  (1,996,481
                  )
                  
                  
                  (816,732
                  )Repayments
      of notes payable - related parties
                  
                  
                  -
                  
                  
                  
                  509,351NET
      CASH PROVIDED BY  FINANCING ACTIVITIES
                  
                  
                  980,937
                  
                  
                  
                  3,472,102EFFECT OF EXCHANGE RATE ON
      CASH
                  
                  
                  247,318
                  
                  
                  
                  228,926NET
      (DECREASE) INCREASE IN CASH
                  
                  
                  (3,279,149
                  )
                  
                  
                  2,468,801CASH  -
      beginning of year
                  
                  
                  4,557,957
                  
                  
                  
                  2,089,156CASH
      - end of year
                  
                  $
                  1,278,808
                  
                  
                  $
                  4,557,957SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW  INFORMATION:Cash
      paid for:Interest
                  
                  $
                  103,250
                  
                  
                  $
                  477,001Income
      taxes
                  
                  $
                  -
                  
                  
                  $
                  -Non-cash
      investing and financing activities:Warrants
      issued for prepaid financing costs
                  
                  $
                  327,565
                  
                  
                  $
                  -Warrants
      issued for consulting
                  
                  $
                  178,187
                  
                  
                  $
                  -Common
      stock issued for compensation
                  
                  $
                  318,551
                  
                  
                  $
                  -Common
      stock issued for conversion of convertible debt
                  
                  $
                  250,000
                  
                  
                  $
                  230,000Debt
      discount for grant of warrants and beneficial conversion
      feature
                  
                  $
                  2,310,263
                  
                  
                  $
                  1,616,839Due
      from related party offset against note payable-related
    parties
                  
                  $
                  -
                  
                  
                  $
                  813,650





See
      notes to consolidated financial
statements.





F-5





LOTUS
      PHARMACEUTICALS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF SHAREHOLDERS'
      EQUITYFor
      the Years Ended December 31, 2008 and
2007





Common
      Stock, $.001 Par Value
                        
                        
                        Additional
                        
                        
                        
                        
                        
                        
                        
                        
                        Other
                        
                        
                        TotalNumber
      of
                        
                        
                        
                        
                        
                        Paid-in
                        
                        
                        Retained
                        
                        
                        Statutory
                        
                        
                        Comprehensive
                        
                        
                        Shareholders'Shares
                        
                        
                        Amount
                        
                        
                        Capital
                        
                        
                        Earnings
                        
                        
                        Reserves
                        
                        
                        Income
                        
                        
                        EquityBalance,
      December 31, 2006
                        
                        
                        41,280,000
                        
                        
                        
                        41,280
                        
                        
                        
                        5,965,323
                        
                        
                        
                        4,530,360
                        
                        
                        
                        769,930
                        
                        
                        
                        501,205
                        
                        
                        
                        11,808,098Discount
      on convertible debt
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,616,839
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,616,839Common
      stock issued for services
                        
                        
                        284,200
                        
                        
                        
                        284
                        
                        
                        
                        283,916
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        284,200Common
      stock issued for conversion of convertible debt
                        
                        
                        230,000
                        
                        
                        
                        230
                        
                        
                        
                        229,770
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        230,000Appropriation
      to statutory reserve
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1,391,575
                        )
                        
                        
                        1,391,575
                        
                        
                        
                        -
                        
                        
                        
                        -Comprehensive
      income:Net
      income for the year
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        11,217,128
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        11,217,128Foreign
      currency translation adjustment
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,480,352
                        
                        
                        
                        1,480,352Total
      comprehensive income
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        12,697,480Balance,
      December 31, 2007
                        
                        
                        41,794,200
                        
                        
                        
                        41,794
                        
                        
                        
                        8,095,848
                        
                        
                        
                        14,355,913
                        
                        
                        
                        2,161,505
                        
                        
                        
                        1,981,557
                        
                        
                        
                        26,636,617Issuance
      of Series A convertible redeemable preferred stock
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,637,828
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,637,828Warrants
      issued for consulting expense
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        178,187
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        178,187Common
      stock issued for services
                        
                        
                        366,962
                        
                        
                        
                        367
                        
                        
                        
                        318,184
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        318,551Common
      stock issued for conversion of convertible debt
                        
                        
                        250,000
                        
                        
                        
                        250
                        
                        
                        
                        249,750
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        250,000Common
      stock issued for warrants exercised
                        
                        
                        9,077
                        
                        
                        
                        9
                        
                        
                        
                        (9
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Warrants
      repricing
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        74,593
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        74,593Appropriation
      to statutory reserve
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1,589,024
                        )
                        
                        
                        1,589,024
                        
                        
                        
                        -
                        
                        
                        
                        -Comprehensive
      income:Net
      income for the year
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        12,790,648
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        12,790,648Foreign
      currency translation adjustment
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,247,686
                        
                        
                        
                        2,247,686Total
      comprehensive income
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        15,038,334Balance,
      December 31, 2008
                        
                        
                        42,420,239
                        
                        
                        
                        42,420
                        
                        
                        
                        11,554,381
                        
                        
                        
                        25,557,537
                        
                        
                        
                        3,750,529
                        
                        
                        
                        4,229,243
                        
                        
                        
                        45,134,110





See
      notes to consolidated financial
statements





F-6


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007


NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





Lotus Pharmaceuticals, Inc.
(“Lotus”or the “Company”), formerly S.E. Asia Trading Company,
Inc. (“SEAA”), was incorporated on January 28, 2004
under the laws of the State of Nevada. SEAA operated as a retailer of jewelry, framed art
and home accessories. In December 2006, SEAA changed its name to Lotus
Pharmaceuticals, Inc.




On September 6, 2006, the Company
entered into a definitive Share Exchange Agreement with Lotus Pharmaceutical
International, Inc.
(“Lotus
International”), whereby
the Company acquired all of the outstanding common stock of Lotus
International in exchange for newly-issued stock of the Company to Lotus
International’s shareholders. On September 28, 2006
(the closing date),Lotus International became a
wholly-owned subsidiary of the Company and Lotus International’s shareholders became the owners of the
majority of the Company’s voting stock. The acquisition of Lotus
International by the Company was accounted for as a reversemerger because on a post-merger basis,
the former shareholders of Lotus International hold a majority of the
outstanding common stock of the Company on a voting and fully-diluted basis. As
a result, Lotus International is deemed to be the acquirer for
accounting purposes.




Lotus International was
incorporated under the laws the State of Nevada on August 28, 2006 to develop
and market pharmaceutical products in the People’s Republic of China (“PRC”or “China”). PRC law currently has limits on
foreign ownership of
certain companies. To comply with these foreign ownership restrictions, Lotus
operates its pharmaceutical business in China through Beijing Liang Fang
Pharmaceutical Co., Ltd. (“Liang Fang”) and an affiliate of Liang Fang,
Beijing En Zhe Jia Shi Pharmaceutical Co., Ltd. (“En Zhe Jia”), both of which are pharmaceutical
companies headquartered in the PRC and organized under the laws of the PRC
(hereinafter, referred to together as “Lotus East”). Lotus International has contractual
arrangements with Lotus East and its shareholders pursuant to
which Lotus International will provide technology consulting and other general
business operation services to Lotus East. Through these contractual
arrangements, Lotus International also has the ability to
substantially influence Lotus East’s daily operations and financial
affairs, appoint its senior executives and approve all matters requiring
shareholder approval. As a result of these contractual arrangements, which
enable Lotus International to control Lotus East,Lotus International is considered
the primary beneficiary of Lotus East. Accordingly, the consolidated financial
statements include the accounts of Lotus Pharmaceuticals, Inc. and its
wholly-owned subsidiary, Lotus International and companies under its
control (Lotus East).




On September 6, 2006, Lotus
International entered into the following contractual
arrangements:




Operating
Agreement. Pursuant to the
operating agreement among Lotus, Lotus East and the shareholders of Lotus East,
(collectively “LotusEast’s Shareholders”), Lotus provides guidance and
instructions on Lotus East’s daily operations, financial management
and employment issues. The shareholders of Lotus East must designate the
candidates recommended by Lotus as their representatives on Lotus East’s Board of Directors. Lotus has the
right to appoint senior executives of Lotus East. In addition, Lotus agreed to
guarantee Lotus East’s performance under any agreements or
arrangements relating to Lotus East’s business arrangements with any
thirdparty. Lotus East, in return, agreed to
pledge its accounts receivable and all of its assets to Lotus. Moreover, Lotus
East agreed that without the prior consent of Lotus, Lotus East would not engage
in any transaction that could materially affect the assets, liabilities, rights or operations
of Lotus East, 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 rightsin favor of a third party or transfer of
any agreements relating to its business operation to any third party. The term
of this agreement is ten (10) years from September 6, 2006 and may be extended
only upon Lotus’s written confirmation prior to the
expiration of the this agreement, with the
extended term to be mutually agreed upon by the parties.





Consulting
Services Agreement.
Pursuant to the exclusive consulting services agreements between Lotus and Lotus
East, Lotus has the exclusive right to provide to Lotus East general pharmaceutical
business operations services as well as consulting services related to the
technological research and development of pharmaceutical products as well as
general business operation advice and strategic planning (the “Services”). Under this agreement, Lotus owns the
intellectual property rights developed or discovered through research and
development, in the course of providing the Services, or derived from the
provision of the Services. Lotus East is required to pay a quarterly consulting service fees in Renminbi
(“RMB”), the functional currency of the PRC,
to Lotus that is equal to Lotus East’s profits, as defined, for such quarter.
To date, no consulting fees have been paid by Lotus East.




Equity
Pledge Agreement.Under the equity pledge agreement between the
shareholders of Lotus East and Lotus, the shareholders of Lotus East pledged all
of their equity interests in Lotus East to Lotus to guarantee Lotus
East’s performance of its obligations under
the technology consulting agreement. If Lotus East or Lotus
East’s Shareholders breaches its respective
contractual obligations, Lotus, as pledgee, will be entitled to certain rights,
including the right to sell the pledged equity interests. Lotus East’s Shareholders also agreedthat upon occurrence of any event of
default, Lotus shall be granted an exclusive, irrevocable power of attorney to
take actions in the


F-7


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Organization
(continued)





place andstead of Lotus East’s Shareholders to carry out the security
provisions of the equity pledge agreement and take any action and execute any
instrument that Lotus may deem necessary or advisable to accomplish the purposes
of the equity pledge agreement. Theshareholders of Lotus East agreed not
to dispose of the pledged equity interests or take any actions that would
prejudice Lotus’interest. The equity pledge agreement
will expire two (2) years after Lotus East’s obligations under the exclusive
consultingservices agreements have been
fulfilled.




Option
Agreement.Under the option agreement between the
shareholders of Lotus East and Lotus, the shareholders of Lotus East irrevocably
granted Lotus or its designated person an exclusive option to purchase, tothe extent permitted under
PRC law, all or part of the equity interests in Lotus East for the cost of the
initial contributions to the registered capital or the minimum amount of
consideration permitted by applicable PRC law. Lotus or its designated
personhas sole discretion to decide when to
exercise the option, whether in part or in full. The term of this agreement is
10 years from September 6, 2006 and may be extended prior to its expiration by
written agreement of the parties.




Proxy
Agreement.Pursuant to the proxy agreement among Lotus
and Lotus East’s Shareholders, Lotus East’s Shareholders agreed to irrevocably
grant a person to be designated by Lotus with the right to exercise Lotus
East’s Shareholders’voting rights and their other rights,
including the attendance at and the voting of
Lotus East’s Shareholders’shares at the shareholders’meetings (or by written consent in lieu
of such meetings) in accordance with applicable laws and its Article of
Association, including but not limited to the rights to sell or transfer all or any of
his equity interests of Lotus East, and appoint and vote for the directors and
Chairman as the authorized representative of the shareholders of Lotus East. The
term of this Proxy Agreement is ten (10) years from September 6, 2006 and may be extended prior to
its expiration by written agreement of the parties.




Liang Fang is a Chinese limited
liability company and was formed under laws of the People’s Republic of China on June 21, 2000.
Liang Fang is engaged in the production, trade and retailing of
pharmaceuticals. Further, Liang Fang is focused on development of innovative
medicines and investing strategic growth to address various medical needs for
patients worldwide. Liang Fang’s operations are based in Beijing,
China.




As of September 30, 2007, Liang Fang
owns and operates 10 drug stores throughout Beijing, China. These drugstores
sell Western and traditional Chinese medicines, and medical treatment
accessories.





Liang Fang’s affiliate, En Zhe Jia is a Chinese
limited liability company
and was formed under laws of the People’s Republic of China on September 17,
1999. En Zhe Jia is the sole manufacturer for Liang Fang and maintains
facilities for the production of medicines, patented Chinese medicine, as well
as theresearch and production of other new
medicines.





As a result of the management agreements
between Lotus International and Lotus East, Lotus East was deemed to be the
acquirer of Lotus International for accounting purposes. Accordingly, the
financial statement data
presented are those of Lotus East for all periods prior to the
Company’s acquisition of Lotus
International on September 28, 2006, and the financial statements of the
consolidated companies from the acquisition date forward.




On May 29, 2007, theCompany formed a new entity, Lotus
Century Pharmaceutical (Beijing) Technology Co., Ltd. (‘‘Lotus Century’’), awholly foreign-owned
enterprise (“WFOE”) organized under the laws of the Peoples’ Republic of
China. Lotus Century is a Chinese
limited liability company
and a wholly-owned subsidiary of Lotus Pharmaceutical International, Inc. Lotus
Centuryintends to beengaged in development of
innovative medicines, medical technology consulting and outsourcing services,
and related training services.





Basisof
presentation




The consolidated financial statements
are prepared in accordance with generally accepted accounting principles in the
United States of America (“US GAAP”). The consolidated statements include
the accounts of Lotus Pharmaceuticals, Inc. and its wholly-owned subsidiaries, Lotus
and Lotus Century andvariable interest entitiesunder its control (Liang Fang and En
Zhe Jia). All significant inter-company balances and transactions have been
eliminated.





The
Company has adopted FASB Interpretation No. 46R "Consolidation of Variable
Interest Entities" ("FIN 46R"), an Interpretation of Accounting Research
Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be
consolidated by a company if that company is subject to a majority of the risk
of loss for the VIE or is entitled to receive a majority of the VIE's residual
returns. VIEs are


F-8


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Basis of
presentation(continued)





those
entities in which the Company, through contractual arrangements, bears the risks
of, and enjoys the rewards normally associated with ownership of the entities,
and therefore the Company is the primary beneficiary of these entities.As a VIE, Lotus East’s revenues are included in the Company’s total
revenues, its income from operations is consolidated with the Company’s, and the
Company’s net income includes all ofLotus East’s net
income.





Use of
estimates




The preparation of financial statements
in conformity with US GAAP requiresmanagement to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results could differ from those estimates. Significant estimates in
2008and 2007include the allowance for doubtful
accounts, the allowance for
obsolete inventory, the useful life of property and equipment and intangible
assets,fair value of
warrants and beneficial conversion features related to the convertible notes,
fair value of warrants grantedand accruals for taxes
due.





Fair
valueof
financial instruments




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





Cash and
cash equivalents




For purposes of the consolidated
statements of cash flows, the Company considers all highly liquid instruments
purchased with a maturity of three months or less and money market accounts to be cash
equivalents.The Company maintains cash
and cash equivalents with various financial institutions mainly in the PRC and
the United States. Balances in the United States are insured up to $250,000 at
each bank. Balances at financial institutions or state-owned banks within the
PRC are not covered by insurance. Non-performance by these institutions could
expose the Company to losses for amounts in excess of insured balances. At
December 31, 2008 and 2007, the Company’s China bank balances of approximately
$1,3 million and $4.5 million, respectively, are uninsured. The Company has not
experienced, nor does it anticipate, non-performance by these
institutions.





Accounts
receivable





The
Company records accounts receivable, net of an allowance for doubtful accounts
and sales returns. The Company maintains allowances for doubtful accounts for
estimated losses. The Company reviews the accounts receivable on a periodic
basis and makes general and specific allowances when there is doubt as to the
collectability of individual balances. In evaluating the collectability of
individual receivable balances, the Company considers many factors, including
the age of the balance, customer’s historical payment history, its current
credit-worthiness and current economic trends. The amount of the provision, if
any is recognized in the consolidated statement of operations within “General
and administrative expenses”. Accounts are written off after exhaustive efforts
at collection. The Company policy regarding sales returns is discussed below.
The activity in the allowance for doubtful accounts and sales returns accounts
for accounts receivable for the years ended December 31, 2008 and 2007 is as
follows:





Allowance
      for doubtful accounts
                
                
                Allowance
      for sales returns
                
                
                TotalBalance
      – December 31, 2006
                
                $
                539,627
                
                
                $
                2,297,399
                
                
                $
                2,837,026Additions
      (Reductions)
                
                
                (26,617
                )
                
                
                (2,354,720
                )
                
                
                (2,381,337
                )Foreign
      currency translation adjustments
                
                
                35,073
                
                
                
                57,321
                
                
                
                92,394Balance
      – December 31, 2007
                
                
                548,083
                
                
                
                0
                
                
                
                548,083Additions
      (Reductions)
                
                
                (575,781
                )
                
                
                0
                
                
                
                (575,781
                )Foreign
      currency translation adjustments
                
                
                27,698
                
                
                
                0
                
                
                
                27,698Balance—December
      31, 2008
                
                $
                -
                
                
                $
                -
                
                
                $
                -





F-9


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007








NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Inventories





Inventories, consisting of raw
materials,
work-in-processand
finished goods related to the Company’s products are stated at the lower
of


cost or marketutilizing themovingaverage method. An allowance is
established when management determines that certain inventories may not be
saleable. If inventory costs exceed expected market value due to obsolescence or
quantities in excess of expected demand, the Company will record reserves for the
difference between the cost and the market value. These reserves are recorded
based on estimates and reflected in cost of sales.The Company recorded an inventory
reserve of$0
and$42,554, respectively,for the year ended December 31,2008and2007.





Property and
equipment





Property and equipment are carried at
cost and are depreciated on a straight-line basis over the estimated useful
lives of the assets. The cost of repairs and maintenance is expensed 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. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”, the Company examines the possibility
of decreases in the value of fixed assets when events or changes in
circumstances reflect the fact that their recorded value
may not be recoverable.





Impairment of long-lived
assets





In accordance with Statement of
Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”, the Company periodically reviews its long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be fully recoverable. The Company
recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the
carrying amount of the asset. The amount of impairment is measured as the
difference between the asset’s estimated fair value and its book
value.The Company did not consider it necessary to record any impairment
charges during the year ended December 31, 2008 and 2007.





Income
taxes





The Company is governed by the Income
Tax Law of the People’s Republic of China and the United
States. Income taxes are accounted for under Statement of Financial Accounting
Standards No.109,
“Accounting for Income
Taxes,”which is an asset
and liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company’s financial statements or tax returns.





Earnings per
common share




Basic earnings per share is computed by
dividing net earnings by the weighted average number of shares of common stock
outstanding during the period. Diluted income 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 each period. Potentially
dilutive common shares consist of the common shares issuable upon the conversion
of convertible debt (using the if-converted
method). The following table presents a reconciliation of basic and diluted
earnings per share:





For theYearEndedDecember 31,2008
                
                
                2007Net
      income for basic and diluted earnings per share
                
                $
                12,790,648
                
                
                $
                11,217,128Weighted
      average shares outstanding – basic
                
                
                42,307,762
                
                
                
                41,417,434Effect
      of dilutive securities:Unexercised
      warrants
                
                
                —
                
                
                
                —Convertible
      debentures
                
                
                5,747,118
                
                
                
                2,443,672Weighted
      average shares outstanding– diluted
                
                
                48,054,880
                
                
                
                43,861,106Earnings
      per share – basic
                
                $
                0.30
                
                
                $
                0.27Earnings
      per share – diluted
                
                $
                0.27
                
                
                $
                0.26





F-10


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007








NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Earnings per
common share(continued)





At
December 31, 2008 and 2007, a total of 5,166,999 and 1,500,000 outstanding
warrants have not been included in the calculation of diluted earnings per
shares as the effect would be anti-dilutive. The closing market price of all
outstanding warrants of the Company on December 31, 2008 and 2007 was lower than
the exercise price of all outstanding warrants. Because of that, the Company
assumes that none of the outstanding warrants at that date would have been
exercised and therefore none were included in the computation of the diluted
earnings per share for the years of 2008 and 2007. Accordingly, the Company has
excluded any effect of outstanding warrants as their effect would be
anti-dilutive.





Revenue
recognition





Product
sales




Product
sales are generally recognized when title to the product has transferred to
customers in accordance with the terms of the sale. The Company recognizes
revenue in accordance with the Securities and Exchange Commission’s (SEC) Staff
Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial
Statements “ as amended by SAB No. 104 (together,
“SAB 104”), and Statement of Financial Accounting Standards (SFAS)
No. 48 “Revenue
Recognition When Right of Return Exists. “ SAB 104 states that
revenue should not be recognized until it is realized or realizable and earned.
In general, the Company records revenue when persuasive evidence of an
arrangement exists, services have been rendered or product delivery has
occurred, the sales price to the customer is fixed or determinable, and
collectability is reasonably assured.




SFAS No. 48 states
that revenue from sales transactions where the buyer has the right to return the
product shall be recognized at the time of sale only if the seller’s price to
the buyer is substantially fixed or determinable at the date of sale, the buyer
has paid the seller, or the buyer is obligated to pay the seller and the
obligation is not contingent on resale of the product, the buyer’s obligation to
the seller would not be changed in the event of theft or physical destruction or
damage of the product, the buyer acquiring the product for resale has economic
substance apart from that provided by the seller, the seller does not have
significant obligations for future performance to directly bring about resale of
the product by the buyer, and the amount of future returns can be
reasonably estimated.




The
Company’s net product revenues represent total product revenues less allowances
for returns.




Allowance
for returns





The
Company accounts for sales returns in accordance with Statements of Financial
Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of
Return Exists, by establishing an accrual in an amount equal to its
estimate of sales recorded for which the related products are expected to be
returned. The Company determines the estimate of the sales return accrual
primarily based on 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. In general, for
wholesale sales, the Company provides credit for product returns that are
returned six months prior to and up to six months after the product expiration
date. Upon sale, the Company estimates an allowance for future product returns.
The Company provides additional reserves for contemporaneous events that were
not known and knowable at the time of shipment. In order to reasonably estimate
future returns, the Company analyzed both quantitative and qualitative
information including, but not limited to, actual return rates, the level of
product manufactured by the





Company,
the level of product in the distribution channel, expected shelf life of the
product, current and projected product demand, the introduction of new or
generic products that may erode current demand, and general economic and
industry wide indicators. The Company also utilizes the guidance provided in
SAB 104 in establishing its return estimates. Historically, approximately
49% of our total revenues consist of sales of four principal products and
product returns from these principal products, as well as the Company’s other
products, have been immaterial.  Accordingly, based upon the Company’s
experience, it historically does not record a reserve at the time of sale and
there have been no accounting entries related to its product return policy which
have reduced its gross revenues or had any material impact on its financial
statements.





Other
revenues




Other revenues consist of (i) leasing
revenues received for the lease of retail space to various retail
merchants; (ii) advertising
revenues from the lease of counter space at the Company’s retail locations; (iii) leasing
revenue from the lease of retail space to licensed
medical


F-11


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Revenue recognition
(continued)





practitioners; (iv) revenues received by
the Company for research and development projects and lab testing jobs conducted
on behalf of third party companies, and; (v) revenues received for performing
third party contract manufacturing projects. In connection with
third-party manufacturing, the customer supplies the raw materials and we are
paid a fee for manufacturing their product and revenue is recognized at the
completion of the manufacturing job. The Company recognizes revenues from leasing of space and
advertising revenues as earned from contracting third parties. The Company
recognizes revenues upon performance of any research or lab testing jobs.
Revenues received in advance are reflected as deferred revenue on the
accompanying balance sheet. Additionally, the
Company receives income from the sale of developed drug formulas. Income from
the sale of drug formulas are recognized upon performance of all of the
Company’s obligations under the respective sales
contract and areincluded in other income on the
accompanying consolidated statement of operations.




Concentrations
of credit risk




Financial instruments which potentially
subject the Company to concentrations of credit risk consist principally of cash
and trade accountsreceivable. Substantially all of the Company’s cash is maintained with state-owned
banks within the People’s Republic of China of which no deposits
are covered by insurance. The Company has not experienced any losses in such
accounts and believes it is not exposed to any risks on its cash in
bank accounts. A significant portion of the Company’s sales are credit sales which are
primarily to customers whose ability to pay is dependent upon the industry
economics prevailing in these areas; however, concentrations of credit risk with respect to
trade accounts receivables is limited due to generally short payment terms. The
Company also performs ongoing credit evaluations of its customers to help
further reduce credit risk.





Shipping
costs





Shipping
costs are included in selling expenses and totaled $210,096 and $420,082 for the
years ended December 31, 2008 and 2007, respectively.





Advertising





Advertising
is expensed as incurred. Advertising expenses were included in selling expenses
and amounted to $181,026 and $2,602,997 for the years ended December 31, 2008
and 2007, respectively.





Research and
development





Research
and development costs are expensed as incurred. These costs primarily consist of
cost of material used and salaries paid for the development of the Company's
products and fees paid to third parties. For the years of 2008 and 2007, the
Company expensed $1,200,194 and $2,411,651 as research and development expense,
respectively, and paid for future research and development services in the
amount of $0 and $769,742 at December 31, 2008 and December 31, 2007,
respectively, which has been included in prepaid expenses on the accompanying
balance sheets. The December 31, 2007 prepaid research and development expense
has been fully expensed during the year ended December 31, 2008.





Foreign currency
translation





The
reporting currency of the Company is the U.S. dollar. The functional currency of
the Company is the local currency, the Chinese Renminbi (“RMB”). Results of
operations and cash flows are translated at average exchange rates during the
period, assets and liabilities are translated at the unified exchange rate at
the end of the period, and equity is translated at historical exchange rates.
Transaction gains and losses that arise from exchange rate fluctuations on
transactions denominated in a currency other than the functional currency are
included in the results of operations as incurred.





Asset and
liability accounts at December 31, 2008 and 2007 were translated at 6.8542 RMB
to $1.00 USD and at 7.3141RMB to $1.00 USD, respectively. Equity accounts were
stated at their historical rate. The average translation rates applied to income
statements for the years ended December 31, 2008 and 2007 were 6.96225 RMB and
7.6172 RMB to $1.00 USD, respectively.  In accordance with Statement
of Financial Accounting Standards No. 95, "Statement of Cash Flows," cash flows
from the Company's operations is calculated based upon the local currencies
using the average translation rate. As a result, amounts related to assets and
liabilities reported on the statement of cash flows will not necessarily agree
with changes in the corresponding balances on the balance
sheet.


F-12


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007








NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Accumulated
othercomprehensive
income




Accumulated
other comprehensive income consisted of unrealized gains on foreign currency
translation adjustments from the translation of financial statements from
Chinese RMB to US dollars. For the years ended December 31, 2008 and 2007,
unrealized foreign currency translation gain was $2,247,686 and $1,480,352,
respectively.





Recent
Accounting Pronouncements





In
February 2007, the FASB issued SFAS No. 159,"The Fair Value Option for Financial
Assets and Financial Liabilities, Including an Amendment of FASB Statement No.
115", under which entities will now be permitted to measure many financial
instruments and certain other assets and liabilities at fair value on an
instrument-by-instrument basis. This Statement is effective as of the beginning
of an entity's first fiscal year that begins after November 15, 2007. Early
adoption is permitted as of the beginning of a fiscal year that begins on or
before November 15, 2007, provided the entity also elects to apply the
provisions of SFAS 157. The adoption of this interpretation did not have an
impact on the Company’s financial position, results of operations, or cash
flows.





In December
2007, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 141R,“Business
Combinations”(“FAS
141R”) which
replaces FAS No. 141 and establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed,and any
non-controlling interest in the acquire. FAS 141R also provides guidance for
recognizing and measuring the goodwill acquired in the business combination and
determines what information to disclose to enable users of the financial
statements to evaluate the
nature and financial effects of the business combination. This Statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December15, 2008.
Early adoption of FAS 141R is prohibited. The Company is currently evaluating
the impact, if any, of adopting FAS 141R on its financial position and
results of operations.





In December 2007, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards No.
160, “Non-controlling
Interests in Consolidated Financial Statements”(“FAS 160”) which amends ARB 51 to establish
accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. It
clarifies that a non-controlling interest in a subsidiary is an ownership
interest in the consolidated entity that should be reported as equity in the
consolidated financial statements. In addition to the amendments to ARB51, this Statement amends FASB Statement
No. 128, Earnings per Share; so that earnings-per-share data will continue to be
calculated the same way those data were calculated before this Statement was
issued. This Statement is effective for fiscal years, andinterim periods within those fiscal
years, beginning on or after December 15, 2008. The Company is currently
evaluating the impact, if any, of adopting FAS 160 on its financial
position and results of operations.




In March 2008, the Financial Accounting
Standards Board issued
Statement of Financial Accounting Standards No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB Statement
No. 133" (FAS 161).  FAS 161 amends and expands disclosures about
derivative instruments and hedging activities. FAS 161
required qualitative disclosures about the objectives and strategies of
derivative instruments, quantitative disclosures about the fair value amounts of
and gains and losses on derivative instruments, and disclosures ofcredit-risk-related contingent features
in hedging activities. FAS 161 is effective for fiscal years beginning after
November 15, 2008 and will be effective for the Company in fiscal year 2010.
Early adoption is prohibited; however, presentation and disclosure requirements must be
retrospectively applied to comparative financial statements. The Company has not
yet determined the effect, if any, that the adoption of this standard will have
on its financial position or results of operations.





In April
2008, FASB Staff Position No. 142-3, Determination of the Useful Life of
Intangible Assets (“FSP 142-3”) was issued. This standard amends the factors
that should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under FASB Statement
No. 142, Goodwill and Other Intangible Assets. FSP 142-3 is effective for
financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those fiscal years. Early adoption is
prohibited.The
Company has not determined the impact on its financial statements of this
accounting standard.




In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement). FSP APB
14-1


F-13


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Recent
Accounting Pronouncements(continued)





clarifies
that convertible debt instruments that may be settled in cash upon either
mandatory or optional conversion (including partial cash settlement) are not
addressed by paragraph 12 of APB Opinion No. 14,Accounting for Convertible Debt and
Debt issued with Stock Purchase Warrants . Additionally, FSP APB 14-1
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim
periods within those fiscal years. We will adopt FSP APB 14-1 beginning in the
first quarter of fiscal 2010, and this standard must be applied on a
retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1
will have on our consolidated financial position and results of
operations.




In May
2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No.
162,The Hierarchy of
Generally Accepted Accounting Principles. This standard is intended to
improve financial reporting by identifying a consistent framework, or hierarchy,
for selecting accounting principles to be used in preparing financial statements
that are presented in conformity with generally accepted accounting principles
in the United States for non-governmental entities. SFAS No. 162 is effective 60
days following approval by the U.S. Securities and Exchange Commission (“SEC”)
of the Public Company Accounting Oversight Board’s amendments to AU Section
411,The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles. We do
not expect SFAS No. 162 to have a material impact on the preparation of our
consolidated financial statements.





In May
2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee
Insurance Contracts – an interpretation of FASB Statement No. 60.”  SFAS
163 requires that an insurance enterprise recognize a claim liability prior to
an event of default (insured event) when there is evidence that credit
deterioration has occurred in an insured financial obligation.  This
Statement also clarifies how Statement 60 applies to financial guarantee
insurance contracts, including the recognition and measurement to be used to
account for premium revenue and claim liabilities. Those clarifications will
increase comparability in financial reporting of financial guarantee insurance
contracts by insurance enterprises. This Statement requires expanded disclosures
about financial guarantee insurance contracts. The accounting and disclosure
requirements of the Statement will improve the quality of information provided
to users of financial statements.  SFAS 163 will be effective for financial
statements issued for fiscal years beginning after December 15, 2008.  The
Company does not expect the adoption of SFAS 163 will have a material impact on
its financial condition or results of operation.




In June 2008, the FASB
ratified
EITF07-5,
“Determining Whether an
Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”. EITF 07-5 addresses how an entity
should evaluate whether an instrument or embedded feature is indexed to its own
stock, carrying forward the guidance in EITF 01-6 and superseding
EITF 01-6. Other issues addressed in EITF 07-5 include addressing
situations where the currency of the linked instrument differs from the host
instrument and how to account for market-based employee stock options.
EITF 07-5is effective for fiscal years beginning
after December 15, 2008 and early adoption is not permitted. The Company
has evaluated this statement and estimated that it is not expected to have an
impact on its financial position and results of operations.





On June
16, 2008, the FASB issued Final Staff Position (“FSP”) No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities”
to address the question of whether instruments granted in share-based payment
transactions are participating securities prior to vesting. The FSP determines
that unvested share-based payment awards that contain rights to dividend
payments should be included in earnings per share calculations. The guidance
will be effective for fiscal years beginning after December 15, 2008. The
Company does not expect the adoption of EITF 03-6-1 will have a material impact
on its financial condition or results of operation.





On October 10, 2008, the FASB issued FSP
157-3, “Determining the
Fair Value of a Financial
Asset When the Market for That Asset Is Not Active,”which clarifies the application of SFAS
157 in a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial assetwhen the market for that financial asset
is not active. FSP 157-3 became effective on October 10, 2008, and its adoption
did not have a material impact on our financial position or
results.








F-14


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007








NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Recent
Accounting Pronouncements(continued)





In January 2009, the FASB issued FSP
EITF 99-20-1, “Amendments
to the Impairment Guidance
of EITF Issue No. 99“Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized Financial
Assets”. FSP EITF 99-20-1
changes the impairment model included within EITF 99-20 to be more consistent
with the impairment model of SFAS No. 115. FSP EITF 99-20-1 achieves this
by amending the impairment model in EITF 99-20 to remove its exclusive reliance
on “market
participant”estimates of
future cash flows used in determining fair value. Changing the cash flows used
to analyze other-than-temporary impairment from the “market participant”view to a holder’s estimate of whether there has been a
“probable”adverse change in estimated cash flows
allows companies to apply reasonable judgment in assessing whether another-than-temporary
impairment has occurred. The adoption of FSP EITF 99-20-1 did not have a
material impact on our
consolidated financial statements.





Reclassifications





Certain prior period amounts have been
reclassified to conform to the current period presentation. These
reclassifications have no effect on net income.





NOTE 2 –
ACCOUNTS
RECEIVABLE





At
December 31, 2008 and 2007, accounts receivable consisted of the
following:





2008
                
                
                2007Accounts
      receivable
                
                $
                6,132,912
                
                
                $
                20,978,910Less:
      allowance for sales returns
                
                
                -
                
                
                
                -Less:
      allowance for doubtful accounts
                
                
                -
                
                
                
                (548,083
                )$
                6,132,912
                
                
                $
                20,430,827





NOTE 3 -
INVENTORIES





At
December 31, 2008 and 2007, inventories consisted of the following:





2008
                
                
                2007Raw
      materials
                
                $
                2,884,092
                
                
                $
                2,312,111Work
      in process
                
                
                -
                
                
                
                279,759Packaging
      materials
                
                
                16,100
                
                
                
                52,967Finished
      goods
                
                
                887,610
                
                
                
                808,4563,787,802
                
                
                
                3,453,293Less:
      reserve for obsolete inventory
                
                
                -
                
                
                
                (42,554
                )$
                3,787,802
                
                
                $
                3
      ,410,739





NOTE 4 -
PROPERTY AND
EQUIPMENT





At
December 31, 2008 and 2007, property and equipment consist of the
following:





Useful
      Life
                    
                    2008
                    
                    
                    2007Office
      equipment and furniture
                    3-8
      Years
                    
                    $
                    228,673
                    
                    
                    $
                    154,488Manufacturing
      equipment
                    10
      – 15 Years
                    
                    
                    5,585,793
                    
                    
                    
                    5,032,601Building
      and building improvements
                    20
      – 40 Years
                    
                    
                    3,136,164
                    
                    
                    
                    2,938,966Construction
      in progress
                    
                    
                    
                    1,181,757
                    
                    
                    
                    —10,132,387
                    
                    
                    
                    8,126,055Less:
      accumulated depreciation
                    
                    
                    
                    (2,577,570
                    )
                    
                    
                    (1,956,089
                    )$
                    7,554,817
                    
                    
                    $
                    6,169,966











F-15


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 4 -
PROPERTY AND EQUIPMENT
(Continued)





For the
year ended December 31, 2008, construction in progress amounted to $1,181,757,
representing construction for a new manufacturing plant located in Cha Ha Er
Industrial Garden District in Inner Mongolia, China. The amount included costs
for road, electrical, sewage, heating and water pipes
constructions.




For the
years ended December 31, 2008 and 2007, depreciation expense amounted to
$482,624 and $424,135 of which $480,201 and $413,586 is included in cost of
sales, respectively.





NOTE 5 –
DEPOSIT AND
INSTALLMENT ON INTANGIBLE ASSETS




Deposit
and Installments on a Chinese Class I drug patent-Laevo-Bambutero





Pursuant
to the technology transfer agreement the Company’ entered into in April 2008
(See note 14), the Company made a deposit to acquire a Chinese Class I drug
patent. Accordingly, the Company recorded $2,917,919 as deposit on patent as of
December 31, 2008.





Also, the
Company has made an installment on the Chinese Class I drug patent to obtain the
patent according to the signed contract. Therefore, the Company recorded
$2,626,127 as installment on intangible assets as of December 31, 2008. The
Company will need to make additional installments of approximately $4,377,000 to
obtain the patent.





In
addition, we expect to incur approximately $14.5 million expenses related to our
Laevo-Bambutero drug that was recently accepted by the Chinese SFDA for clinical
trial evaluations in the next 24 to 30 months.





Installment
on Yipubishan





The
Company has made an installment on the drug Yipubishan in accordance with a new
drug certificate and intellectual property right transfer contract the Company
entered into on December 2, 2008 (See note 14). Accordingly, the Company
recorded $2,917,919 as installment on intangible assets as of December 31, 2008.
The Company will need to make additional installments of approximately
$4,960,000 to obtain the new drug certificate and intellectual property
right.





Installments
on land use right




As of
December 31, 2008, the Company paid $32,631,088 (RMB 223.66 million) for land
use rights to property in the Cha Ha Er Industrial Park ( See note 14), located
in Inner Mongolia. The amount has reflected as an installmentpayments on land use
rightsonits balance
sheet at December 31, 2008. The installment payment is non-refundable in the
event the Company decides not to construct the manufacture
facility.




NOTE 6 –
INTANGIBLE
ASSETS





The Companypurchasedmanufacturing rights for twoapproveddrugs. The manufacturing rights issued
are in connection with the Company’s products Valsartan and Brimonidine.
The manufacturing rights for Valsartan becameeffective in November 2000 and had a
life of 6.5 years, which expired in 2007. The manufacturing rights for
Brimonidine became effective on August 27, 2005 andwill expire in August 2009.





On
October 9, 2006, the Company entered into a five-year loan agreement and a
contract with Wu Lan Cha Bu Emergency Hospital (“Wu Lan”), whereby the Company
agreed to lend to Wu Lan approximately $4,377,000 for the construction of a
hospital ward in Inner Mongolia, China. In exchange for agreeing to lend to Wu
Lan the funds, Wu Lan agreed that the Company will be the exclusive provider for
all medicines and disposable medical treatment apparatus to Wu Lan for a period
of twenty (20) years. In October 2006, the Company’s chief executive officer,
Mr. Liu, lent these funds to Wu Lan on behalf of the Company. The Company
entered into an assignment agreement whereby the Company assigned all of its
rights, obligations, and receipts under the Loan Agreement to Mr. Liu,
except for the rights to revenues from the sale of medical and disposable
medical treatment apparatus which will remain with the Company. As compensation
to Mr. Liu for accepting the assignment under the loan agreement including
all of the risks and obligations and for Liu not accepting the rights to
revenues from the sale of medical and disposable medical treatment apparatus
which will remain with the Company, the Company agreed to pay Mr. Liu an
aggregate of approximately $1,313,000 in 5 equal annual installments of
approximately $263,000. Accordingly, the Company recorded an intangible asset of
approximately $1,313,000 related to exclusive rights to provide all medicines
and disposable medical treatment apparatus to Wu Lan for a period of twenty (20)
years. The Company will amortize this exclusive right over a term of 20
years.




F-16


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007







NOTE 6 –
INTANGIBLE ASSETS
(Continued)





At
December 31, 2008 and 2007, intangible assets consist of the
following:





2008
                  
                  
                  2007Manufacturing
      rights
                  
                  $
                  1,264,334
                  
                  
                  $
                  1,187,569Revenue
      rights
                  
                  
                  1,313,064
                  
                  
                  
                  1,230,500Software
                  
                  
                  10,796
                  
                  
                  
                  -2,588,194
                  
                  
                  
                  2,418,069Less:  accumulated
      amortization
                  
                  
                  (1,356,464
                  )
                  
                  
                  (1,126,747
                  )$
                  1,231,730
                  
                  
                  $
                  1,291,322




Amortization expense amounted toapproximately $151,723 and $140,472for the year ended December 31,
2008and 2007.





The projected amortization expense attributedto future periods is as
follows:




Year
      ending December 31:2009
                
                $
                127,7112010
                
                
                68,2792011
                
                
                67,3552012
                
                
                65,653Thereafter
                
                
                902,732$
                1,231,730





NOTE 7 –
RELATED PARTY
TRANSACTIONS





Notes
payable – related parties





Notes payable - related parties
consisted of the following atDecember 31, 2008and 2007:


2008
                
                
                2007Note
      to Song Guoan, father of Song Zheng Hong, director and spouse of Liu Zhong
      Yi, due on December 30, 2015 with variable annual interest at 80% of
      current bank rate (4.75% and 6.26%  at December 31, 2008 and
      2007, respectively), and unsecured
                
                $
                761,894
                
                
                $
                1,895,424Note
      to Zheng Gui Xin, employee, due on December 30, 2015 with with variable
      annual interest at 80% of current bank rate (4.75% and 6.26%  at
      December 31, 2008 and 2007, respectively), and unsecured
                
                
                1,649,354
                
                
                
                1,545,645Note
      to Ma Zhao Zhao, employee, due on December 30, 2015 with variable annual
      interest at 80% of current bank rate (4.75% and 6.26%  at
      December 31, 2008 and 2007, respectively), and unsecured
                
                
                660,562
                
                
                
                619,027Note
      to Liu Zhong Yi, officer and director, due on December 30, 2015 with
      variable annual interest at 80% of current bank rate (4.75% and
      6.26%  at December 31, 2008 and 2007, respectively), and
      unsecured
                
                
                1,406,094
                
                
                
                136,244Note
      to Song Zheng Hong, director and spouse of the Company chief executive
      officer, Liu Zhong Yi, due on December 30, 2015 with variable annual
      interest at 80% of current bank rate (4.75% and 6.26%  at
      December 31, 2008 and 2007, respectively), and unsecured
                
                
                578,547
                
                
                
                542,168Total
      notes payable – related parties, long term
                
                $
                5,056,451
                
                
                $
                4,738,508





F-17


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007








NOTE 7 –
RELATED PARTY
TRANSACTIONS (Continued)





For the
years ended December 31, 2008 and 2007, interest expense related to these
related loans amounted to $294,394 and $209,834, respectively.





Due
to related parties





Several
employees of the Company, from time to time, provided advances to the Company
for operating expenses. During the years ended December 31, 2008 and 2007, the
Company repaid approximately $0 and $118,919 of these advances, respectively. At
December 31, 2008 and 2007, the Company had a payable to these employees
amounting to $36,358 and $34,072, respectively. These advances are short-term in
nature and non-interest bearing.





The chief
executive officer of the Company and his spouse, from time to time, provided
advances to the Company for operating expenses. During the years ended December
31, 2008 and 2007, the Company repaid $0 and $561,878 of these advances,
respectively. At December 31, 2008 and 2007, the Company had a payable to the
chief executive officer and his spouse amounting to $682,178 and $0,
respectively. These advances are short-term in nature and non-interest
bearing.





On
October 9, 2006, the Company entered into a five-year loan agreement and a
contract with Wu Lan Cha Bu Emergency Hospital ("Wu Lan"), whereby the Company
agreed to lend to Wu Lan approximately $4,377,000for the construction of a
hospital ward in Inner Mongolia, China. In exchange for agreeing to lend to Wu
Lan the funds, Wu Lan agreed that the Company will be the exclusive provider for
all medicines and disposable medical treatment apparatus to Wu Lan for a period
of twenty (20) years. In October 2006, the Company's chief executive officer,
Mr. Liu, lent these funds to Wu Lan on behalf of the Company. Accordingly, the
Company entered into an assignment agreement whereby the Company assigned all of
its rights, obligations, and receipts under the Loan Agreement to Mr. Liu,
except for the rights to revenues from the sale of medical and disposable
medical treatment apparatus which will remain with the Company. As compensation
to Mr. Liu for accepting the assignment under the loan agreement including all
of the risks and obligations and for Liu not accepting the rights to revenues
from the sale of medical and disposable medical treatment apparatus which will
remain with the Company, the Company agreed to pay Mr. Liu an aggregate of
approximately $1,313,000 to be paid in 5 equal annual installments of
approximately $263,000. Accordingly, the Company recorded an intangible asset of
approximately $1,313,000 related to exclusive rights to provide all medicines
and disposable medical treatment apparatus to Wu Lan for a period of twenty (20)
years and a corresponding related party liability. For the years ended December
31, 2008 and 2007, the Company paid approximately $0 and $195,000 of this
related party liability, respectively. At December 31, 2008 and 2007, amounts
due under this assignment agreement amounted to $1,031,028 and $966,198 of which
$525,225 and $738,300 is included in long-term liabilities and has been included
in due to related parties on the accompanying balance sheets,
respectively.





At
December 31, 2008 and 2007, the Company has recorded accrued interest relating
to notes payable - related parties of
$364,350             and
$61,208, respectively, which have been included in due to related parties on the
accompanying balance sheets.





For the
year ended December 31, 2008 and 2007, a summary of activities in due to related
parties is as follows:





Assignment
      fee payable
              
              
              Working
      capital advances
              
              
              Accrued
      interest
              
              
              TotalBalance  -
      December 31, 2006
              
              $
              1,093,700
              
              
              $
              695,231
              
              
              $
              -
              
              
              $
              1,788,931Additions
              
              
              -
              
              
              
              -
              
              
              
              58,774
              
              
              
              58,774Payments
      made
              
              
              (194,709
              )
              
              
              (680,797
              )
              
              
              -
              
              
              
              (875,506
              )Foreign
      currency fluctuations
              
              
              67,207
              
              
              
              19,638
              
              
              
              2,434
              
              
              
              89,279Balance  -
      December 31, 2007
              
              
              966,198
              
              
              
              34,072
              
              
              
              61,208
              
              
              
              1,061,478Additions
              
              
              -
              
              
              
              682,179
              
              
              
              299,036
              
              
              
              981,215Payments
      made
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Foreign
      currency fluctuations
              
              
              64,830
              
              
              
              2,285
              
              
              
              4,106
              
              
              
              71,221Balance  -
      December 31, 2008
              
              $
              1,031,028
              
              
              $
              718,536
              
              
              $
              364,350
              
              
              $
              2,113,914


F-18


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 7 –
RELATED PARTY
TRANSACTIONS (Continued)





Due
from related parties





In
December 2008, in connection with the new plant facility in Cha Ha Er Industrial
Garden District in Inner Mongolia (See Note 14), the Company planned to form a
new subsidiary in Inner Mongolia. In preparation for the register capital of the
originally planned new entity, on December 25, 2008, the Company transferred
$2,027,954 to the Company’s CEO to register for the new entity. The Company
subsequently determined forming an Inner Mongolia new entity was not necessary
and the money was returned to the Company on January 5, 2009.





NOTE8-CONVERTIBLE
DEBT




The convertible debenture liability is
as follows at December 31, 2007:




Convertible debentures
      payable
                
                $
                2,770,000Less: unamortized discount on
      debentures
                
                
                (208,355)Convertible debentures,
      net
                
                $
                2,561,645





In
January 2008, the Company issued 250,000 shares of its common stock in
connection with the conversion of $250,000 of convertible debt. In February
2008, in connection with a private placement (See Note 10), the remaining
$2,520,000 of convertible debt and any unpaid interest was repaid in full. The
Company amortized the remaining $208,355 in discount on debentures in the fiscal
year ended December 31, 2008. As of December 31, 2008, the balance of the
convertible debt is $0.





NOTE 9 -
CONVERTIBLE REDEEMABLE
PREFERRED STOCKS





On
February 25, 2008, the Company entered into a Convertible Redeemable Preferred
Share and Warrant Purchase Agreement (the “Purchase Agreement”) by and among the
Company, Dr. Liu ZhongYi and Mrs. Song Zhenghong (the “Founders”), and
accredited investors (each a “Purchaser” and collectively, the “Purchasers”),
pursuant to which the Company sold to the Purchasers 5,747,118 shares of the
Company’s series A convertible redeemable preferred stock and warrants to
purchase 2,873,553 shares of the Company’s common stock, in a private placement
(the “February 2008 Private Placement”) pursuant to Regulation D under the
Securities Act of 1933, for the aggregate purchase price of $5 million (the
“Transaction”). The transaction closed on February 25, 2008 (the “Closing
Date”). Net proceeds, exclusive of expenses of the Transaction, from the sale to
the Company were $4.6 million in cash, after the Company paid fees
of approximately $469,000 in cash of which $400,000 was paid to Maxim
Group, LLC, the placement agent for the Transaction. The Company recorded the
approximately $796,000 in fees, of which $327,565 was related to value of the
warrants granted to placement agent, as a deferred debt cost and amortized
approximately $331,722 of the deferred cost during the year ended December 31,
2008. The Company has presented the convertible redeemable preferred stocks as
long term debt due to the mandatory redeemable feature of the preferred
stocks.




The
Company used $2,576,556 of the net proceeds of the Transaction to repay in full
all of its outstanding principal obligations including accrued interest under
the 14% Secured Convertible Notes due February 2008 and the Company will use the
remainder of the net proceeds for working capital and general corporate
purposes.




The
Purchase Agreement includes customary representations and warranties by each
party thereto. The following is a brief description of the terms and conditions
of the Purchase Agreement and the transactions contemplated there under that are
material to the Company:




Pursuant
to the Purchase Agreement, the Company issued to the Purchasers an aggregate of
5,747,118 shares of the Company’s series A convertible redeemable preferred
stock, par value $0.001 per share, at a price equal to $0.87 per share (the
“Preferred Shares”). Each of these Preferred Shares may be converted into one
share of the Company’s common stock, par value $0.001 per share (as adjusted for
stock splits, stock dividends, reclassification and the like). The Preferred
Shares pay an 8% dividend annually, which is payable in additional Preferred
Shares. Preferred Shares also pay any dividend paid on the common shares on an
as converted basis. For a period of 90 days after February 25, 2010, these
Preferred Shares may also be redeemed at the option of the Purchasers at the
redemption price of $0.87 per share (as adjusted for stock splits, stock
dividends, reclassification and the like), and no other capital stock of the
Company may be redeemable prior to the Preferred Shares. Holders of Preferred
Shares may not convert Preferred Shares to common shares if the conversion would
result in the holder beneficially owning more than 4.99% of the Company’s
outstanding common shares. That limitation may be waived by a holder of
Preferred Shares on not less than 61 days written notice to the Company. In
addition, the Company issued to the Purchasers warrants to purchase up to
2,873,553 shares of the Company’s common stock in the
aggregate.


F-19


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007








NOTE 9 -
CONVERTIBLE REDEEMABLE
PREFERRED STOCKS (Continued)





The
warrants have an initial exercise price of $1.20 (subject to adjustment pursuant
to the terms of the warrants). The warrants are exercisable for a period of five
(5) years from the Closing Date. Holders of the warrants may not exercise the
warrants if the exercise would result in the holder beneficially owning more
than 4.99% of the Company’s outstanding common shares. That limitation may be
waived by a holder of the warrants on not less than 61 days written notice to
the Company.





Other key
provisions of the February 2008 Private Placement:




•
            The
      Preferred Shares vote with the common stock on an as converted basis,
      except that the
              Preferred
      Shares are not entitled to vote for directors. The Company is prohibited
      from taking
              certain
      corporate actions, including, without limitation, issuing securities
      senior to the
              Preferred
      Shares, selling substantially all assets, repurchasing securities and
      declaring or paying dividends, without the approval of the holders of a
      majority of the Preferred Shares
outstanding.




•
            The
      Company agreed to undertake to file a registration statement within 60
      days following
              the
      Closing Date in order to register the maximum number of common stock
      issuable from
              conversion
      of the Preferred Shares and underlying the warrants that is allowable
      under
              applicable
      federal securities regulations. The Company is also obligated to have the
      registration statement declared effective within 120 days following the
      Closing Date. If the Company is informed by the SEC that there are no
      comments to the registration statement, then the registration statement
      must be effective within five (5) business days thereafter or on the 60th
      day after the filing date, whichever is sooner. The registration statement
      must be declared effective by the 120th day after its filing if the SEC
      has comments. Otherwise, the Company is subject to liquidated damages,
      equal to 1% of the total conversion price and exercise price for the
      common stock being registered under the registration statement, for every
      30-day period following the date that the registration statement should
      have been effective, prorated for any period less than 30 days, until
      either all of common shares registered under the registration statement
      have been sold or all such common shares may be sold in any three (3)
      month period pursuant to Rule 144 promulgated under the Securities Act,
      whichever is earlier. The Company must also pay the liquidated damages if
      sales cannot be made pursuant to the registration statement for any reason
      (excepting market conditions). The maximum amount of liquidated damages is
      $500,000.





•
            The
      Founders delivered in the aggregate 7,500,000 shares of the Company’s
      common stock owned by them (the “Escrow Shares”) to an escrow account.
      Portions of the Escrow Shares are being held in escrow subject to the
      Company meeting certain earning targets in fiscal years 2007, 2008 and
      2009. The target for 2007 was $8.5 million in net income. The target for
      2008 is 95% of $13.8 million in net income and the target for 2009 is 95%
      of $17.5 million in net income, both after eliminating the effect of
      non-cash charges associated with the Transaction and adjusting for
      differences in the exchange rate between Chinese Renminbi and US dollars
      used in the Company’s financial statements and an exchange rate of RMB
      7.30 to USD 1.00. These Escrow Shares will be transferred to the
      Purchasers if the Company does not meet the earning targets, and released
      back to the Founders if the Company does. Another portion of the Escrow
      Shares is being held in escrow subject to the Company listing on the
      NASDAQ Stock Market within 18 months following the Closing Date. These
      Escrow Shares will be transferred to the Purchasers if the listing is not
      completed within that time period, and released back to the Founders if it
      is. In addition, two-thirds of the Escrow Shares are held in escrow to
      ensure that the Purchasers receive their full redemption payments if they
      choose to redeem their Preferred Shares. Each Preferred Share may be
      redeemed for $0.87 per share (adjusted for stock splits, stock dividends,
      reclassification and the like). If a Purchaser receives less than the full
      redemption amount for each Preferred Share being redeemed, the Purchaser
      will receive a number of Escrow Shares to make up the difference, based on
      the then-current market price of the common shares. Following the end of
      the redemption period, these Escrow Shares, less those transferred to any
      Purchasers that redeemed their Preferred Shares, will be released back to
      the Founders.




In
connection with the issuance of the series A convertible redeemable
preferred stock and warrants to purchase 2,873,553 shares of the Company’s
common stock, the Company recorded a total debt discount of $ 2,310,263 to be
amortized over the term of this Purchase Agreement. For the year ended December
31, 2008, amortization of debt discount amounted to $ 962,604 and has been
included in interest expense.




F-20


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 9 -
CONVERTIBLE REDEEMABLE
PREFERRED STOCKS (Continued)





For the
year ended December 31, 2008, the Company evaluated whether or not the series A
convertible redeemable preferred stock contain embedded conversion options,
which meet the definition of derivatives under SFAS 133 “Accounting for
Derivative Instruments and Hedging Activities” and related interpretations. The
Company concluded that since the series A convertible redeemable preferred stock
had a fixed redemption price of $0.87, the convertible redeemable preferred
stock was not a derivative instrument. The Company analyzed this provision under
EITF 05-04 and therefore it qualified as equity under EITF 00-19.




The
series A convertible redeemable preferred stock is as follows at December 31,
2008:


Series
      A convertible redeemable preferred stock
                  
                  $
                  5,000,000Less:
      unamortized discount
                  
                  
                  (1,347,659)Series
      A convertible redeemable preferred stock, net
                  
                  $
                  3,652,341





NOTE 10 –
INCOME
TAXES





The
Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 requires
the recognition of deferred tax assets and liabilities for both the expected
impact of differences between the financial statements and the tax basis of
assets and liabilities, and for the expected future tax benefit to be derived
from tax losses and tax credit carryforwards. SFAS 109 additionally requires the
establishment of a valuation allowance to reflect the likelihood of realization
of deferred tax assets. Realization of deferred tax assets, including those
related to the U.S. net operating loss carryforwards, are dependent upon future
earnings, if any, of which the timing and amount are uncertain. Accordingly, the
net deferred tax asset related to the U.S. net operating loss carryforward has
been fully offset by a valuation allowance. The Company is governed by the
Income Tax Law of the People's Republic of China and the United
States.




The
components of income (loss) before income tax consist of the
following:
 
 Year
      Ended December 31,2008
                            
                            
                            2007U.S.
      Operations
                            
                            $
                            (3,099,592
                            )
                            
                            $
                            (2,801,788
                            )Chinese
      Operations
                            
                            
                            15,890,240
                            
                            
                            
                            14,018,916$
                            12,790,648
                            
                            
                            $
                            11,217,128


Under the
Income Tax Laws of PRC, Chinese companies are generally subject to an income tax
at an effective rate of 25% on income reported in the statutory financial
statements after appropriate tax adjustments. The PRC local government has
provided various incentives to companies in order to encourage economic
development. Such incentives include reduced tax rates and other measures. Since
2002, the Company has been entitled to an income tax exemption for a six-year
period and was exempted from all of its income tax in the 2008 and 2007 period.
The estimated tax savings due to the tax exemption for the years ending December
31, 2008 and 2007 amounted to approximately $3,973,000 and $4,600,000,
respectively. The net effect on earnings per share if the income tax had been
applied would decrease basic earnings per share for December 31, 2008 and 2007
to $0.21 and $0.16, respectively.





Lotus
Pharmaceuticals, Inc. was incorporated in the United States and has available
net operating losses of $2,258,217 for income tax purposes at December 31, 2008,
subject to the Internal Revenue Code Section 382, which places a limitation on
the amount of taxable income that can be offset by net operating losses after a
change in ownership. The net operating loss carries forwards for United States
income taxes, which may be available to reduce future years' taxable income.
These carry forwards will expire, if not utilize, through 2028. Management
believes that the realization of the benefits from these losses appears
uncertain due to the Company's limited operating history and continuing losses
for United States income tax purposes. Accordingly, the Company has provided a
100% valuation allowance on the deferred tax asset benefit to reduce the asset
to zero. Management will review this valuation allowance periodically and make
adjustments as warranted. The valuation allowance at December 31, 2008 and 2007
was approximately $528,000 and $246,000, respectively. The consolidated income
is earned overseas and the Company does not intend to repatriate the funds and,
in the event of repatriation there will be a tax on the repatriated
income.





The table
below summarizes the differences between the U.S. statutory federal rate and the
Company’s effective tax rate and as follows for years ended December 31, 2008
and 2007:


F-21


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 10 –
INCOME TAXES
(Continued)








2008
                  
                  
                  2007US
      Statutory rates
                  
                  
                  34.0
                  %
                  
                  
                  34.0%US
      effective rate in excess of China tax rate
                  
                  
                  (11.1
                  %)
                  
                  
                  (0.4%
                  )China
      income tax exemptions
                  
                  
                  (31.1
                  %)
                  
                  
                  (42.1%
                  )Non-deductible
      compensation, debt cost and interest expense attributable to
      warrants
                  
                  
                  4.1
                  %
                  
                  
                  5.3%US
      valuation allowance
                  
                  
                  4.1
                  %
                  
                  
                  3.2%Total
      provision for income taxes
                  
                  
                  0.0
                  %
                  
                  
                  0.0%





Deferred
tax assets and liabilities are provided for significant income and expense items
recognized in different years for tax and financial reporting purposes.
Temporary differences, which give rise to a net deferred tax asset is as
follows:





2008
              
              
              2007Tax
      benefit of net operating loss carryforward
              
              $
              768,000
              
              
              $
              246,000Valuation
      allowance
              
              
              (768,000
              )
              
              
              (246,000
              )Net
      deferred tax asset
              
              $
              -
              
              
              $
              -





After
consideration of all the evidence, both positive and negative, management has
recorded a valuation allowance at December 31, 2008 and 2007, due to the
uncertainty of realizing the deferred income tax assets related to the U.S. net
operating loss carryforward.





Beginning
January 1, 2008, the new PRC Enterprise Income Tax ("EIT") law replaced the
existing laws for PRC Domestic Enterprises ("DES") and PRC Foreign Invested
Enterprises ("FIEs"). The key changes are:


a.
            The
      new standard PRC EIT rate of 25% replaced the 33% rate currently
      applicable to both DES and FIEs, except for High Tech companies who pays a
      reduced rate of 15%; andb.
            Companies
      established before March 16, 2007 will continue to enjoy tax holiday
      treatment approved by local government for a grace period of the next 5
      years or until the tax holiday term is completed, whichever is
      sooner.





NOTE
11–TAXES
PAYABLE




Value Added Tax





The
Company is subject to value added tax ("VAT") for manufacturing products. The
applicable VAT tax rate is 17% for products sold in the PRC. The amount of VAT
liability is determined by applying the applicable tax rate to the invoiced
amount of goods sold (output VAT) less VAT paid on purchases made with the
relevant supporting invoices (input VAT). Under the commercial practice of the
PRC, the Company paid value added taxes ("VAT") based on tax invoices issued.
The tax invoices may be issued subsequent to the date on which revenue is
recognized, and there may be a considerable delay between the date on which the
revenue is recognized and the date on which the tax invoice is issued. In the
event that the PRC tax authorities dispute the date of which revenue is
recognized for tax purposes, the PRC tax office has the right to assess a
penalty, which can range from zero to five times the amount of the taxes which
are determined to be late or deficient. Accordingto the PRC tax laws, any
potential tax penalty payable on late or deficient payments of this tax could be
between zero and five times the amount of the late or deficient tax payable, and
will be expensed as a period expense if and when a determination has been made
by the taxing authorities that a penalty is due. At December 31, 2008 and 2007,
the Company accrued $5,015,908 and $572,200, respectively, of unpaid value-added
taxes.


F-22


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 12-SHAREHOLDERS’EQUITY




In
January 2008, the Company issued 250,000 shares of its common in connection with
the conversion of $250,000 of convertible debt.




In April
2008, the Company issued in aggregate 331,668 shares of restricted common stock
to the several directors, consultants and officers of the Company for services
rendered. The Company valued these common shares at the fair market value on the
date of grant at $0.87 per share or $288,551 in total. In connection with
issuance of these shares, the Company recorded prepaid stock-based expenses of
$288,551. As of December 31, 2008, the recorded stock-based expenses of $288,551
had fully amortized.




In April
2008, in connection with a cashless exercise of 60,000 warrants, the Company
issued 9,077 shares of common stock accordingly.




In
June 2008, the Company issued 35,294 shares of restricted common stock to a
consultant for services rendered to the Company. The Company valued these common
shares at the fair market value on the date of the grant at $0.85 per share or
$30,000 in total. The Company recorded stock-based compensation expenses of
$30,000 for the year ended December 31, 2008 accordingly.




In
February 2007, the Company's Board of Directors and its consenting majority
stockholders have adopted and approved an amendment to increase the number of
the Company's authorized shares of capital stock from 50,000,000 to 210,000,000
total authorized shares of capital stock. The capital stock shall consist of
200,000,000 authorized shares of Common Stock, $0.001 par value per share, and
10,000,000 authorized shares of Preferred Stock, with a par value $0.001 per
share.




In May
2007, the Company issued 74,200 shares of common stock to an officer and a
director of the Company for services rendered. The shares were issued at the
fair values at the date of the grant of $74,200 or $1.00 per share. Accordingly,
the Company recorded stock-based compensation of $74,200.




In
September 2007, the Company issued 210,000 shares of common stock to seven
directors of the Company for services rendered. The shares were issued at the
fair values at the date of the grant of $210,000 or $1.00 per share.
Accordingly, the Company recorded stock-based compensation of
$210,000.




During
the three months ended December 2007, the Company issued 230,000 shares of its
common in connection with the conversion of $230,000 of convertible
debt.





Stock
warrants




In
January, 2008, the Company granted 250,000 stock warrants to a consulting
company at an exercise price of $1.50 per share in connection with a one year
contract. The warrants are not vested until January 2009. The Company valued
these warrants utilizing the Black-Scholes options pricing model at
approximately $0.71 per warrant or $178,187 in total and recorded a prepaid
consulting expense of $178,187 for the year ended December 31 2008. Those
warrants will expire in January 2012. For the year ended December 31, 2008, the
Company recorded amortization expenses of $163,338 related to the consulting
contract.




In
connection with the preferred share financing (See Note 9), the Company granted
2,873,553 warrants to investors purchase up to 2,873,553 shares of common stock
of the Company at an exercise price of $1.21 per share. The Warrants have a term
of 5 years after the issue date of February 12, 2007. Additionally, the Company
granted 603,446 stock warrants to an investment banking firm at an exercise
price of $1.21 per share. The Company valued these warrants utilizing the
Black-Scholes options pricing model at approximately $0.54 per warrant or
$327,565 in total and recorded a deferred financing costs of $327,565. Those
warrants will expire in February 2013. Forthe year ended December 31,
2008, the Company recorded amortization expenses of $ 136,485 related to the
deferred financing costs.




On
February 25, 2008, pursuant to a Convertible Redeemable Preferred Share and
Warrant Purchase Agreement (See Note 9), the exercise price of the 1,500,000
warrants granted in February 2007 were reduced and repriced to $0.87 per share.
As a result of the repricing, the Company recorded an interest expense of
$74,593 for the year ended December, 2008.




Stock
warrants issued, terminated/forfeited and outstanding during the year ended
December 31, 2008 are as follows:


F-23


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 12-SHAREHOLDERS’EQUITY(Continued)





Shares
                
                Average
      Exercise price per share
                
                Average
      life (year)Warrants
      outstanding on December 31, 2007
                1,500,000
                
                
                0.87
                
                5.00Warrants
      issued
                3,726,999
                
                
                1.23
                
                4.93Warrants
      terminated/forfeited
                -
                
                
                -
                
                -Warrants
      exercised
                (60,000)
                
                
                0.87
                
                -Warrants
      outstanding on December 31, 2008
                5,166,999
                
                
                1.13
                
                4.95





In
connection with the debt financing , the Company granted 1,500,000 to investors
purchase up to 1,500,000 shares of common stock of the Company at an exercise
price of $1.50 per share. The Warrants have a term of 5 years after the issue
date of February 12, 2007. On February 25, 2008, pursuant to a Convertible
Redeemable Preferred Share and Warrant Purchase Agreement, the exercise prices
of these warrants were reduced to $1.20 per share.





NOTE 13 - SEGMENT
INFORMATION





The
following information is presented in accordance with SFAS No. 131, Disclosure
about Segments of an Enterprise and Related Information.  In the year
ended December 31, 2007 and 2006, the Company operated in two reportable
business segments - (1) the manufacture and distribution of pharmaceutical
products and (2) the retailing of traditional and Chinese medicines and supplies
through ten drug stores located in Beijing China and other ancillary revenues
generated from retail location such as advertising income, rental income, and
examination income. The Company's reportable segments are strategic business
units that offer different products. They are managed separately based on the
fundamental differences in their operations.




Information
with respect to these reportable business segments for the year ended December
31, 2008 and 2007 is as follows:




2008
                  
                  Wholesale
      and third-party manufacturing and examination
                  
                  Retail
      Operations
                  
                  Rent
      and Advertising
                  
                  Unallocated
                  
                  TotalNet
      Revenues
                  $
                  70,186,196
                  $
                  2,837,257
                  $
                  779,576
                  $
                  -
                  $
                  73,803,029Cost
      of Sales
                  
                  37,846,272
                  
                  2,593,816
                  
                  -
                  
                  -
                  
                  40,440,088Operating
      Expenses
                  
                  -
                  
                  -
                  
                  -
                  
                  18,292,997
                  
                  18,292,997Other
      Expense (Income)
                  
                  -
                  
                  -
                  
                  -
                  
                  2,279,296
                  
                  2,279,296Income
      Taxes
                  
                  -
                  
                  -
                  
                  -
                  
                  -
                  
                  -Net
      Income
                  $
                  32,339,924
                  $
                  243,442
                  $
                  779,576
                  $
                  (20,572,293)
                  $
                  12,790,648





F-24


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 13 - SEGMENT
INFORMATION (Continued)





2007
                
                Wholesale
      and third-party manufacturing and examination
                
                
                Retail
      Operations
                
                
                Rent
      and Advertising
                
                
                Unallocated
                
                
                TotalNet
      Revenues
                
                $
                51,940,532
                
                
                $
                3,471,960
                
                
                $
                1,460,623
                
                
                $
                -
                
                
                $
                56,873,115Cost
      of Sales
                
                
                30,901,395
                
                
                
                2,777,568
                
                
                
                -
                
                
                
                -
                
                
                
                33,678,963Operating
      Expenses
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                11,885,859
                
                
                
                11,885,859Other
      Expense (Income)
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                91,165
                
                
                
                91,165Income
      Taxes
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      Income
                
                $
                21,039,137
                
                
                $
                694,392
                
                
                $
                1,460,623
                
                
                $
                (11,977,024
                )
                
                $
                11,217,128





The Company does not allocate selling
andgeneral and administrative expenses to
its reportable segments, because these activities are managed at a corporate
level.





Asset information by reportable segment
is not reported to or reviewed by the chief operating decision maker and,
therefore, the Company has not disclosed asset information for each reportable
segment.Substantially allof the Company’s assets are located in
China.





NOTE 14 –
COMMITMENTS AND
CONTINGENCIES





Operating
Leases





The
      Company leases office and manufacturing space under leases in Beijing,
      China that expire through July
2019.





Future minimum rental payments
required under these
operating leases are as follows:





Year
      Ending December 31,2009
                  
                  $
                  251,0842010
                  
                  
                  132,9172011
                  
                  
                  109,4222012
                  
                  
                  109,4222013
      and thereafter
                  
                  
                  702,124Total
      minimum lease payments
                  
                  $
                  1,304,969





For the
years ended December 31, 2008 and 2007, rent expense amounted to $210,954 and
$242,856, respectively.


F-25


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007


NOTE 14 –
COMMITMENTS AND
CONTINGENCIES (Continued)





Technology Transfer
Agreement




In April
2008, one of the Company’s affiliates, En Ze Jia, entered into a Technology
Transfer Agreement with Dong Guan Kai Fa Biological Medicine LTD (“Dong Guan”)
pursuant to which Dong Guan agreed to transfer the technology material, new
medicine research and rights to the Chinese patent of the anti-asthma new
medicine R-BM to En Ze Jia on an exclusive basis in exchange for a transfer
technology fee of approximately $7 million (RMB 48 million) to be paid at
various intervals. Under the terms of the agreement, En Ze Jia is obligated
to:




•
            complete
      the filing with the Chinese State Food and Drug Administration (SFDA) of
      the medicine’s clinical research ratification document,•
            complete
      the clinical research,•
            complete
      the medicine’s trial production, and•
            provide
      raw materials and formulation related documentation and apply for the new
      medicine certification and production
approval.





In
addition to the payment of the technology transfer fee, En Ze Jia is responsible
for paying all costs associated with its responsibility under the agreement
which are presently estimated at $2.3 million (RMB 16 million). Lotus East
intends to use its working capital to fund the project costs.




Dong Guan
is responsible for preparing and transferring the clinical research and
application documents as well as assisting En Ze Jia in the completing the
clinical research and applying for the new medicine certification and production
approval documents.





Under the
terms of the agreement, the technology transfer fee is to be paid upon the
following schedule:





•
            Approximately
      $1.46 million (RMB 10 million) is due by the 15th business day following
      the receipt of the processing notice of the receipt of the clinical
      application and all related material from SFDA is
  received,•
            Approximately
      $1.17 million (RMB 8 million) is due by the 10th business day
      after
              the
      receipt of the medicine’s clinical ratification
  document,•
            Approximately
      $1.46 million (RMB 10 million) is due by the 15th business day
      after
              the
      medicine’s Phase I clinical study is completed and ratification from the
      SFDA
              is
      obtained, and•
            Approximately
      $2.92 million (RMB 20 million) is due by the 10th business day
      after
              the
      medicine’s Phase II clinical study is completed and ratification from the
      SFDA is obtained.




En Ze Jia
paid Dong Guan a deposit of approximately $2.92 million (RMB 20 million) in
April 2008 which is to be returned to En Ze Jia within 10 days after the
transfer technology fee is fully paid. In the event Dong Guan should be unable
to timely return the deposit, it will pay En Ze Jia a late fee and En Ze Jia is
entitled to damages for Dong Guan’s failure to timely return the
deposit.




The
intellectual property arising from the agreement will be jointly shared by the
parties. In addition, En Ze Jia has guaranteed that both parties must jointly
apply for related government grants prior to when the new medicine is marketed.
Upon receipt of the government grants En Ze Jia guaranteed that the grant monies
will be shared equally by both parties. As of December 31, 2008, the Company has
not received any government grant. The agreement can be terminated by Dong Guan
if En Ze Jia should fail to make any of the aforedescribed payments in which
event the patent rights would revert to Dong Guan and it is entitled to transfer
the project rights to a third party.




New Manufacturing
Facility




In June
2008, one of the Company’s affiliates, Liang Fang, entered into an agreement
with Cha You Qian Qi Economy Commission, a governmental agency (“Cha You”)
related to the construction of a pharmaceutical plant in Cha You’s Cha Ha Er
Industrial Garden


F-26


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 14 –
COMMITMENTS AND
CONTINGENCIES (Continued)





New Manufacturing Facility
(continued)





District
in Inner Mongolia. The new facility, which will be comprised approximately
40,000 square meters situated on 600 MU of land (approximately 400,200 square
meters), will be used to expand Liang Fang’s current manufacturing capacity. The
Company was subsequently granted the right to expand the land use right area to
1,000 MU (approximately 667,000 square meters). The new facility, which will
manufacture medical injection products, including 0.9% physiological saline
injection, hydroxyethyl starch 130/0.4 injection and hydroxyethyl starch 200/0.5
injection, Qiang Yi Ji starch, a medical corn starch commonly known as
O-2-hydeoxyethyl starch, dextran and additional pharmaceuticals, will require a
total investment of RMB 623.66 million, or approximately $91 million. The
construction began on the project in August 2008 and the Company anticipates
that it will take between 12 to 30 months to complete the construction. As of
December 31, 2008, the Company has incurred approximately $1.2 million related
to this project and the amount has been included as construction in progress in
the consolidated financial statements.




Included
in the total cost of the project is land cost of approximately $32.6 million
(RMB 223.66 million) which was fully paid to Cha You. Other components of the
project include construction costs of approximately $17.5 million (RMB 120
million) costs associated with the various production lines estimated at
approximately $33.6 million (RMB 230 million) and working capital of
approximately $7.3 million (RMB 50 million).




Liang
Fang intends to use its present working capital together with bank loans and
government grants to fund the project. The funds are required to be invested
over the next 18 months under a specified schedule ending in December 2010. As
of December 31, 2008, Liang Fang has paid approximately $33 million
(approximately RMB 226.5 million) of the total investment. Liang Fang, however,
has not secured either the bank loans or government grants and does not have
sufficient working capital to complete this project without securing substantial
funds from those third party sources.




Under the
terms of the agreement, Cha You agreed to abate fees associated with water
resources, waste and other relative supplies for a period of 30 years and agreed
to ensure that the land use tax to be paid by Liang Fang after it begins normal
production will be at the lowest tax rate imposed for five years. Once the
project is completed, for a period of eight years the local reserved portion of
the imposed corporation income tax will be returned to Liang Fang.





New Drug Certificate and
Intellectual Property Right Transfer Contract




On
December 2, 2008, the Company entered into a New Drug Certificate and
Intellectual Property Right Transfer Contract with Beijing Yipuan Bio-Medical
Technology, Co., Ltd. related to the drug Yipubishan (common name Octreotide
Acetate Injection). Under the terms of the agreement, the Company agreed to pay
Beijing Yipuan Bio-Medical a total of approximately $7.9 million (RMB 54
million) for technology transfer fees. We have paid approximately $2.9 million
(RMB 20 million) to Yipuan as of December 31, 2008 and the balance of
approximately $5 million (RMB 34 million) is due by May 31, 2009. Liang Fang
intends to use its present working capital to fund the commitments under the
agreement. Upon payment of these amounts, Liang Fang will own all intellectual
property rights associated with the drug.




As part
of the sale of Yipubishan, Yipuan is transferring its distribution channels,
including sales representatives, to Liang Fang in phases. Most of Yipuan's sales
of Yipubishan take place in Jiangxi province, Xi'an and Shanghai. In 2006, Liang
Fang started distributing Yipubishan in Anhui and Inner Mongolia. Liang Fang is
considering whether to use the distribution channels it is acquiring from Yipuan
for some of its own products.





NOTE 15 –
OPERATING
RISK





(a)
Country risk





Currently,
the Company’s revenues are primarily derived from the sale of pharmaceutical
products to customers in the Peoples Republic of China (PRC).  The
Company hopes to expand its operations to countries outside the PRC, however,
such expansion has not been commenced and there are no assurances that the
Company will be able to achieve such an expansion
successfully.  Therefore, a downturn or stagnation in the economic
environment of the PRC could have a material adverse effect on the Company’s
financial condition.





F-27


LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 and 2007





NOTE 15 –
OPERATING RISK
(Continued)





(b)
Products risk





In
addition to competing with other manufacturers of pharmaceutical product
offerings, the Company competes with larger Chinese and International companies
who may have greater funds available for expansion, marketing, research and
development and the ability to attract more qualified
personnel.  These Chinese companies may be able to offer products at a
lower price.  There can be no assurance that the Company will remain
competitive.





(c)
Political risk





Currently,
PRC is in a period of growth and is openly promoting business development in
order to bring more business into PRC.  Additionally PRC allows a
Chinese corporation to be owned by a United States corporation.  If
the laws or regulations are changed by the PRC government, the Company's ability
to operate the PRC subsidiaries could be affected.





NOTE 16 –
SUBSEQUENT
EVENT





In
February 2009, the Company issued 842,308 shares of common stock to Liu Zhongyi
(CEO) using a fair value of $0.26 per share for services rendered through
December 31, 2008 as the Company’s chief executive officer.





In
February 2009, the Company issued 67,308 shares of common stock to Adam
Wasserman (CFO) using a fair value of $0.26 per share for services rendered
through December 31, 2008 as the Company’s chief financial officer.





In
February 2009, the Company issued 48,077 shares of common stock to Mel Rothberg
using a fair value of $0.26 per share for director fees from January 1, 2008 to
April 15, 2008 and consulting services rendered through November 30,
2008.


F-28