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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------

For the quarterly period ended June 30, 2007



| ̈ | Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------

For the transition period from  to

Commission File No. 0-29785



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AMERICAN ORIENTAL
BIOENGINEERING, INC.

(Exact Name of Registrant as specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|NEVADA                                                         |  | 84-0605867                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

NO. 4018 JINTIAN ROAD, ANLIAN PLAZA, 12F SUITE B02 , FUTIAN DISTRICT SHENZHEN

PEOPLE'S REPUBLIC OF CHINA, 518026

(Address of principal executive offices)

86-451-8666-6601

(Issuers telephone number, including area code)



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Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈

Check whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer ̈Accelerated filer  x    Non-accelerated filer ̈

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

The number of shares outstanding of each of the issuers classes of equity as of the latest practicable date is stated below



|                                    |  |                                 
|----------------------------------- |  | --------------------------------
|Title of each class of Common Stock |  | Outstanding as of August 1, 2007
|Preferred Stock, $0.001 par value   |  | 1,000,000                       
|Common Stock, $0.001 par value      |  | 74,467,910                      



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|                               |  |                                                                                                |  |     
|------------------------------ |  | ---------------------------------------------------------------------------------------------- |  | ----
|                               |  |                                                                                                |  | Page
|PART I  FINANCIAL INFORMATION |  | 3                                                                                             
|                               |  |                                                                                               
|                               |  | ITEM 1  FINANCIAL STATEMENTS                                                                  |  | 3   
|                               |  |                                                                                               
|                               |  | ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 18  
|                               |  |                                                                                               
|                               |  | ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 30  
|                               |  |                                                                                               
|                               |  | ITEM 4  CONTROLS AND PROCEDURES                                                               |  | 30  
|                               | 
|PART II  OTHER INFORMATION    |  | 31                                                                                            
|                               |  |                                                                                               
|                               |  | ITEM 1  LEGAL PROCEEDINGS                                                                     |  | 31  
|                               |  |                                                                                               
|                               |  | ITEM 1A  RISK FACTORS                                                                         |  | 31  
|                               |  |                                                                                               
|                               |  | ITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           |  | 41  
|                               |  |                                                                                               
|                               |  | ITEM 3  DEFAULTS UPON SENIOR SECURITIES                                                       |  | 41  
|                               |  |                                                                                               
|                               |  | ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |  | 41  
|                               |  |                                                                                               
|                               |  | ITEM 5  OTHER INFORMATION                                                                     |  | 41  
|                               |  |                                                                                               
|                               |  | ITEM 6  EXHIBITS                                                                              |  | 41  



2



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PART I  FINANCIAL INFORMATION

ITEM 1  FINANCIAL STATEMENTS

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS



|                                                                                                                                    |  |               |             |                  |   |            
|----------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ----------- | ---------------- | - | -----------
|                                                                                                                                    |  | JUNE 30, 2007 |             | DECEMBER 31,2006
|                                                                                                                                    |  | UNAUDITED     |             |                 
|CURRENT ASSETS                                                                                                                      |  |               |             |                  |   |            
|Cash and cash equivalents                                                                                                           |  | $             | 108,449,801 |                  | $ | 87,784,419 
|Accounts receivable, net of reserve of $77,652 and $39,776 at June 30, 2007 andDecember 31, 2006, respectively                      |  |               | 11,867,708  |                  |   | 11,141,057 
|Inventories, net of $598,169 and $615,552 provision for slow moving inventories atJune 30, 2007 and December 31, 2006,
respectively |  |               | 12,131,254  |                  |   | 10,684,316 
|Advances to suppliers                                                                                                               |  |               | 3,322,663   |                  |   | 1,950,101  
|Notes receivable                                                                                                                    |  |               | 695,156     |                  |   | 3,238,161  
|Other receivables                                                                                                                   |  |               | 53,162      |                  |   | 37,545     
|Due from employees                                                                                                                  |  |               | 215,349     |                  |   | 585,050    
|Deferred consulting expenses                                                                                                        |  |               | 162,500     |                  |   | 166,600    
|                                                                                                                                    |  |               |             |                  |   |            
|Total Current Assets                                                                                                                |  |               | 136,897,593 |                  |   | 115,587,249
|                                                                                                                                    |  |               |             |                  |   |            
|LONG-TERM ASSETS                                                                                                                    |  |               |             |                  |   |            
|Plant and equipment, net                                                                                                            |  |               | 32,955,702  |                  |   | 32,194,957 
|Land use rights, net                                                                                                                |  |               | 33,394,666  |                  |   | 32,937,743 
|Construction in progress                                                                                                            |  |               | 182,373     |                  |   | 326,121    
|Deferred tax assets                                                                                                                 |  |               | 1,679,788   |                  |   | 1,797,153  
|License, net                                                                                                                        |  |               | 344,273     |                  |   | 383,755    
|Goodwill                                                                                                                            |  |               | 1,933,100   |                  |   | 1,933,100  
|Long-term investment and advance                                                                                                    |  |               | 196,979     |                  |   | 113,868    
|                                                                                                                                    |  |               |             |                  |   |            
|Total Long-Term Assets                                                                                                              |  |               | 70,686,881  |                  |   | 69,686,697 
|                                                                                                                                    |  |               |             |                  |   |            
|TOTAL ASSETS                                                                                                                        |  | $             | 207,584,474 |                  | $ | 185,273,946
|                                                                                                                                    |  |               |             |                  |   |            

See accompanying notes to the condensed consolidated financial statements



3



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AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS EQUITY



|                                                                                                                                                             |  |               |             |   |                   |   |            
|------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ----------- | - | ----------------- | - | -----------
|                                                                                                                                                             |  | JUNE 30, 2007 |             |   | DECEMBER 31, 2006
|                                                                                                                                                             |  | UNAUDITED     |             |   |                  
|CURRENT LIABILITIES                                                                                                                                          |  |               |             |   |                   |   |            
|Accounts payable                                                                                                                                             |  | $             | 3,754,082   |   |                   | $ | 2,871,981  
|Other payables and accrued expenses                                                                                                                          |  |               | 3,883,326   |   |                   |   | 4,549,867  
|Taxes payable                                                                                                                                                |  |               | 1,749,568   |   |                   |   | 2,211,542  
|Short-term bank loans                                                                                                                                        |  |               | 8,524,858   |   |                   |   | 8,314,679  
|Current portion of long-term bank loans                                                                                                                      |  |               | 1,488,198   |   |                   |   | 1,450,905  
|Customer deposits                                                                                                                                            |  |               | 2,155,563   |   |                   |   | 2,263,654  
|Notes payable                                                                                                                                                |  |               | 68,625      |   |                   |   | 66,216     
|Other liabilities                                                                                                                                            |  |               | 933,211     |   |                   |   | 1,606,334  
|                                                                                                                                                             |  |               |             |   |                   |   |            
|Total Current Liabilities                                                                                                                                    |  |               | 22,557,431  |   |                   |   | 23,335,178 
|                                                                                                                                                             |  |               |             |   |                   |   |            
|LONG-TERM LIABILITIES                                                                                                                                        |  |               |             |   |                   |   |            
|Long-term bank loans, net of current portion                                                                                                                 |  |               | 887,551     |   |                   |   | 915,909    
|Long-term notes payable                                                                                                                                      |  |               | 266,435     |   |                   |   | 255,836    
|Deferred tax liabilities                                                                                                                                     |  |               | 4,656,198   |   |                   |   | 4,580,698  
|Other liabilities                                                                                                                                            |  |               | 3,148       |   |                   |   | 9,083      
|                                                                                                                                                             |  |               |             |   |                   |   |            
|Total Long-Term Liabilities                                                                                                                                  |  |               | 5,813,332   |   |                   |   | 5,761,526  
|                                                                                                                                                             |  |               |             |   |                   |   |            
|TOTAL LIABILITIES                                                                                                                                            |  |               | 28,370,763  |   |                   |   | 29,096,704 
|                                                                                                                                                             |  |               |             |   |                   |   |            
|COMMITMENTS                                                                                                                                                  |  |               |             |   |                   |   |            
|SHAREHOLDERS EQUITY                                                                                                                                         |  |               |             |   |                   |   |            
|Preferred stock, $0.001 par value; 2,000,000 shares authorized; 1,000,000 shares issued and outstanding at June 30, 2007 and
December 31, 2006, respectively |  |               | 1,000       |   |                   |   | 1,000      
|Common stock, $0.001 par value; 150,000,000 shares authorized; 65,117,910 and64,230,369 shares issued and outstanding,
respectively                          |  |               | 65,118      |   |                   |   | 64,230     
|Stock to be issued                                                                                                                                           |  |               | 73,447,943  |   |                   |   | 599,069    
|Additional paid-in capital                                                                                                                                   |  |               | 97,082,545  |   |                   |   | 92,307,960 
|Receivable from sale of stock                                                                                                                                |  |               | (74,107,250 | ) |                   |   |           
|Retained earnings (the restricted portion of retained earnings is $8,498,766 atJune 30, 2007 and December 31, 2006,
respectively)                            |  |               | 74,944,728  |   |                   |   | 58,826,911 
|Accumulated other comprehensive income                                                                                                                       |  |               | 7,779,627   |   |                   |   | 4,378,072  
|                                                                                                                                                             |  |               |             |   |                   |   |            
|Total Shareholders Equity                                                                                                                                   |  |               | 179,213,711 |   |                   |   | 156,177,242
|                                                                                                                                                             |  |               |             |   |                   |   |            
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                   |  | $             | 207,584,474 |   |                   | $ | 185,273,946
|                                                                                                                                                             |  |               |             |   |                   |   |            

See accompanying notes to the condensed consolidated financial statements



4



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AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(UNAUDITED)



|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|-------------------------------------------------------- |  | -------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                         |  | THREE MONTHS ENDEDJUNE 30, |            |   | SIX MONTHS ENDED JUNE 30, |  
|                                                         |  | 2007                       |            |   | 2006                      |   |            | 2007 |  |   | 2006       |  
|REVENUES                                                 |  | $                          | 33,913,234 |   |                           | $ | 22,761,882 |      |  | $ | 59,662,608 |   |  | $ | 41,808,826 |  
|COST OF GOODS SOLD                                       |  |                            | 10,210,485 |   |                           |   | 8,092,663  |      |  |   | 18,240,539 |   |  |   | 14,875,987 |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|GROSS PROFIT                                             |  |                            | 23,702,749 |   |                           |   | 14,669,219 |      |  |   | 41,422,069 |   |  |   | 26,932,839 |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Selling and marketing                                    |  |                            | 3,886,564  |   |                           |   | 1,956,629  |      |  |   | 6,590,035  |   |  |   | 3,655,169  |  
|Advertising                                              |  |                            | 5,412,510  |   |                           |   | 3,001,974  |      |  |   | 9,237,855  |   |  |   | 5,222,067  |  
|General and administrative                               |  |                            | 2,557,805  |   |                           |   | 2,437,645  |      |  |   | 5,495,949  |   |  |   | 4,316,287  |  
|Depreciation and amortization                            |  |                            | 341,562    |   |                           |   | 267,129    |      |  |   | 675,836    |   |  |   | 365,559    |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total operating expenses                                 |  |                            | 12,198,441 |   |                           |   | 7,663,377  |      |  |   | 21,999,675 |   |  |   | 13,559,082 |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|INCOME FROM OPERATIONS                                   |  |                            | 11,504,308 |   |                           |   | 7,005,842  |      |  |   | 19,422,394 |   |  |   | 13,373,757 |  
|INTEREST INCOME, NET                                     |  |                            | 43,048     |   |                           |   | 361,951    |      |  |   | 17,238     |   |  |   | 443,514    |  
|OTHER INCOME, NET                                        |  |                            | 60,840     |   |                           |   | 10,136     |      |  |   | 142,958    |   |  |   | 9,144      |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|INCOME BEFORE INCOME TAXES                               |  |                            | 11,608,196 |   |                           |   | 7,377,929  |      |  |   | 19,582,590 |   |  |   | 13,826,415 |  
|INCOME TAXES                                             |  |                            | 1,939,825  |   |                           |   | 1,550,708  |      |  |   | 3,464,773  |   |  |   | 3,094,888  |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|NET INCOME                                               |  |                            | 9,668,371  |   |                           |   | 5,827,221  |      |  |   | 16,117,817 |   |  |   | 10,731,527 |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|OTHER COMPREHENSIVE INCOME                               |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Foreign currency translation gain                        |  |                            | 2,191,408  |   |                           |   | 378,670    |      |  |   | 3,401,555  |   |  |   | 638,295    |  
|Unrealized gain of marketable security                   |  |                            |           |   |                           |   | 1,089      |      |  |   |           |   |  |   | 1,089      |  
|Income tax expense related to other comprehensive income |  |                            | (723,165   | ) |                           |   | (125,320   | )    |  |   | (1,122,513 | ) |  |   | (210,997   | )
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|TOTAL OTHER COMPREHENSIVE INCOME, NET OF TAX             |  |                            | 1,468,243  |   |                           |   | 254,439    |      |  |   | 2,279,042  |   |  |   | 428,387    |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|COMPREHENSIVE INCOME                                     |  | $                          | 11,136,614 |   |                           | $ | 6,081,660  |      |  | $ | 18,396,859 |   |  | $ | 11,159,914 |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|NET INCOME PER SHARE                                     |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|BASIC                                                    |  | $                          | 0.15       |   |                           | $ | 0.09       |      |  | $ | 0.25       |   |  | $ | 0.17       |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|DILUTED                                                  |  | $                          | 0.15       |   |                           | $ | 0.09       |      |  | $ | 0.24       |   |  | $ | 0.17       |  
|                                                         |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING            |  |                            |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|BASIC                                                    |  |                            | 65,144,311 |   |                           |   | 62,657,876 |      |  |   | 64,877,916 |   |  |   | 61,944,618 |  
|DILUTED                                                  |  |                            | 66,600,080 |   |                           |   | 62,795,439 |      |  |   | 66,483,294 |   |  |   | 62,060,700 |  

See accompanying notes to the condensed consolidated financial statements



5



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AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(UNAUDITED)



|                                                                                  |  |                           |             |   |      |   |             |  
|--------------------------------------------------------------------------------- |  | ------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                                  |  | SIX MONTHS ENDED JUNE 30, |            
|                                                                                  |  | 2007                      |             |   | 2006 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                           |             |   |      |   |             |  
|Net income                                                                        |  | $                         | 16,117,817  |   |      | $ | 10,731,527  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                           |             |   |      |   |             |  
|Depreciation and amortization                                                     |  |                           | 1,515,934   |   |      |   | 1,067,548   |  
|Loss on disposal of plant and equipment                                           |  |                           |            |   |      |   | 1,131       |  
|Amortization of deferred consulting expenses                                      |  |                           | 264,100     |   |      |   | 490,520     |  
|Provision for doubtful accounts                                                   |  |                           | 50,398      |   |      |   | (77,401     | )
|Provision for slow moving inventories                                             |  |                           | (75,239     | ) |      |   | (78,990     | )
|Deferred taxes                                                                    |  |                           | 192,865     |   |      |   | 22,077      |  
|Common stock to be issued for services                                            |  |                           | 108,833     |   |      |   | 87,598      |  
|Stock option compensation expense                                                 |  |                           | 65,340      |   |      |   | 70,802      |  
|Equity income from unconsolidated entity                                          |  |                           | (10,999     | ) |      |   | (5,315      | )
|Changes in operating assets and liabilities, net of effects of acquisition:       |  |                           |             |   |      |   |             |  
|(Increase) Decrease In:                                                           |  |                           |             |   |      |   |             |  
|Accounts receivable                                                               |  |                           | (777,050    | ) |      |   | (241,073    | )
|Notes receivable                                                                  |  |                           | 2,543,005   |   |      |   | (424,530    | )
|Inventories                                                                       |  |                           | (1,371,699  | ) |      |   | (2,933,276  | )
|Advances to suppliers                                                             |  |                           | (1,453,861  | ) |      |   | 1,172,463   |  
|Prepaid expenses and other receivables                                            |  |                           | (4,157      | ) |      |   | 153,022     |  
|Due from employees                                                                |  |                           | 369,701     |   |      |   | (328,563    | )
|Increase (Decrease) In:                                                           |  |                           |             |   |      |   |             |  
|Accounts payable                                                                  |  |                           | 734,805     |   |      |   | (1,152,229  | )
|Other payables and accrued expenses                                               |  |                           | (1,897,810  | ) |      |   | (226,397    | )
|Taxes payable                                                                     |  |                           | (461,975    | ) |      |   | (96,738     | )
|Customer deposits                                                                 |  |                           | (108,091    | ) |      |   | (44,592     | )
|Other liabilities                                                                 |  |                           | 205,524     |   |      |   |            |  
|                                                                                  |  |                           |             |   |      |   |             |  
|Net cash provided by operating activities                                         |  |                           | 16,007,441  |   |      |   | 8,187,584   |  
|                                                                                  |  |                           |             |   |      |   |             |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                           |             |   |      |   |             |  
|Purchases of construction in progress                                             |  |                           | (488,063    | ) |      |   | (284,576    | )
|Purchases of plant and equipment                                                  |  |                           | (953,637    | ) |      |   | (367,153    | )
|Purchases of subsidiary, net of cash acquired                                     |  |                           |            |   |      |   | (18,074,186 | )
|                                                                                  |  |                           |             |   |      |   |             |  
|Net cash used in investing activities                                             |  |                           | (1,441,700  | ) |      |   | (18,725,915 | )
|                                                                                  |  |                           |             |   |      |   |             |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |                           |             |   |      |   |             |  
|Proceeds from short-term bank loans                                               |  |                           | 1,920,680   |   |      |   | 1,250,688   |  
|Prepayments of short-term bank loans                                              |  |                           | (1,938,641  | ) |      |   | (1,638,401  | )
|Repayment of notes payable                                                        |  |                           |            |   |      |   | (1,615,699  | )
|Repayments of capital lease                                                       |  |                           | (7,355      | ) |      |   | (6,538      | )
|Payment for offering expense                                                      |  |                           | (25,121     | ) |      |   |            |  
|Cash proceeds from private placement, net                                         |  |                           |            |   |      |   | 24,974,955  |  
|Cash contribution from shareholder                                                |  |                           | 150,900     |   |      |   |            |  
|Proceeds from exercise of warrants                                                |  |                           | 3,960,164   |   |      |   |            |  
|                                                                                  |  |                           |             |   |      |   |             |  
|Net cash provided by financing activities                                         |  |                           | 4,060,627   |   |      |   | 22,965,005  |  
|                                                                                  |  |                           |             |   |      |   |             |  
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                         |  |                           | 18,626,368  |   |      |   | 12,426,674  |  
|Effect of exchange rate changes on cash                                           |  |                           | 2,039,014   |   |      |   | 383,814     |  
|Cash and cash equivalents, beginning of period                                    |  |                           | 87,784,419  |   |      |   | 57,532,049  |  
|                                                                                  |  |                           |             |   |      |   |             |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                          |  | $                         | 108,449,801 |   |      | $ | 70,342,537  |  
|                                                                                  |  |                           |             |   |      |   |             |  

See accompanying notes to the condensed consolidated financial statements



6



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AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)

NOTE 1  BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements of American Oriental
Bioengineering, Inc. and subsidiaries (the Company) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the requirements for reporting on Form 10-Q.
Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. However, the information included in these interim financial
statements reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations.
Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year. The condensed consolidated balance sheet information as of December 31, 2006 was derived from the audited consolidated financial
statements included in the Companys Annual Report on Form 10-K. These interim financial statements should be read in conjunction with that report.

NOTE 2  USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses
during the reporting period. Actual results when ultimately realized could differ from those estimates. See Critical Accounting Policies and Estimates in the Managements Discussion and Analysis of Financial Condition and Results of
Operations section below.

NOTE 3  SIGNIFICANT ACCOUNTING POLICIES AND NEW PRONOUNCEMENT

Cash and Cash EquivalentsThe Company considers all highly liquid investments purchased with original maturities of three months or less to be cash
equivalents.

InventoriesInventories consisting of raw materials, work-in-progress and finished goods are stated at the lower of weighted
average cost or market value. Finished goods are comprised of direct materials, direct labor and an appropriate proportion of overhead.

Revenue
RecognitionRevenues represent the invoiced value of goods sold, recognized upon the shipment of goods to customers. Revenues are recognized when all of the following criteria are met:



| |  | Persuasive evidence of an arrangement exists,
|- |  | ---------------------------------------------



| |  | Delivery has occurred or services have been rendered,
|- |  | -----------------------------------------------------



| |  | The seller's price to the buyer is fixed or determinable, and
|- |  | -------------------------------------------------------------



| |  | Collectibility is reasonably assured.
|- |  | -------------------------------------

The Company
established a subsidiary in Hong Kong with a specialty retail store to sell its products. The retail store sells certain products to certain customers on consignment. The Company records revenue for consignment transactions when the consignee sells
the product to the end user.

Stock Based CompensationThe Company adopted Statement of Financial Accounting Standards (SFAS)
No. 123R in the first quarter of 2006, at which time the Company began recognizing an expense for unvested share-based compensation that has been issued or will be issued after that date. The Company adopted SFAS No. 123R on a prospective
basis.



7



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



The Company estimates fair value of restricted stock based on the number of shares granted and the quoted price of
the Companys common stock on the date of grant. The fair value of stock options is estimated using the Black-Scholes model. The Companys expected volatility assumption is based on the historical volatility of Companys stock. The
expected life assumption is primarily based on historical exercise patterns and post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of
grant.

Stock compensation expense recognized is based on awards expected to vest, and there were no estimated forfeitures as the current options
outstanding were only issued to founders and senior executives of the Company. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those
estimates.

There were no options issued in the first quarter of 2007 and the fair value of the stock based compensation expense for the three and six
months ended June 30, 2007 was $65,340.

Adoption of New Accounting PolicyEffective January 1, 2007, the Company adopted Financial
Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).an interpretation of FASB Statement No. 109, Accounting for Income Taxes.The Interpretation addresses the
determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not
that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest
benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires
increased disclosures. At the date of adoption, and as of June 30, 2007, the Company does not have a liability for unrecognized tax benefits.

The
Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is subject to U.S. federal or state income tax examinations by tax authorities for years after 2002. During the periods open to examination, the
Company has net operating loss and tax credit carry forwards for U.S. federal and state tax purposes that have attributes from closed periods. Since these NOLs and tax credit carry forwards may be utilized in future periods, they remain subject to
examination. The Company also files certain tax returns in China. As of June 30, 2007 the Company was not aware of any pending income tax examinations by China tax authorities.

The Companys policy is to record interest and penalties on uncertain tax positions as income tax expense. As of June 30, 2007, The Company has no accrued interest or penalties related to uncertain tax
positions.

New Accounting PronouncementIn September 2006, the Financial Accounting Standard Board (FASB) issued SFAS
No. 157, "Fair Value Measurements," which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 provides a common definition of fair value and establishes a framework to make the measurement of
fair value in generally accepted accounting principles more consistent and comparable. SFAS No. 157 also requires expanded disclosures to provide information about the extent to which fair value is used to measure assets and liabilities, the
methods and assumptions used to measure fair value, and the effect of fair value measures on earnings. SFAS No. 157 is effective for financial statements



8



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



issued in fiscal years beginning after November 15, 2007 and to interim periods within those fiscal years. The Company is currently in the process of
evaluating the effect, if any, the adoption of SFAS No. 157 will have on its consolidated results of operations, financial position, or cash flows.

In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  including an amendment of FASB Statement No. 115 (FAS 159). FAS 159 will become effective for
the company on January 1, 2008. This standard permits companies to choose to measure many financial instruments and certain other items at fair value and report unrealized gains and losses in earnings. Such accounting is optional and is
generally to be applied instrument by instrument. The Company does not anticipate that the election, if any, of this fair-value option will have a material effect on results or operations or consolidated financial position.

NOTE 4  EARNINGS PER SHARE

Basic earnings per share are
computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is
increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.

Basic and diluted earnings per share are calculated as follows:



|                                            |  |                            |            |                           |   |            |  |      |            |  |   |           
|------------------------------------------- |  | -------------------------- | ---------- | ------------------------- | - | ---------- |  | ---- | ---------- |  | - | ----------
|                                            |  | THREE MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDED JUNE 30,
|                                            |  | 2007                       |            | 2006                      |   | 2007       |  | 2006
|Basic:                                      |  |                            |            |                           |   |            |  |      |            |  |   |           
|Income applicable to common shareholders    |  | $                          | 9,668,371  |                           | $ | 5,827,221  |  | $    | 16,117,817 |  | $ | 10,741,527
|Weighted average shares outstanding         |  |                            | 65,144,311 |                           |   | 62,657,876 |  |      | 64,877,916 |  |   | 61,944,618
|                                            |  |                            |            |                           |   |            |  |      |            |  |   |           
|Basic earnings per share                    |  | $                          | 0.15       |                           | $ | 0.09       |  | $    | 0.25       |  | $ | 0.17      
|                                            |  |                            |            |                           |   |            |  |      |            |  |   |           
|Diluted:                                    |  |                            |            |                           |   |            |  |      |            |  |   |           
|Income applicable to common shareholders    |  | $                          | 9,668,371  |                           | $ | 5,827,221  |  | $    | 16,117,817 |  | $ | 10,741,527
|Weighted average shares outstanding         |  |                            | 65,144,311 |                           |   | 62,657,876 |  |      | 64,877,916 |  |   | 61,944,618
|Effect of dilutive securities:              |  |                            |            |                           |   |            |  |      |            |  |   |           
|Stock options                               |  |                            | 79,833     |                           |   | 48,687     |  |      | 81,083     |  |   | 45,201    
|Warrants                                    |  |                            | 1,375,936  |                           |   | 88,876     |  |      | 1,524,295  |  |   | 70,881    
|                                            |  |                            |            |                           |   |            |  |      |            |  |   |           
|Diluted weighted average shares outstanding |  |                            | 66,600,080 |                           |   | 62,795,439 |  |      | 66,483,294 |  |   | 62,060,700
|                                            |  |                            |            |                           |   |            |  |      |            |  |   |           
|Diluted earnings per share                  |  | $                          | 0.15       |                           | $ | 0.09       |  | $    | 0.24       |  | $ | 0.17      
|                                            |  |                            |            |                           |   |            |  |      |            |  |   |           



9



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



NOTE 5  FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company's financial instruments include cash and cash equivalents, accounts receivable, advances to suppliers, notes receivable, other receivables due from employees,
taxes payable, accounts payable, accrued expenses, debt, customer deposits and other payables. Management has estimated that the carrying amount approximates their fair value due to their short-term nature or long-term debt interest rates, which
approximate the current market rates.

NOTE 6  FOREIGN CURRENCY TRANSLATION

The accompanying consolidated financial statements are presented in United States dollars. The functional currency of the Company is the Renminbi (RMB), the official currency of the Peoples Republic of China.
Capital accounts of the consolidated financial statements are translated into United States dollars from RMB at their historical exchange rates when the capital transactions occurred. Assets and liabilities are translated at the exchange rates as of
balance sheet date. Income and expenditures are translated at the average exchange rate of the quarter.



|                                          |  |        |  |       
|----------------------------------------- |  | ------ |  | ------
|                                          |  | 2007   |  | 2006  
|Quarter end RMB : US$ exchange rate       |  | 7.6248 |  | 8.0065
|Average quarterly RMB : US$ exchange rate |  | 7.6829 |  | 8.0228

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place
through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US dollars at the rates used in translation.

NOTE 7  INVENTORIES



|                                           |  |               |            |   |                   |   |            |  
|------------------------------------------ |  | ------------- | ---------- | - | ----------------- | - | ---------- | -
|                                           |  | June 30, 2007 |            |   | December 31, 2006 |  
|                                           |  | Unaudited     |            |   |                   |  
|Raw materials                              |  | $             | 9,273,031  |   |                   | $ | 9,033,729  |  
|Work in progress                           |  |               | 1,133,631  |   |                   |   | 1,219,796  |  
|Finished goods                             |  |               | 2,322,761  |   |                   |   | 1,046,343  |  
|                                           |  |               |            |   |                   |   |            |  
|                                           |  |               | 12,729,423 |   |                   |   | 11,299,868 |  
|Less provision for slow moving inventories |  |               | (598,169   | ) |                   |   | (615,552   | )
|                                           |  |               |            |   |                   |   |            |  
|Inventories, net                           |  | $             | 12,131,254 |   |                   | $ | 10,684,316 |  
|                                           |  |               |            |   |                   |   |            |  

NOTE 8  LAND USE RIGHTS

According to the law of China, the government owns all the land in China. Companies are authorized to possess and use land through land use rights granted by the Chinese government. Land use rights are being amortized
using the straight-line method over the lease term of 40 to 50 years. Land use rights consist of the following as of June 30, 2007 and December 31, 2006:



|                               |  |               |            |   |                   |   |            |  
|------------------------------ |  | ------------- | ---------- | - | ----------------- | - | ---------- | -
|                               |  | June 30, 2007 |            |   | December 31, 2006 |  
|                               |  | Unaudited     |            |   |                   |  
|Cost of land use rights        |  | $             | 34,733,982 |   |                   | $ | 33,877,618 |  
|Less: Accumulated amortization |  |               | (1,339,316 | ) |                   |   | (939,875   | )
|                               |  |               |            |   |                   |   |            |  
|Land use rights, net           |  | $             | 33,394,666 |   |                   | $ | 32,937,743 |  
|                               |  |               |            |   |                   |   |            |  



10



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



Amortization expense for the three months ended June 30, 2007 and 2006 was $186,421 and $178,806, respectively.
Amortization expense for the six months ended June 30, 2007 and 2006 was $370,993 and $221,330, respectively. As of June 30, 2007, the net book value of land use rights pledged as collateral was $13,311,055. See Note 10.

NOTE 9  PLANT AND EQUIPMENT

Plant and equipment consist of the
following as of June 30, 2007 and December 31, 2006:



|                                |  |               |             |   |                   |   |             |  
|------------------------------- |  | ------------- | ----------- | - | ----------------- | - | ----------- | -
|                                |  | June 30, 2007 |             |   | December 31, 2006 |  
|                                |  | Unaudited     |             |   |                   |  
|At cost:                        |  |               |             |   |                   |   |             |  
|Buildings                       |  | $             | 28,166,180  |   |                   | $ | 27,208,232  |  
|Machinery and equipment         |  |               | 14,584,591  |   |                   |   | 13,706,903  |  
|Motor vehicles                  |  |               | 892,184     |   |                   |   | 827,740     |  
|Office equipment                |  |               | 868,324     |   |                   |   | 664,892     |  
|Other equipment                 |  |               | 140,520     |   |                   |   | 138,472     |  
|Leasehold improvements          |  |               | 103,934     |   |                   |   | 75,813      |  
|                                |  |               |             |   |                   |   |             |  
|                                |  |               | 44,755,733  |   |                   |   | 42,622,052  |  
|                                |  |               |             |   |                   |   |             |  
|Less : Accumulated depreciation |  |               |             |   |                   |   |             |  
|Buildings                       |  |               | (2,735,272  | ) |                   |   | (2,325,950  | )
|Machinery and equipment         |  |               | (7,862,698  | ) |                   |   | (7,050,834  | )
|Motor vehicles                  |  |               | (574,886    | ) |                   |   | (502,510    | )
|Office equipment                |  |               | (461,750    | ) |                   |   | (398,450    | )
|Other equipment                 |  |               | (98,146     | ) |                   |   | (91,071     | )
|Leasehold improvements          |  |               | (67,279     | ) |                   |   | (58,280     | )
|                                |  |               |             |   |                   |   |             |  
|                                |  |               | (11,800,031 | ) |                   |   | (10,427,095 | )
|                                |  |               |             |   |                   |   |             |  
|Plant and equipment, net        |  | $             | 32,955,702  |   |                   | $ | 32,194,957  |  
|                                |  |               |             |   |                   |   |             |  

Depreciation expense for the three months ended June 30, 2007 and 2006 was $553,290 and $479,131,
respectively. Depreciation expense for the six months ended June 30, 2007 and 2006 was $1,096,373 and $799,534, respectively. As of June 30, 2007, the net book value of plant and equipment pledged as collateral for a bank loan was
$4,905,531. See Note 10.

NOTE 10  DEBT

Short-term bank loans are obtained from local banks with interest rates ranging from 6.12% to 7.05% per annum. All the short-term bank loans are repayable within one year and are secured by fixed assets and land use rights owned by the
Company.



11



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



Long-term bank loan include $1,488,198 long term bank loans repayable within one year and a mortgage of $887,551
obtained during 2006 for the expansion of our Hong Kong office. The current portion of the long-term bank loans is mainly from GLP and bears 6.138% interest per annum, and is repayable by December 2007. The mortgage loan bears 5.5% interest per
annum and is repayable over 15 years. Long-term loans are secured by fixed assets and land use rights owned by the Company.

Notes payable have interest
rates ranging form 6.30% to 7.06% per annum. All notes payable are non-secured and repayable on demand.

Interest expense for the three months ended
June 30, 2007 and 2006 was $213,961 and $162,185, respectively. Interest expense for the six months ended June 30, 2007 and 2006 was $441,119 and $229,688, respectively.

Also see Note 8 and 9.

NOTE 11  SHAREHOLDERS EQUITY

A. Issuance of Common Stock

A total of 48,379 shares of common stock
were issued to three of the Companys independent directors in January 2007 for the services rendered by them through December 31, 2006. All the related stock compensation expenses were fully accrued at the end of 2006.

A total of 839,162 shares of common stock were issued during the first six months of 2007 in connection with the exercise of the Companys warrants. The Company
received total proceeds of $3,960,164 from the exercise of warrants.

B. Warrants.

On November 28, 2005, the Company entered into a stock purchase and warrant agreement, ("Purchase Agreement"), with thirty-one (31) accredited investors. Pursuant to the Purchase Agreement, the investors
purchased 12,500,000 units, each unit consisting of (a) one share of common stock and (b) three-tenths of one common stock purchase warrant, at a purchase price of $4.80 per unit.

With the warrants attached to the units sold in the private placement, the investors are entitled to purchase an aggregate of 3,750,000 shares of common stock at an
exercise price of $6.50 per share. Upon completion of the placement, the Company paid 5% of the gross proceeds in cash to placement agents and issued to them warrants representing the right to purchase up to 1,137,500 shares of the Company's common
stock at an exercise price of $4.80 per share. All these warrants expire on December 8, 2008.

Warrants for 364,580 shares of common stock were
exercised as of December 31, 2006. The following tables summarize the movement of warrants during the first six months of 2007:



|                                |  |           |  |                                    |     
|------------------------------- |  | --------- |  | ---------------------------------- | ----
|                                |  | Warrants  |  | Weighted Average of Exercise Price
|Outstanding January 1, 2007     |  | 4,522,920 |  | $                                  | 5.51
|Granted                         |  |          |  |                                    |    
|Exercised                       |  | 839,162   |  | $                                  | 5.16
|Cancelled                       |  |          |  |                                    |    
|                                |  |           |  |                                    |     
|Outstanding as of June 30, 2007 |  | 3,683,758 |  | $                                  | 6.40
|                                |  |           |  |                                    |     



12



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



Also see Note 15 for subsequent events related to the exercise of warrants.

C. Stock Options

A new stock incentive plan (the 2006
Plan) was approved by shareholders of the Company at an annual shareholders meeting held in November 2006. The 2006 Plan replaced the Companys stock option plan adopted by the Companys Board of Directors in March 2004 (the
2004 Plan). All stock options granted under the 2004 Plan will remain in effect pursuant to the terms of the respective grant agreements. As of December 31, 2006, the Company had issued a total of 99,269 options under the 2004 Plan
to four of the Companys executives pursuant to their respective employment agreements. In April 2007, the Companys Compensation Committee approved new compensation packages and the Company entered into new 2007 employment agreements with
the four executives. The executives have agreed to waive their right to receive stock options under their prior employment agreements.

On April 20,
2007, the Compensation Committee of the Board of Directors of the Company approved the grant of stock options to the Company's principal executive officer, principal financial officer and certain other executives. Stock options for 660,000 shares of
common stock were granted under the 2006 Plan and will vest ratably over a five year period. The company valued the stock options at $1,960,200 and recorded $65,340 stock compensation expense for the period ended June 30, 2007. Of the total
value, $1,894,860 has not yet been recognized and will be amortized over the requisite service period. The value of the option was estimated using the Black Scholes Model with an expected volatility of 19.3%, expected life of 5 years and risk-free
interest rate of 4.6%.

The following table summarizes the stock option activity:



|                                |  |          |  |                                 |      
|------------------------------- |  | -------- |  | ------------------------------- | -----
|                                |  | Activity |  | Weighted Average Exercise Price
|Outstanding January 1, 2007     |  | 99,269   |  | $                               | 2.00 
|Granted                         |  | 660,000  |  |                                 | 10.74
|Exercised                       |  |         |  |                                 |     
|Cancelled                       |  |         |  |                                 |     
|                                |  |          |  |                                 |      
|Outstanding as of June 30, 2007 |  | 759,269  |  | $                               | 9.60 
|                                |  |          |  |                                 |      

The following table summarizes information about stock options outstanding as of June 30, 2007:



|                         |  |                     |  |                               |       |                                                    |      |                 |        |                               |   |     
|------------------------ |  | ------------------- |  | ----------------------------- | ----- | -------------------------------------------------- | ---- | --------------- | ------ | ----------------------------- | - | ----
|                         |  | Options Outstanding |  | Options Exercisable          
|Range of Exercise Prices |  | Number ofShares     |  | WeightedAverageExercise Price |       | WeightedAverageRemainingContractual Life(in years) |      | Number ofShares |        | WeightedAverageExercise Price
|$2.00                    |  | 99,269              |  | $                             | 2.00  |                                                    | 2.82 |                 | 99,269 |                               | $ | 2.00
|$10.74                   |  | 660,000             |  | $                             | 10.74 |                                                    | 5.00 |                 |       |                               |   |    
|                         |  |                     |  |                               |       |                                                    |      |                 |        |                               |   |     
|                         |  | 759,269             |  |                               |       |                                                    |      |                 | 99,269 |                               |   |     
|                         |  |                     |  |                               |       |                                                    |      |                 |        |                               |   |     



13



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



The weighted average fair value per share of the 759,269 options issued under the Plan is $3.04 per share.

D. Common Stock to be Issued

For the six months ended
June 30, 2007, the Company recorded general and administrative expenses of $108,833 for stock compensation in connection with the services rendered by the Companys independent directors. A total of 9,833 shares of common stock are
issuable to independent directors as of June 30, 2007. Common stock is expected to be issued at the end of 2007 pursuant to the service agreements.

The Company entered into a consulting agreement in February 2007 and agreed to issue 20,000 shares of common stock as part of the consulting fee. The Company recorded deferred consulting expenses of $260,000, based on the market value of
the common stock at the date of grant, which has been and will be amortized over a one-year service period. Of the total value, $97,500 was amortized through June 30, 2007.

The Company entered into a stock purchase agreement with a group of underwriters on June 28, 2007 and offered to sell 8,000,000 shares of the Companys common stock. Under the same agreement, the Company
also granted the underwriters an option to purchase an additional 1,275,000 to cover over-allotments. The underwriters exercised their option in full to purchase an additional 1,275,000 shares of the Company's common stock to cover over-allotments
on June 30, 2007. In total, including the over-allotment shares, the Company sold 9,275,000 shares of the Company's common stock at $7.99 per share, after underwriting discounts and commissions, resulting in net proceeds of approximately $74.1
million, which includes approximately $10.2 million in net proceeds from the exercise of the over- allotment option. The closing of the offering, including the over-allotment shares, occurred on July 3, 2007 and 9,275,000 shares of the
Companys common stock were issued on the same date.

NOTE 12  COMMITMENTS

Capital Commitment

The Company entered into an unconditional purchase commitment for construction of manufacturing
facilities in Harbin and Guangxi, China. As of June 30, 2007, the future obligations of the Company under this commitment are as follows:



|                |  |   |       
|--------------- |  | - | ------
|Within one year |  | $ | 18,980
|Thereafter      |  |   | 3,148 
|                |  |   |       
|Total           |  | $ | 22,128
|                |  |   |       

Purchase Commitment

The Company entered into an unconditional purchase commitment for raw materials and packing materials. As of June 30, 2007, the future obligations of the Company under this commitment are as follows:



|                |  |   |          
|--------------- |  | - | ---------
|Within one year |  | $ | 3,512,242
|Thereafter      |  |   |         
|                |  |   |          
|Total           |  | $ | 3,512,242
|                |  |   |          



14



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



Lease Commitments

As of June 30, 2007, the Company had remaining outstanding commitments with respect to its non-cancelable operating leases for its offices in New York, Shenzhen and some regional representative offices in China. The future obligations
of the Company under these commitments are as follows:



|                |  |   |        
|--------------- |  | - | -------
|Within one year |  | $ | 93,082 
|Thereafter      |  |   | 122,818
|                |  |   |        
|Total           |  | $ | 215,900
|                |  |   |        

NOTE 13  REPORTING SEGMENTS

The Company operates in one operating segment in accordance with the provisions of Statement of Financial Accounting Standard (SFAS) No. 131, Disclosures about Segments of an Enterprise and
Related Information. Although the Company develops, manufactures and commercializes both PBP and PBN products, the Companys chief operating decision maker reviews and evaluates one set of combined financial information to decide how
to allocate resources and to assess performance.

For the three months and six months ended June 30, 2007 and 2006, the Companys revenue from
Plant Based Pharmaceutical (PBP) products and Plant Based Nutraceutical (PBN) products are as follows:



|             |  |                            |            |                           |   |            |  |      |            |  |   |           
|------------ |  | -------------------------- | ---------- | ------------------------- | - | ---------- |  | ---- | ---------- |  | - | ----------
|             |  | THREE MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDED JUNE 30,
|             |  | 2007                       |            | 2006                      |   | 2007       |  | 2006
|PBP products |  | $                          | 26,002,968 |                           | $ | 15,845,371 |  | $    | 44,578,676 |  | $ | 27,999,263
|PBN products |  |                            | 7,910,266  |                           |   | 6,916,511  |  |      | 15,083,932 |  |   | 13,809,563
|             |  |                            |            |                           |   |            |  |      |            |  |   |           
|TOTAL        |  | $                          | 33,913,234 |                           | $ | 22,761,882 |  | $    | 59,662,608 |  | $ | 41,808,826
|             |  |                            |            |                           |   |            |  |      |            |  |   |           

NOTE 14  INCOME TAX

The Company has not recorded a provision for federal income tax for the six months ended June 30, 2007 due to the net operating loss carry forward in the United States. In accordance with the relevant tax laws
and regulations of the Peoples Republic of China (PRC), the Corporate Income Tax rate (CIT) applicable to our subsidiaries in the PRC range from 0% to 33%. The newly acquired GLP is entitled to a full exemption from CIT
for the first two years and a 50% reduction in CIT for the next three years, commencing from the first profitable year after offsetting all tax losses carried forward from the previous five years. Three Happiness, on the other hand, enjoys a
favorable tax rate of 15% as it is located in a special economic development zone and is being considered a high technology company by the Chinese government. HSPL does not qualify for any tax concession and has a 33% tax rate.



15



---

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



The Company's tax expense differs from the "expected" tax expense for the three months and six months ended
June 30, 2007 and 2006 are as follows:



|                            |  |                            |           |                          |           |      |   |           |  |          
|--------------------------- |  | -------------------------- | --------- | ------------------------ | --------- | ---- | - | --------- |  | ---------
|                            |  | THREE MONTHS ENDEDJUNE 30, |           | SIX MONTHS ENDEDJUNE 30,
|                            |  | 2007                       |           | 2006                     |           | 2007 |   | 2006     
|Computed "expected" expense |  | $                          | 1,929,184 |                          | 1,550,708 |      | $ | 3,444,778 |  | 3,094,888
|Permanent difference        |  |                            | 10,641    |                          |          |      |   | 19,995    |  |         
|                            |  |                            |           |                          |           |      |   |           |  |          
|Income tax expense          |  | $                          | 1,939,825 |                          | 1,550,708 |      | $ | 3,464,773 |  | 3,094,888
|                            |  |                            |           |                          |           |      |   |           |  |          

The provisions for income taxes for the three months and six months ended June 30, 2007 and 2006, are
summarized as follows:



|         |  |                            |           |      |                          |   |      |   |           |  |           |  
|-------- |  | -------------------------- | --------- | ---- | ------------------------ | - | ---- | - | --------- |  | --------- | -
|         |  | THREE MONTHS ENDEDJUNE 30, |           |      | SIX MONTHS ENDEDJUNE 30, |  
|         |  | 2007                       |           | 2006 |                          |   | 2007 |   | 2006      | 
|Current  |  | $                          | 1,915,065 |      | 1,556,886                |   |      | $ | 3,448,954 |  | 3,193,227 |  
|Deferred |  |                            | 24,760    |      | (6,178                   | ) |      |   | 15,819    |  | (98,339   | )
|         |  |                            |           |      |                          |   |      |   |           |  |           |  
|Total    |  | $                          | 1,939,825 |      | 1,550,708                |   |      | $ | 3,464,773 |  | 3,094,888 |  
|         |  |                            |           |      |                          |   |      |   |           |  |           |  

The tax effects of temporary differences that give rise to the Company's net deferred tax assets as of
June 30, 2007 and December 31, 2006 are as follows:



|                               |  |               |            |   |                   |   |            |  
|------------------------------ |  | ------------- | ---------- | - | ----------------- | - | ---------- | -
|                               |  | June 30, 2007 |            |   | December 31, 2006 |  
|Deferred tax assets            |  |               |            |   |                   |   |            |  
|Bad debt                       |  | $             | 207,700    |   |                   | $ | 204,636    |  
|Amortization                   |  |               | 87,590     |   |                   |   | 81,234     |  
|Other costs                    |  |               | 890,698    |   |                   |   | 1,011,508  |  
|Stock provision                |  |               | 339,071    |   |                   |   | 330,711    |  
|Depreciation                   |  |               | 154,729    |   |                   |   | 169,064    |  
|                               |  |               |            |   |                   |   |            |  
|Total deferred tax assets      |  |               | 1,679,788  |   |                   |   | 1,797,153  |  
|Deferred tax liabilities       |  |               |            |   |                   |   |            |  
|Over accrual of welfare        |  |               | (156,622   | ) |                   |   | (152,562   | )
|Amortization                   |  |               | (223,376   | ) |                   |   | (178,216   | )
|Depreciation                   |  |               | (49,323    | ) |                   |   | (45,496    | )
|Government grant               |  |               | (851,468   | ) |                   |   | (830,475   | )
|GLP acquisition                |  |               | (3,275,593 | ) |                   |   | (3,275,593 | )
|Others                         |  |               | (99,816    | ) |                   |   | (98,356    | )
|                               |  |               |            |   |                   |   |            |  
|Total deferred tax liabilities |  |               | (4,656,198 | ) |                   |   | (4,580,698 | )
|Net deferred tax liabilities   |  | $             | (2,976,410 | ) |                   | $ | (2,783,545 | )
|                               |  |               |            |   |                   |   |            |  



16



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AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF JUNE 30, 2007

(UNAUDITED)



NOTE 15  SUBSEQUENT EVENTS

Subsequent to June 30, 2007, the Company received a total of $487,550 in connection with the exercise of warrants to purchase 75,000 shares of the Companys common stock. The number of warrants outstanding as of
the date of this report is 3,608,757.

In June 2007, the Company signed a letter of intent to acquire Changchun Xinan Pharmaceutical Group Company Limited
(CCXA), a privately owned plant based pharmaceutical company in a transaction the Company expects not to exceed US$30 million. Pursuant to the terms of the letter of intent, the Company has 90 days to enter into a definitive purchase agreement and
close the transaction with CCXA.

On August 8, 2007, the Company signed a letter of intent to acquire Guangxi Boke Pharmaceutical Company Limited (BOKE), a
privately owned healthcare company in a transaction the Company expects not to exceed US$40 million, and be paid in cash. BOKE is located in the city of Nanning in Guangxi province, China. BOKEs has mainly OTC product lines sold throughout
China including: products for alleviating nasal congestion, plant-based shampoo products to treat dandruff, and throat lozenges to alleviate sore throat symptoms. The Company expects the acquisition will close by the end of the third quarter 2007.



17



---

ITEM 2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following
discussion should be read in conjunction with the information contained in the condensed consolidated financial statements of the Company and the notes thereto appearing elsewhere herein and in conjunction with the Managements Discussion and
Analysis set forth in (1) the Companys Annual Report on Form 10-K for the year ended December 31, 2006, and (2) the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2006. Readers should carefully
review the risk factors disclosed in the Companys Form 10-K for the year ended December 31, 2006 filed by the Company with the SEC.

As used in
this report, the terms Company, we, our, us and AOBO refer to American Oriental Bioengineering, Inc., a Nevada corporation.

PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains forward-looking statements
within the meaning of the federal securities laws. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as anticipate, expect,
intend, plan, will, we believe, AOBO believes, management believes and similar language. The forward-looking statements are based on the current expectations of AOBO and are
subject to certain risks, uncertainties and assumptions, including those set forth in the discussion under Managements Discussion and Analysis of Financial Condition and Results of Operations in this report. Actual results may
differ materially from results anticipated in these forward-looking statements. We base the forward-looking statements on information currently available to us, and we assume no obligation to update them.

Investors are also advised to refer to the information in our previous filings with the Securities and Exchange Commission (SEC), especially on Forms 10-K, 10-Q and 8-K,
in which we discuss in more detail various important factors that could cause actual results to differ from expected or historic results. It is not possible to foresee or identify all such factors. As such, investors should not consider any list of
such factors to be an exhaustive statement of all risks and uncertainties or potentially inaccurate assumptions.

CRITICAL ACCOUNTING POLICIES AND
ESTIMATES

This section should be read together with the Summary of Significant Accounting Policies included as Note 3 to the consolidated financial
statements included in our Annual Report on Form 10-K for 2006 filed with the SEC.

Estimates affecting accounts receivable and
inventories

The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect our reporting of
assets and liabilities (and contingent assets and liabilities). These estimates are particularly significant where they affect the reported net realizable value of the Companys accounts receivable and inventories.

At June 30, 2007, the Company provided a $77,652 reserve against accounts receivable. Managements estimate of the appropriate reserve on accounts receivable
at June 30, 2007 was based on the aged nature of these accounts receivable. In making its judgment, management assessed its customers ability to continue to pay their outstanding invoices on a timely basis, and whether their financial
position might deteriorate significantly in the future, which would result in their inability to pay their debts to the Company.

At June 30, 2007,
the Company provided an allowance against its inventories amounting to $598,169. Management determination of this allowance is based on potential impairments to the current carrying value of the inventories due to slow moving of aged inventories. In
making its estimate, management considered the probable demand for our products in the future and historical trends in the turnover of our inventories.



18



---

While the Company currently believes that there is little likelihood that actual results will differ materially from
these current estimates, if customer demand for our products decreases significantly in the near future, or if the financial condition of our customers deteriorates in the near future, the Company could realize significant write downs for
slow-moving inventories or uncollectible accounts receivable.

Policy affecting recognition of revenue

Among the most important accounting policies affecting our consolidated financial statements is our policy of recognizing revenue in accordance with the SECs Staff
Accounting Bulletin (SAB) No. 104. Under this policy, all of the following criteria must be met in order for us to recognize revenue:



| | 1. | Persuasive evidence of an arrangement exists;
| | -- | ---------------------------------------------



| | 2. | Delivery has occurred or services have been rendered;
| | -- | -----------------------------------------------------



| | 3. | The sellers price to the buyer is fixed or determinable; and
| | -- | -------------------------------------------------------------



| | 4. | Collectibility is reasonably assured.
| | -- | -------------------------------------

The majority of the Companys
revenue results from sales contracts with distributors and revenue is recorded upon the shipment of goods. Management conducts credit background checks for new customers as a means to reduce the subjectivity of assuring collectibility. Based on
these factors, the Company believes that it can apply the provisions of SAB 104 with minimal subjectivity.

In August 2005, we established a subsidiary in
Hong Kong with a specialty store to sell some of our products. Our subsidiary in Hong Kong also sells certain products to certain customers on consignment. We record revenue from consignment transactions when the consignee sells the product to the
end user. Revenue from our Hong Kong subsidiary was less than 1% of the consolidated revenue of the Company for the quarter ended June 30, 2007.

RECENT ACCOUNTING PRONOUNCEMENT

In September 2006, the Financial Accounting Standard Board (FASB) issued SFAS No. 157,
"Fair Value Measurements," which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 provides a common definition of fair value and establishes a framework to make the measurement of fair value in
generally accepted accounting principles more consistent and comparable. SFAS No. 157 also requires expanded disclosures to provide information about the extent to which fair value is used to measure assets and liabilities, the methods and
assumptions used to measure fair value, and the effect of fair value measures on earnings. SFAS No. 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007 and to interim periods within those
fiscal years. The Company is currently in the process of evaluating the effect, if any, the adoption of SFAS No. 157 will have on its consolidated results of operations, financial position, or cash flows.

In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  including an amendment of FASB
Statement No. 115 (FAS 159). FAS 159 will become effective for the company on January 1, 2008. This standard permits companies to choose to measure many financial instruments and certain other items at fair value and report unrealized
gains and losses in earnings. Such accounting is optional and is generally to be applied instrument by instrument. The company does not anticipate that the election, if any, of this fair-value option will have a material effect on results or
operations or consolidated financial position.



19



---

RESULTS OF OPERATIONS  THREE MONTHS ENDED JUNE 30, 2007 AS COMPARED TO THREE MONTHS ENDED JUNE 30, 2006

The following table sets forth the amounts and the percentage relationship to revenues of certain items in our condensed consolidated statements of income
for the three months ended June 30, 2007 and 2006:



|                              |  |                            |            |                            |   |            |  |     |      |  |     |  
|----------------------------- |  | -------------------------- | ---------- | -------------------------- | - | ---------- |  | --- | ---- |  | --- | -
|                              |  | THREE MONTHS ENDEDJUNE 30, |            | THREE MONTHS ENDEDJUNE 30, |  
|                              |  | 2007                       |            | 2006                       |   | 2007       |  |     | 2006 | 
|REVENUES                      |  | $                          | 33,913,234 |                            | $ | 22,761,882 |  | 100 | %    |  | 100 | %
|COST OF GOODS SOLD            |  |                            | 10,210,485 |                            |   | 8,092,663  |  | 30  |      |  | 36  |  
|                              |  |                            |            |                            |   |            |  |     |      |  |     |  
|GROSS PROFIT                  |  |                            | 23,702,749 |                            |   | 14,669,219 |  | 70  |      |  | 64  |  
|Selling and marketing         |  |                            | 3,886,564  |                            |   | 1,956,629  |  | 11  |      |  | 9   |  
|Advertising                   |  |                            | 5,412,510  |                            |   | 3,001,974  |  | 16  |      |  | 13  |  
|General and administrative    |  |                            | 2,557,805  |                            |   | 2,437,645  |  | 8   |      |  | 11  |  
|Depreciation and amortization |  |                            | 341,562    |                            |   | 267,129    |  | 1   |      |  | 1   |  
|                              |  |                            |            |                            |   |            |  |     |      |  |     |  
|Total operating expenses      |  |                            | 12,198,441 |                            |   | 7,663,377  |  | 36  |      |  | 34  |  
|INCOME FROM OPERATIONS        |  |                            | 11,504,308 |                            |   | 7,005,842  |  | 34  |      |  | 30  |  
|Interest income, net          |  |                            | 43,048     |                            |   | 361,951    |  | 0   |      |  | 2   |  
|Other income, net             |  |                            | 60,840     |                            |   | 10,136     |  | 0   |      |  | 0   |  
|                              |  |                            |            |                            |   |            |  |     |      |  |     |  
|INCOME BEFORE INCOME TAXES    |  |                            | 11,608,196 |                            |   | 7,377,929  |  | 34  |      |  | 32  |  
|Income taxes                  |  |                            | 1,939,825  |                            |   | 1,550,708  |  | 6   |      |  | 7   |  
|                              |  |                            |            |                            |   |            |  |     |      |  |     |  
|NET INCOME                    |  | $                          | 9,668,371  |                            | $ | 5,827,221  |  | 28  |      |  | 26  |  
|                              |  |                            |            |                            |   |            |  |     |      |  |     |  

Revenues

Revenues for the second quarter of 2007 were $33,913,234 an increase of $11,151,352 over revenues for the second quarter of 2006. Revenues by product categories were as follows:



|             |  |                            |            |                     |   |                     |  |            |  |    |  
|------------ |  | -------------------------- | ---------- | ------------------- | - | ------------------- |  | ---------- |  | -- | -
|             |  | THREE MONTHS ENDEDJUNE 30, |            | Increase/(Decrease) |   | Increase/(Decrease) | 
|             |  | 2007                       |            | 2006                |   |                    
|             |  |                            |            |                     |   | $                   |  | %          | 
|PBP products |  | $                          | 26,002,968 |                     | $ | 15,845,371          |  | 10,157,597 |  | 64 | %
|PBN products |  |                            | 7,910,266  |                     |   | 6,916,511           |  | 993,755    |  | 14 | %
|             |  |                            |            |                     |   |                     |  |            |  |    |  
|TOTAL        |  | $                          | 33,913,234 |                     | $ | 22,761,882          |  | 11,151,352 |  | 49 | %
|             |  |                            |            |                     |   |                     |  |            |  |    |  

Sales of our PBP products increased by $10,157,597, or 64%, as compared to the same period during 2006 primarily
due to the following factors:



| |  | Guangxi Lingfeng Pharmaceutical Co. Ltd. (GLP) contributed $11,502,487 to our revenue for the three months ended June 30, 2007, which was an $8,462,465
increase compared to the same period last year. Revenue from GLPs Jinji series was approximately $9,226,351 and revenue from Yi Mu Cao was $2,277,136.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



---

| |  | The sales of Shuanghuanglian Injection Powder and Cease Enuresis Soft Gel contributed $11,526,585 to our revenue for the second quarter of 2007, which was a
$1,480,708, or 15% increase as compared to the same period last year.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sales from our PBN products increased to $7,910,266 in the second
quarter of 2007 from $6,916,511 in the same period during 2006, representing a growth of 14%. This increase was mainly attributed to the increase in sales of peptide tablets and peptide powder.

Cost of Goods Sold and Gross Profit

Cost of goods sold was
$10,210,485 for the three months ended June 30, 2007, compared to $8,092,663 for the three months ended June 30, 2006. Expressed as a percentage of revenues, cost of goods sold was 30% for the three months ended June 30, 2007,
compared to 36% for the three months ended June 30, 2006. The reduction in cost of goods sold as a percentage of revenues reflected a continued focus on operating cost management, sourcing efficiencies and operation efficiencies. Cost of goods
sold for the quarters ended June 30, 2007 and 2006 by product categories were as follows:



|             |  |                            |            |                     |   |                     |  |           |  |    |  
|------------ |  | -------------------------- | ---------- | ------------------- | - | ------------------- |  | --------- |  | -- | -
|             |  | THREE MONTHS ENDEDJUNE 30, |            | Increase/(Decrease) |   | Increase/(Decrease) | 
|             |  | 2007                       |            | 2006                |   |                    
|             |  |                            |            |                     |   | $                   |  | %         | 
|PBP products |  | $                          | 7,278,150  |                     | $ | 5,629,083           |  | 1,649,067 |  | 29 | %
|PBN products |  |                            | 2,932,335  |                     |   | 2,463,580           |  | 468,755   |  | 19 | %
|             |  |                            |            |                     |   |                     |  |           |  |    |  
|TOTAL        |  | $                          | 10,210,485 |                     | $ | 8,092,663           |  | 2,117,822 |  | 26 | %
|             |  |                            |            |                     |   |                     |  |           |  |    |  

The cost of goods sold of PBP and PBN products increased by 29% and 19%, respectively, in the three months ended
June 30, 2007 compared to the same quarter of 2006. These increases were attributed to our increase in sales.

Gross profit increased $9,033,530, or
62%, for the three months ended June 30, 2007 compared to the three months ended June 30, 2006. This increase reflected higher net sales, improved margins and operating efficiencies generally across our PBP businesses.

Gross profit as a percentage of net revenues increased from 64% in the comparable period of the prior year to 70% in the second quarter of 2007 due to the reductions in
cost of goods sold as a percentage of revenues discussed above, improved operational efficiency and increase in the sales of PBP products which have higher gross profit margins.

Selling and Marketing

Selling and marketing expenses, including distribution expenses, increased from $1,956,629 in
the three months ended June 30, 2006 to $3,886,564 in the same period of 2007, representing a 99% increase. The details of our selling and marketing expenses were as follows:



|                               |  |                            |           |                      |   |           |  |           |  |       |  
|------------------------------ |  | -------------------------- | --------- | -------------------- | - | --------- |  | --------- |  | ----- | -
|                               |  | THREE MONTHS ENDEDJUNE 30, |           | Increase/ (Decrease) |  
|                               |  | 2007                       |           | 2006                 |   | $         |  | %         | 
|Payroll                        |  | $                          | 1,004,415 |                      | $ | 379,249   |  | 625,166   |  | 165   | %
|Shipping                       |  |                            | 569,645   |                      |   | 518,970   |  | 50,675    |  | 10    | %
|Promotional materials and fees |  |                            | 523,719   |                      |   | 460,974   |  | 62,745    |  | 14    | %
|Sales conference               |  |                            | 97,743    |                      |   | 48,447    |  | 49,296    |  | 102   | %
|Offices supplies               |  |                            | 218,736   |                      |   | 117,600   |  | 101,136   |  | 86    | %
|Trip and traveling             |  |                            | 441,022   |                      |   | 100,488   |  | 340,534   |  | 339   | %
|Business expense               |  |                            | 524,573   |                      |   | 246,556   |  | 278,017   |  | 113   | %
|Stores decoration expense      |  |                            | 410,211   |                      |   | 1,831     |  | 408,380   |  | 22304 | %
|Other                          |  |                            | 96,500    |                      |   | 82,514    |  | 13,986    |  | 17    | %
|                               |  |                            |           |                      |   |           |  |           |  |       |  
|TOTAL                          |  | $                          | 3,886,564 |                      | $ | 1,956,629 |  | 1,929,935 |  | 99    | %
|                               |  |                            |           |                      |   |           |  |           |  |       |  



21



---

The increase in selling and marketing expenses in the quarter ended June 30, 2007 compared to the same quarter
during 2006 was primarily due to the following factors:



| |  | The increase in the payroll expenses was due to the increase in hiring of sales and marketing professionals in the first half of 2007 to support future growth of
businesses.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Pharmacy and store decoration increased because of a new marketing initiative launched by the Company in 2007 to help establish and enforce relationship with
retailers by providing decorative posters and print ads for store windows. This initiative also serves as a promotional function.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The increase in trip and traveling and business expense reflect increased spending in marketing communications to increase market awareness of our brand and
products. More sales conferences in more cities were held in the second quarter of 2007 compared to the same quarter of 2006.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Advertising

Advertising expenses increased by $2,410,536, from $3,001,974 in the second quarter of 2006 to $5,412,510 in the same quarter
of 2007. The increase in advertising expenses resulted from an increase in promotional efforts to promote GLPs Jinji product series and Yi Mu Cao which was launched in early 2007.

General and Administrative

General and administrative expenses increased from $2,437,645 in the second quarter of
2006 to $2,557,805 in the same quarter of 2007, or a 5% increase. The details of general and administrative expenses were as follows:



|                                         |  |                            |           |                      |   |           |  |   |          |   |  |     |   
|---------------------------------------- |  | -------------------------- | --------- | -------------------- | - | --------- |  | - | -------- | - |  | --- | --
|                                         |  | THREE MONTHS ENDEDJUNE 30, |           | Increase/ (Decrease) |  
|                                         |  | 2007                       |           | 2006                 |   | $         |  |   | %        |  
|Payroll                                  |  | $                          | 509,113   |                      | $ | 342,517   |  | $ | 166,596  |   |  | 49  | % 
|Directors remuneration                  |  |                            | 163,083   |                      |   | 114,250   |  |   | 48,833   |   |  | 43  | % 
|Stock compensation  directors           |  |                            | 136,673   |                      |   | 79,950    |  |   | 56,723   |   |  | 71  | % 
|Stock compensation  consultants         |  |                            | 148,300   |                      |   | 245,262   |  |   | (96,962  | ) |  | (40 | )%
|Office rental                            |  |                            | 84,498    |                      |   | 96,889    |  |   | (12,391  | ) |  | (13 | )%
|Professional fees  accounting           |  |                            | 28,943    |                      |   | 99,605    |  |   | (70,662  | ) |  | (71 | )%
|Professional fees  legal and consulting |  |                            | 89,232    |                      |   | 205,236   |  |   | (116,004 | ) |  | (57 | )%
|Investors relation and listing expenses  |  |                            | 80,363    |                      |   | 90,724    |  |   | (10,361  | ) |  | (11 | )%
|Office supplies                          |  |                            | 121,177   |                      |   | 179,835   |  |   | (58,658  | ) |  | (33 | )%
|Vehicles & Utilities                     |  |                            | 91,580    |                      |   | 77,120    |  |   | 14,460   |   |  | 19  | % 
|Research                                 |  |                            | 203,847   |                      |   | 198,097   |  |   | 5,750    |   |  | 3   | % 
|Trip and traveling                       |  |                            | 245,825   |                      |   | 63,329    |  |   | 182,496  |   |  | 288 | % 
|Business entertainment                   |  |                            | 43,954    |                      |   | 132,302   |  |   | (88,348  | ) |  | (67 | )%
|Provision for bad debts                  |  |                            | 11,135    |                      |   | 38,033    |  |   | (26,898  | ) |  | (71 | )%
|Staff welfare and insurance              |  |                            | 151,528   |                      |   | 158,320   |  |   | (6,792   | ) |  | (4  | )%
|Maintenance and repair fee               |  |                            | 35,566    |                      |   | 82,505    |  |   | (46,939  | ) |  | (57 | )%
|Miscellaneous                            |  |                            | 412,988   |                      |   | 233,671   |  |   | 179,317  |   |  | 77  | % 
|                                         |  |                            |           |                      |   |           |  |   |          |   |  |     |   
|TOTAL                                    |  | $                          | 2,557,805 |                      | $ | 2,437,645 |  | $ | 120,160  |   |  | 5   | % 
|                                         |  |                            |           |                      |   |           |  |   |          |   |  |     |   



22



---

The increase in general and administrative expenses in the three months ended June 30, 2007 compared to the same
period during 2006 was primarily due to the following factors:



| |  | Payroll expenses increased by $166,596, or 49% compared with the first quarter during 2006, as a result of hiring new employees.
|- |  | --------------------------------------------------------------------------------------------------------------------------------



| |  | Expenses for trip and traveling increased by $182,496, or 288% compared with the same quarter of 2006, as a result of increased overseas travel to attend corporate
and investor functions and increased local travel between operating facilities and the new corporate office.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The company made general provisions for bad debts based on the age of its accounts receivable. A tight credit control policy and the consistent efforts in
collecting long outstanding debts inherited from acquired subsidiaries resulted in a better receivable turnover rate and a higher recovery of old debts. The company provided $11,135 provision for bad debts during the quarter.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other expenses increased by $179,317 during the second quarter of 2007 compared with the second quarter of 2006. This increase was due to increase in conference
fee, staff training, other miscellaneous, local taxes and consumable amortization expenses.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Depreciation and Amortization

Depreciation and amortization expenses increased by $74,433, or 28%, in the quarter ended June 30, 2007 compared to the same quarter during 2006.
The increase was mainly due to the integration of GLP with the net book value of $10,459,848 in fixed assets and $25,275,578 in intangible assets in May of 2006.

Interest Income, Net

Net interest income was $43,048 for the three months ended June 30, 2007, compared to net interest income of
$361,951 for the three months ended June 30, 2006. Decrease in net interest income for the second quarter of 2007 was because the interest income was offset by interest expense incurred by GLP.

Other Income (expense), Net

Other income was $60,840 for the three
months ended June 30, 2007 compared to a net income of $10,136 for the three months ended June 30, 2006.

Income Taxes

Income tax expense for the quarter ended June 30, 2007 was $1,939,825, compared to $1,550,708 for the quarter ended June 30, 2007. The Companys effective
tax rate for this quarter was 17%.



23



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RESULTS OF OPERATIONS  SIX MONTHS ENDED JUNE 30, 2007 AS COMPARED TO SIX MONTHS ENDED JUNE 30, 2006

The following table sets forth the amounts and the percentage relationship to revenues of certain items in our condensed consolidated statements of
income for the six months ended June 30, 2007 and 2006:



|                              |  |                           |            |                          |   |            |  |     |      |  |     |  
|----------------------------- |  | ------------------------- | ---------- | ------------------------ | - | ---------- |  | --- | ---- |  | --- | -
|                              |  | SIX MONTHS ENDED JUNE 30, |            | SIX MONTHS ENDEDJUNE 30, |  
|                              |  | 2007                      |            | 2006                     |   | 2007       |  |     | 2006 | 
|REVENUES                      |  | $                         | 59,662,608 |                          | $ | 41,808,826 |  | 100 | %    |  | 100 | %
|COST OF GOODS SOLD            |  |                           | 18,240,539 |                          |   | 14,875,987 |  | 31  |      |  | 36  |  
|                              |  |                           |            |                          |   |            |  |     |      |  |     |  
|GROSS PROFIT                  |  |                           | 41,422,069 |                          |   | 26,932,839 |  | 69  |      |  | 64  |  
|Selling and marketing         |  |                           | 6,590,035  |                          |   | 3,655,169  |  | 11  |      |  | 9   |  
|Advertising                   |  |                           | 9,237,855  |                          |   | 5,222,067  |  | 15  |      |  | 12  |  
|General and administrative    |  |                           | 5,495,949  |                          |   | 4,316,287  |  | 9   |      |  | 10  |  
|Depreciation and amortization |  |                           | 675,836    |                          |   | 365,559    |  | 1   |      |  | 1   |  
|                              |  |                           |            |                          |   |            |  |     |      |  |     |  
|Total operating expenses      |  |                           | 21,999,675 |                          |   | 13,559,082 |  | 36  |      |  | 32  |  
|INCOME FROM OPERATIONS        |  |                           | 19,422,394 |                          |   | 13,373,757 |  | 33  |      |  | 32  |  
|Interest income, net          |  |                           | 17,238     |                          |   | 443,514    |  | 0   |      |  | 1   |  
|Other income, net             |  |                           | 142,958    |                          |   | 9,144      |  | 0   |      |  | 0   |  
|                              |  |                           |            |                          |   |            |  |     |      |  |     |  
|INCOME BEFORE INCOME TAXES    |  |                           | 19,582,590 |                          |   | 13,826,415 |  | 33  |      |  | 33  |  
|Income taxes                  |  |                           | 3,464,773  |                          |   | 3,094,888  |  | 6   |      |  | 7   |  
|                              |  |                           |            |                          |   |            |  |     |      |  |     |  
|NET INCOME                    |  | $                         | 16,117,817 |                          | $ | 10,731,527 |  | 27  |      |  | 26  |  
|                              |  |                           |            |                          |   |            |  |     |      |  |     |  

Revenues

Revenues for the six months ended June 30, 2007 were $59,662,608, increased by $17,853,782, as compared to the same period during 2006. Revenues by product categories were as follows:



|             |  |                           |            |           |   |            |  |            |  |    |  
|------------ |  | ------------------------- | ---------- | --------- | - | ---------- |  | ---------- |  | -- | -
|             |  | SIX MONTHS ENDED JUNE 30, |            | Increase/ |   | Increase/  | 
|             |  | 2007                      |            | 2006      |   | (Decrease) |  | (Decrease) | 
|             |  |                           |            |           |   | $          |  | %          | 
|PBP products |  | $                         | 44,578,676 |           | $ | 27,999,263 |  | 16,579,413 |  | 59 | %
|PBN products |  |                           | 15,083,932 |           |   | 13,809,563 |  | 1,274,369  |  | 9  | %
|             |  |                           |            |           |   |            |  |            |  |    |  
|TOTAL        |  | $                         | 59,662,608 |           | $ | 41,808,826 |  | 17,853,782 |  | 43 | %
|             |  |                           |            |           |   |            |  |            |  |    |  

Sales of our PBP products increased by $16,579,413, or 59%, as compared to the same period during 2006 primarily
due to the following factors:



| |  | GLP contributed $17,895,079 to our revenue for the six months ended June 30, 2007. Revenue from GLPs Jinji series was approximately $14,351,058 and
revenue from Yi Mu Cao was $3,544,021. GLP was not a subsidiary until April of 2006.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



24



---

| |  | The sales of Shuanghuanglian Injection Powder and Cease Enuresis Soft Gel contributed $21,203,417 to our revenue for the six months of 2007, which was a $1,411,935,
or 7% increase, as compared to the same period last year.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sales from our PBN products increased to $15,083,932 in the six months ended
June 30, 2007 from $13,809,563 in the same period during 2006, representing a growth of 9%. This increase was mainly attributed to the increase in sales of peptide coffee and peptide powder.

Cost of Goods Sold and Gross Profit

Cost of goods sold was
$18,240,539 for the six months ended June 30, 2007, compared to $14,875,987 for the six months ended June 30, 2006. Expressed as a percentage of revenues, cost of goods sold was 31% for the six months ended June 30, 2007, compared to
36% for the six months ended June 30, 2006. The reduction in cost of goods sold as a percentage of revenues reflected a continued focus on operating cost management, sourcing efficiencies and operation efficiencies. Cost of goods sold for the
six months ended June 30, 2007 and 2006 by product categories were as follows:



|             |  |                           |            |           |   |            |  |            |  |    |  
|------------ |  | ------------------------- | ---------- | --------- | - | ---------- |  | ---------- |  | -- | -
|             |  | SIX MONTHS ENDED JUNE 30, |            | Increase/ |   | Increase/  | 
|             |  | 2007                      |            | 2006      |   | (Decrease) |  | (Decrease) | 
|             |  |                           |            |           |   | $          |  | %          | 
|PBP products |  | $                         | 12,758,789 |           | $ | 10,024,117 |  | 2,734,672  |  | 27 | %
|PBN products |  |                           | 5,481,750  |           |   | 4,851,870  |  | 629,880    |  | 13 | %
|             |  |                           |            |           |   |            |  |            |  |    |  
|TOTAL        |  | $                         | 18,240,539 |           | $ | 14,875,987 |  | 3,364,552  |  | 23 | %
|             |  |                           |            |           |   |            |  |            |  |    |  

The cost of goods sold of PBP and PBN products increased by 27% and 13%, respectively, in the six months ended
June 30, 2007 compared to the same period of 2006. These increases were attributed to our increase in sales.

Gross profit increased $14,489,230, or
54%, for the six months ended June 30, 2007 over the six months ended June 30, 2006. This increase reflected higher net sales, improved margins and operating efficiencies generally across our PBP businesses.

Gross profit as a percentage of net revenues increased from 64% in the comparable period of the prior year to 69% due to the reductions in cost of goods sold as a
percentage of revenues discussed above, improved operational efficiency and increase in the sales of PBP products which have higher gross profit margins.

Selling and Marketing

Selling and marketing expenses, including distribution expenses, increased from $3,655,169 during the six months
ended June 30, 2006 to $6,590,035 in the same period of 2007, representing an 80% increase. The details of our selling and marketing expenses were as follows:



|                               |  |                           |           |                      |   |           |  |           |  |       |  
|------------------------------ |  | ------------------------- | --------- | -------------------- | - | --------- |  | --------- |  | ----- | -
|                               |  | SIX MONTHS ENDED JUNE 30, |           | Increase/ (Decrease) |  
|                               |  | 2007                      |           | 2006                 |   | $         |  | %         | 
|Payroll                        |  | $                         | 1,622,208 |                      | $ | 572,763   |  | 1,049,445 |  | 183   | %
|Shipping                       |  |                           | 969,398   |                      |   | 952,769   |  | 16,629    |  | 2     | %
|Promotional materials and fees |  |                           | 1,093,701 |                      |   | 828,120   |  | 265,581   |  | 32    | %
|Sales conference               |  |                           | 590,357   |                      |   | 253,041   |  | 337,316   |  | 133   | %
|Offices supplies               |  |                           | 264,613   |                      |   | 190,066   |  | 74,547    |  | 39    | %
|Trip and traveling             |  |                           | 749,327   |                      |   | 129,914   |  | 619,413   |  | 477   | %
|Business expense               |  |                           | 687,153   |                      |   | 616,555   |  | 70,598    |  | 11    | %
|Store decoration expense       |  |                           | 410,306   |                      |   | 3,448     |  | 406,858   |  | 11800 | %
|Other                          |  |                           | 202,972   |                      |   | 108,493   |  | 94,479    |  | 87    | %
|                               |  |                           |           |                      |   |           |  |           |  |       |  
|TOTAL                          |  | $                         | 6,590,035 |                      | $ | 3,655,169 |  | 2,934,866 |  | 80    | %
|                               |  |                           |           |                      |   |           |  |           |  |       |  



25



---

The increase in selling and marketing expenses in the six months ended June 30, 2007 compared to the same period
during 2006 was primarily due to the following factors:



| |  | The increase in the payroll expenses was due to the increase in hiring of sales and marketing professionals in the first half of 2007 to support future growth of
businesses.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Pharmacy and store decoration increased because of this new marketing initiative launched by the Company in 2007 to help establish and enforce relationship with
retailers by providing decorative posters and print ads for store windows. This initiative also serves as a promotional function.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The increase in trip and traveling and business expense reflects increased spending in marketing communications to increase market awareness of our brand and
products. More sales conferences in more cities were held in the first half of 2007 compared to the same period of 2006.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Advertising

Advertising expenses increased by $4,015,788, from $5,222,067 in the six months ended June 30, 2006 to $9,237,855 in the same period during 2007.
The increase in advertising expenses resulted from an increase in promotional efforts to promote GLPs Jinji product series and Yi Mu Cao. GLP incurred $4,523,585 in advertising expenses during the six months of 2007. GLP was not a subsidiary
until April of 2006.

General and Administrative

General and administrative expenses increased from $4,316,287 in the first six months of 2006 to $5,495,949 in the same period of 2007, or a 27% increase. The details of general and administrative expenses were as follows:



|                                         |  |                           |           |      |                      |           |   |  |           |   |  |     |   
|---------------------------------------- |  | ------------------------- | --------- | ---- | -------------------- | --------- | - |  | --------- | - |  | --- | --
|                                         |  | SIX MONTHS ENDED JUNE 30, |           |      | Increase/ (Decrease) |          
|                                         |  | 2007                      |           | 2006 |                      |           | $ |  |           | % | 
|Payroll                                  |  | $                         | 960,143   |      | $                    | 620,006   |   |  | 340,137   |   |  | 55  | % 
|Directors remuneration                  |  |                           | 292,333   |      |                      | 228,500   |   |  | 63,833    |   |  | 28  | % 
|Stock compensation  directors           |  |                           | 174,173   |      |                      | 158,400   |   |  | 15,773    |   |  | 10  | % 
|Stock compensation  consultants         |  |                           | 264,100   |      |                      | 490,520   |   |  | (226,420  | ) |  | (46 | )%
|Office rental                            |  |                           | 180,796   |      |                      | 190,559   |   |  | (9,763    | ) |  | (5  | )%
|Professional fees  accounting           |  |                           | 559,938   |      |                      | 355,411   |   |  | 204,527   |   |  | 58  | % 
|Professional fees  legal and consulting |  |                           | 234,714   |      |                      | 318,937   |   |  | (84,223   | ) |  | (26 | )%
|Investors relation and listing expenses  |  |                           | 175,785   |      |                      | 201,364   |   |  | (25,579   | ) |  | (13 | )%
|Office supplies                          |  |                           | 344,293   |      |                      | 326,190   |   |  | 18,103    |   |  | 6   | % 
|Vehicles & Utilities                     |  |                           | 186,471   |      |                      | 156,105   |   |  | 30,366    |   |  | 19  | % 
|Research                                 |  |                           | 380,662   |      |                      | 370,660   |   |  | 10,002    |   |  | 3   | % 
|Trip and traveling                       |  |                           | 486,749   |      |                      | 159,081   |   |  | 327,668   |   |  | 206 | % 
|Business entertainment                   |  |                           | 84,589    |      |                      | 201,503   |   |  | (116,914  | ) |  | (58 | )%
|Provision for bad debts                  |  |                           | 50,398    |      |                      | (77,402   | ) |  | 127,800   |   |  | 165 | % 
|Staff welfare and insurance              |  |                           | 319,531   |      |                      | 176,405   |   |  | 143,126   |   |  | 81  | % 
|Maintenance and repair fee               |  |                           | 104,978   |      |                      | 96,645    |   |  | 8,333     |   |  | 9   | % 
|Miscellaneous                            |  |                           | 696,296   |      |                      | 343,403   |   |  | 352,893   |   |  | 103 | % 
|                                         |  |                           |           |      |                      |           |   |  |           |   |  |     |   
|TOTAL                                    |  | $                         | 5,495,949 |      | $                    | 4,316,287 |   |  | 1,179,662 |   |  | 27  | % 
|                                         |  |                           |           |      |                      |           |   |  |           |   |  |     |   



26



---

The increase in general and administrative expenses in the six months ended June 30, 2007 compared to the same
period during 2006 was primarily due to the following factors:



| |  | Payroll expenses increased by $340,137, or 55% compared with the first half during 2006, as a result of hiring new employees.
|- |  | -----------------------------------------------------------------------------------------------------------------------------



| |  | Professional fees related to accounting increased by $204,527, or 58% during the first six months of 2007 as compared to the same period of 2006 due to an increase
in our audit fees as this was the first year our auditors performed additional procedures to support their opinion for year ended December 31, 2006 on the effectiveness of the companys internal control over financial reporting.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Expenses for trip and traveling increased by $327,668, or 206% compared with the same period of 2006, as a result of increased overseas travel to attend corporate
and investor functions and increased local travel between operating facilities and new corporate office.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The company made general provisions for bad debts based on the age of its accounts receivable. A tight credit control policy and the consistent efforts in
collecting long outstanding debts inherited from acquired subsidiaries resulted in a better receivable turnover rate and a higher recovery of old debts. The company provided $50,398 provision for bad debts during the first half of 2007.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other expenses increased by $352,893 during the first half of 2007 compared with the same period of 2006. This increase was due to increase in conference fee, staff
training, other miscellaneous, local taxes and consumable amortization expenses.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Depreciation and Amortization

Depreciation and amortization expenses increased by $310,277 to $675,836 during the first six months of 2007. The increase was mainly due to the integration of GLP with
the net book value of $10,459,848 in fixed assets and $25,275,578 in intangible assets. The depreciation and amortization expenses at GLP amounted to $335,855 for the first six months of 2007. GLP was not a subsidiary until April of 2006.

Interest Income, Net

Net interest income was $17,238
for the six months ended June 30, 2007, compared to net interest income of $443,514 for the six months ended June 30, 2006. Decrease in net interest income for first six months of 2007 was because the interest income was offset by interest
expense incurred by GLP, which was not a subsidiary until April of last year.

Other Income (expense), Net

Other income was $142,958 for the six months ended June 30, 2007 compared to a net income of $9,144 for the six months ended June 30, 2006.



27



---

Income Taxes

Income
tax expense for the six months ended June 30, 2007 was $3,464,773, compared to $3,094,888 for the six months ended June 30, 2006. The Companys effective tax rate during the six months ended June 30, 2007 was 18%.



28



---

LIQUIDITY AND CAPITAL RESOURCES

Cash

Our cash balance at June 30, 2007, was $108,449,801, representing an increase of $20,665,382, or 24%,
compared with our cash balance of $87,784,419 at December 31, 2006. The increase was mainly attributable to net cash provided by operating activities and the receipt of proceeds from the exercise of warrants.

We plan to use our cash for acquisitions, research and development activities, sales and marketing of our products, and other general corporate purposes.

Currently our operations and facilities are mainly in China. Especially for the purpose of acquisitions, it is very important to have cash in local currency maintained
in a bank in China to demonstrate our financial strength to acquire potential companies in cash and to pay immediately. Because of the anticipated appreciation of Renminbi, interest rates in China are lower than other foreign currencies. In
addition, the newly increased interest rate for savings accounts is at 0.81% per annum. We manage our cash based on thorough consideration of our corporate strategy as well as the macro economic situation. Factors we take into account when
managing our cash include interest income, foreign currency fluctuation as well as flexibility in executing our acquisition strategy.

Cash Flow

Cash flows from operations during the six months ended June 30, 2007 amounted to $16,007,441, representing an increase of approximately 96% compared
with cash flows from operations of $ 8,187,584 in the same period of 2006. The increased cash flow was due primarily to the increase in our net income by 50%, to $16,117,817 in the first six months of 2007, compared with net income of $10,731,527 in
the same period last year. The increased cash flow was also due in part to a decrease in notes receivable by $2,543,005 and increase in accounts payable of $734,805 during the six months ended June 30, 2007, due to our better control over
payment to our vendors. These increases were partly offset by an increase in our advance to suppliers of $1,453,861 and our inventories of $1,371,699 to support increased production activities. The increased cash flow was also offset by a decrease
in other payable and accrual of $1,897,810 and tax payable of $461,975, which resulted from the payment of accrued bonus and income tax.

Our cash flows
used in investing activities amounted to $1,441,700 in the six months ended June 30, 2007. During that period, we paid $953,637 for purchases of plant and equipment and spent $488,063 on construction in progress.

Our cash flows from financing activities amounted to $4,060,627 in the six months ended June 30, 2007. During that period, we repaid $17,961 bank loans and received
$3,960,164 proceeds from exercise of warrants.

Working Capital

Our working capital increased by $22,088,091 to $114,340,162 at June 30, 2007 as compared to $92,252,071 at December 31, 2006, primarily due to our increase in cash of $20,665,382, inventories of $1,446,938, advances to suppliers
of $1,372,562 and partly offset by a decrease of $2,543,005 in notes receivable and an increase of $882,101 in accounts payable. The increase of inventory was because we maintained higher inventory level to prepare for increased operating
activities. The decrease in notes receivable was the result of better credit control.

We currently generate our cash flow through operations. We believe
that our cash flow generated from operations will be sufficient to sustain operations for at least the next twelve months. There is no identifiable expansion plan as of June 30, 2007, but from time to time, we may identify new expansion
opportunities for which there will be a need for use of cash.



29



---

ISSUANCE OF COMMON STOCK

None noted

INFLATION

Inflation has not had a
material impact on our business and we do not expect inflation to have an impact on our business in the near future.

CURRENCY EXCHANGE FLUCTUATIONS

All of the Companys revenues and a majority of its expenses in the six months ended June 30, 2007 were denominated in Renminbi
(RMB), the currency of China, and were converted into US dollars at the exchange rate of 7.7211 to 1. In the third quarter of 2005, the Renminbi began to rise against the US dollar. As a result of the appreciation of the RMB, we
recognized a foreign currency translation gain of $3,401,555 during the six months ended June 30, 2007. There can be no assurance that RMB-to-U.S. dollar exchange rates will remain stable. A devaluation of RMB relative to the U.S. dollar would
adversely affect our business, consolidated financial condition and results of operations. We do not engage in currency hedging.

ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not hold any derivative instruments and do
not engage in any hedging activities. Because most of our purchases and sales are made in RMB, any exchange rate change affecting the value of the RMB relative to the U.S. dollar could have an effect on our financial results as reported in U.S.
dollars. If the RMB were to depreciate against the U.S. dollar, amounts reported in U.S. dollars would be correspondingly reduced. If the RMB were to appreciate against the U.S. dollar, amounts reported in U.S. dollars would be correspondingly
increased.

ITEM 4CONTROLS AND PROCEDURES

As of the end of the period covered by this report (the Evaluation Date),
we carried out an evaluation in accordance with the requirements of Chinese auditing standards and applicable U.S. rules. The Company has an audit group, which consists of the Chief Executive Officer, Chief Financial Officer, one member of the board
of directors and two executives (including the manager) from our internal audit department. This audit group is under the supervision of our Chief Executive Officer and Chief Financial Officer. The audit group evaluated the effectiveness of the
design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), with respect to this Quarterly Report on Form 10-Q
before its filing with the Commission. The audit group made its evaluation pursuant to Rule 13a-15 under the Exchange Act to the maximum possible extent and to the best knowledge of the audit group.

Based upon our evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures
were effective and basically sound in all material aspects under Rule 13a-15. However, given the fact that our major operations are located China, the Company and the audit group consistently make efforts to coordinate the evolving control and
disclosure environment in China with the regulatory environment in the United States. The Company has identified this aspect as an area for improvement and is taking measures to train its staff for better performance.

There were no changes in the Companys internal control over financial reporting during the second quarter of 2007 that have materially affected, or are reasonably
likely to materially affect the Companys internal control over financial reporting.



30



---

PART II  OTHER INFORMATION

ITEM 1  LEGAL PROCEEDINGS

We are currently not involved in any litigation that we believe could have a material
adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the
knowledge of our executive officers or any of our subsidiaries, threatened against or affecting our company, our common stock, or any of our subsidiaries, or against our Companys or our Companys subsidiaries officers or directors
in their capacities as such, in which an adverse decision could have a material adverse effect.

ITEM 1A  RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider
the risk factors discussed in Part I, Item 1A Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2006. Additional risks and uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, consolidated financial condition and/or operating results. The following risk factors disclose new risks or are material changes from risk factor set forth in our Annual Report on Form
10-K.

Risks Related to Our Business and Industry

A disproportionate amount of our sales revenue is derived from five of our products and a disruption in, or a compromise of, our manufacturing or sales operations, or distribution channels related to any of these five products could
materially and adversely affect our financial condition and results of operations.

Our top five products, which comprise Shuanghuanglian Lyophilized
Injection Powder, or SHL Injection Powder, Cease Enuresis Soft Gel, or CE Gel, Cease Enuresis Patch, or CE patch, Jinji Capsule and Soybean Peptide Tablets, constituted approximately 86.1% of our total revenues in fiscal 2006 and 80.0% of our total
revenues for the six months ended June 30, 2007. We expect that these five products will continue to account for a majority of our sales in the near future. Because of our dependence on a few products, any disruption in, or compromise of, our
manufacturing operations, sales operations or distribution channels, relating to any of these products could result in our failure to meet shipping and delivery deadlines or meet quality standards, which in turn could result in the cancellation of
purchase orders, refusal to accept deliveries or a reduction in purchase prices, any of which could have a material adverse effect on our financial condition and results of operations.

Intense competition from existing and new companies may adversely affect our revenues and profitability.

We compete
with other companies, many of whom are developing, or can be expected to develop, products similar to ours. Some of our competitors are more established than we are, have greater brand recognition of products that compete with ours, have more
financial, technical, marketing and other resources than we presently possess and a larger customer base. These competitors may be able to respond more quickly to new or changing opportunities and customer requirements and may be able to undertake
more extensive promotional activities, offer more attractive terms to customers or adopt more aggressive pricing policies. Our commercial opportunity will be reduced or eliminated if our competitors develop and commercialize products that are safer,
more effective, have fewer side effects, are less expensive or have more attractive product characteristics than our current products or products that we may develop in the future. We cannot assure you that we will be able to compete effectively
with current or future competitors or that the competitive pressures we face will not harm our business.



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

Our success depends in part on our continued ability to attract, retain and motivate highly qualified management. We place substantial reliance upon the
efforts and abilities of our executive officers, including Tony Liu, Yanchun Li, Jun Min and Binsheng Li. The loss of services of any of these individuals or one or more other members of our senior management could delay or prevent the successful
execution of our business objectives and could have a material adverse effect on our operations.

Replacing key employees may be difficult and costly and
may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to develop and commercialize products successfully. We do not maintain key person
insurance policies on the lives of these individuals or the lives of any of our other employees. We employ these individuals on an at-will basis and their employment can be terminated by us or them at any time, for any reason and with or without
notice. We will need to hire additional personnel as we expand our commercial activities. We may not be able to attract or retain qualified management on acceptable terms in the future due to the intense competition for qualified personnel in our
industry. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede these objectives.

We cannot assure you that we will be able to complete acquisitions or successfully integrate new businesses into our own.

We intend to pursue opportunities to grow our business by acquiring businesses, products and technologies that are complementary or related to our existing product lines. Successful completion of an acquisition depends on a number of
factors that are not entirely within our control, including our ability to negotiate acceptable terms, conclude satisfactory agreements and obtain all necessary regulatory approvals. We may not be able to locate suitable acquisition candidates at
prices that we consider appropriate. If we do identify an appropriate acquisition candidate, we may face competition from other companies interested in acquiring the target company that have greater financial and other resources than we have.
Acquisitions of businesses, products, technologies or other material operations may require debt financing or additional equity financing, resulting in leverage or dilution of ownership.

Even if we complete one or more strategic transactions, we may be unable to integrate or coordinate successfully the personnel and operations of a business. Integration of acquired business operations could disrupt
our business by diverting management away from day-to-day operations. The difficulties of integration may be increased by the necessity of coordinating geographically dispersed organizations, integrating personnel with disparate business backgrounds
and combining different corporate cultures. We also may not be able to maintain key employees or customers of an acquired business or realize cost efficiencies or synergies or other benefits we anticipated when selecting our acquisition candidates.
In addition, we may incur non-recurring severance expenses, restructuring charges and change of control payments and may need to record write-downs from future impairments of intangible assets, which could reduce our future reported earnings. At
times, acquisition candidates may have liabilities or adverse operating issues that we fail to discover through due diligence prior to the acquisition.

We
cannot assure you that any completed acquisitions will meet one or more of our stated acquisition criteria. For example, we recently entered into a binding letter of intent to acquire Changchun Xin An Pharmaceutical Company Limited, a privately
owned pharmaceutical company. While we believe that this acquisition, if consummated, is consistent with our acquisition strategy to acquire companies that are accretive within one year of the closing of the transaction, we cannot assure you that
the transaction will be accretive.



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In addition to the above, acquisitions in China, including of state owned businesses, will be required to comply with
laws of the Peoples Republic of China, or PRC, to the extent applicable. There can be no assurance that any proposed acquisition will be able to comply with PRC requirements, rules and/or regulations, or that we will successfully obtain
governmental approvals to the extent required, which may be necessary to consummate such acquisitions.

We may face difficulties in implementing our
organic growth strategy.

Many obstacles to entering new markets exist, such as the costs associated with entering new markets, recruiting and
retaining adequate numbers of effective sales and marketing personnel, developing and implementing effective marketing efforts abroad, establishing and maintaining the appropriate regulatory compliance and maintaining attractive foreign exchange
ratios. However, there is no assurance that we will be successful in implementing our strategies or that our strategies, even if implemented, will lead to the successful achievement of our objectives. Our business plan and growth strategy is based
on currently prevailing circumstances and the assumption that certain circumstances will or will not occur, as well as the inherent risks and uncertainties involved in various stages of development. We cannot, therefore, assure you that we will be
able to successfully overcome such difficulties and continue to grow our business.

If we fail to manage our growth and current operations, we may not
achieve future growth or our expected revenues.

In order to maximize potential growth in our current and potential markets, we believe that we must
expand our manufacturing and marketing operations. To this end, we are and expect to continue to substantially increase our employee headcount which will place a significant strain on our management and on our operational, accounting, and
information systems. Our need to manage our operations and growth effectively requires us to continue to expend funds to improve our financial controls, operating procedures, management information systems, reporting systems and procedures to manage
our increased operations. If we are unable to implement improvements to our management information and control systems successfully in an efficient or timely manner, or if we encounter deficiencies in our existing systems and controls, then
management may receive inadequate information to manage our day-to-day operations. We will also need to effectively train, motivate and manage our employees. Our failure to manage our growth could disrupt our operations and ultimately prevent us
from generating the revenues we expect.

We may have difficulty defending our intellectual property rights from infringement which may undermine our
competitive position.

We regard our service marks, trademarks, trade secrets, patents and similar intellectual property as critical to our success. We
rely on trademark, patent and trade secret law, as well as confidentiality agreements to protect our proprietary rights. Certain of our products have received trademark and patent protection in China and Hong Kong. No assurance can be given that
such patents and licenses will not be challenged, invalidated, infringed or circumvented, or that such intellectual property rights will provide a competitive advantage to us. Our trade secrets may otherwise become known or be independently
discovered by our competitors. Policing the unauthorized use of proprietary technology can be difficult and expensive. Also, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity
and scope of the proprietary rights of others. The outcome of such potential litigation may not be in our favor and any success in litigation may not be able to adequately protect our rights. Such litigation may be costly and divert management
attention away from our business. An adverse determination in any such litigation would impair our intellectual property rights and may harm our business, prospects and reputation. Enforcement of judgments in China and Hong Kong is uncertain and
even if we are successful in such litigation it may not provide us with an effective remedy. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are
unable to recover them from other parties. The occurrence of



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any of the foregoing could have a material adverse effect on our business, financial condition and results of operations. In addition, there can be no
assurance that we will be able to obtain licenses from third-parties that we may need to conduct our business or that such licenses can be obtained at a reasonable cost.

In addition, third parties may file infringement claims against us asserting that we are infringing on their patents or trademarks. In the event that such claims are filed, regardless of the merit of such a claim, we
may incur substantial costs and diversion of management as a result of our involvement in such proceedings.

We currently sell our products mainly in
China. China will remain our primary market for the foreseeable future. If we expand into additional countries, our risk of intellectual property infringement may be heightened. Laws and enforcement mechanisms in other countries may not protect
proprietary rights to the same extent as China and Hong Kong. To date, no trademark or patent filings have been made other than in China and Hong Kong.

The measures we take to protect our proprietary rights may be inadequate, and we cannot give you any assurance that our competitors will not independently develop formulations and processes that are substantially equivalent or superior to
our own or copy our products.

If we cannot procure our raw materials from our current sources we may be forced to seek alternative sources of supply,
which may disrupt our operations or may result in the supply of lesser quality products.

The loss of any of our primary supply sources, or delays,
disruptions or other difficulties in procuring these raw materials from our primary supply sources, could have a material adverse effect on our business and results of operations. Additionally, due to the nature of the raw materials, mainly plants,
the supply of these raw materials can be adversely affected by any material change in the climatic or environmental conditions in China, which may, in turn, result in increased costs to purchase these raw materials. If we are required to procure
alternative sources of supply, our ability to maintain high quality products, lower costs and to provide our products to customers when needed could be impaired, and as a result we could lose business and our results of operations could be
materially and adversely affected.

We do not have product liability insurance and we could be exposed to substantial liability.

We face an inherent business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in adverse side effects.
Adverse side effects, marketing or manufacturing problems pertaining to any of our products could result in:



| |  | decreased demand for our products;
|- |  | ----------------------------------



| |  | adverse publicity resulting in injury to our reputation;
|- |  | --------------------------------------------------------



| |  | product liability claims and significant litigation costs;
|- |  | ----------------------------------------------------------



| |  | substantial monetary awards to or costly settlements with consumers;
|- |  | --------------------------------------------------------------------



| |  | product recalls;
|- |  | ----------------



| |  | loss of revenues; or
|- |  | --------------------



| |  | the inability to commercialize future products.
|- |  | -----------------------------------------------

These risks will exist for those products in clinical development and with respect to those products that have received regulatory approval for commercial sale or any product we may acquire. To date, we have not experienced any product
liability claims. However, that does not mean that we will not have any such claims with respect to our products in the future. We do not carry product liability insurance. The lack of product liability insurance exposes us to risks associated with
potential product liability claims, which can be significant.



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Our international operations require us to comply with a number of U.S. and international regulations.

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

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

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

As a public company, we are required to comply with Sarbanes-Oxley and the related rules and regulations of the SEC, including expanded disclosure, accelerated reporting
requirements and more complex accounting rules. Compliance with Section 404 of Sarbanes-Oxley and other requirements resulted in increased costs for fiscal 2006 and will continue to require additional management resources. We upgraded our
finance and accounting systems, procedures and controls and will need to continue to implement additional finance and accounting systems, procedures and controls as we grow to satisfy these reporting requirements. In addition, we may need to hire
additional legal and accounting staff with appropriate experience and technical knowledge, and we cannot assure you that if additional staffing is necessary that we will be able to do so in a timely fashion. If we are unable to complete the required
annual assessment as to the adequacy of our internal reporting or if our independent registered public accounting firm is unable to provide us with an unqualified report as to the effectiveness of our internal controls over financial reporting in
the future, we could incur significant costs to become compliant.

We continuously evaluate and monitor developments with respect to Section 404 of
Sarbanes-Oxley and other applicable rules, however, we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

Risks Related to China

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

The manufacture and sale of pharmaceutical products in China is heavily regulated by many state, provincial
and local authorities. These regulations significantly increase the difficulty and costs involved in obtaining and



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maintaining regulatory approvals for marketing new and existing products. Our future growth and profitability depend to a large extent on our ability to
obtain regulatory approvals. Additionally, the law could change so as to prohibit the use of certain pharmaceuticals. If one of our products becomes prohibited, this change would cease the productivity of that product. The China National Development
and Reform Commission, or CNDRC, has recently implemented price adjustments on many marketed pharmaceutical products. We have no control over such governmental policies, which may impact the pricing and profitability of our products.

The State Food and Drug Administration of China requires pharmaceutical manufacturers to obtain Good Manufacturing Practices, or GMP, certifications. We have received
our certifications. However, should we fail to receive or maintain the GMP certifications in the future, we would no longer be able to manufacture pharmaceuticals in China, and our businesses would be materially and adversely affected.

Moreover, the laws and regulations regarding acquisitions in the pharmaceutical industry in China may change, which could significantly impact our ability to grow
through acquisitions.

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

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

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

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

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



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Currency conversion and exchange rate volatility could adversely affect our financial condition and the value of our
common stock.

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

Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the State Council which came into effect on April 1, 1996, and the Regulations on the Administration of Foreign Exchange Settlement, Sale
and Payment of the PRC which came into effect on July 1, 1996, regarding foreign exchange control, conversion of RMB into foreign exchange by Foreign Investment Enterprises, or FIEs, for use on current account items, including the distribution
of dividends and profits to foreign investors, is permissible. FIEs are permitted to convert their after-tax dividends and profits to foreign exchange and remit such foreign exchange to their foreign exchange bank accounts in China. Conversion of
RMB into foreign currencies for capital account items, including direct investment, loans, and security investment, is still under certain restrictions. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and
added, among other things, an important provision, which provides that the PRC government shall not impose restrictions on recurring international payments and transfers under current account items.

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

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

Our wholly owned subsidiaries, Three Happiness, HSPL, GLP and HQPL are FIEs to which
the Foreign Exchange Control Regulations are applicable. There can be no assurance that we will be able to obtain sufficient foreign exchange to pay dividends or satisfy other foreign exchange requirements in the future.

Between 1994 and 2004, the exchange rate for RMB against the U.S. dollar remained relatively stable, most of the time in the region of approximately RMB8.28 to US$1.00.
However, in 2005, the Chinese government announced that it would begin pegging the exchange rate of the RMB against a number of currencies, rather than just the U.S. dollar. As our operations are primarily in China, any significant revaluation of
the RMB may materially and adversely affect our cash flows, revenues, financial condition and the value of our common stock. For example, to the extent that we need to convert U.S. dollars into RMB for our operations, appreciation of this currency
against the U.S. dollar could have a material adverse effect on our business, financial condition, results of operations and the value of our common stock. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of
declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the RMB, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.

Future inflation in China may inhibit our ability to conduct business in China.

In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as 2.2%.
These



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factors have led to the adoption by the PRC government, from time to time, of various corrective measures designed to restrict the availability of credit or
regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause the PRC government to impose controls on credit or prices, or to take other action, which could inhibit economic
activity in China, and thereby harm the market for our products.

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

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

Any future outbreak of avian influenza, or the Asian bird flu, or any
other epidemic in China could have a material adverse effect on our business operations, financial condition and results of operations.

Since
mid-December 2003, a growing number of Asian countries have reported outbreaks of highly pathogenic avian influenza in chickens and ducks. Since all of our operations are in China, an outbreak of the Asian Bird Flu in China in the future may disrupt
our business operations and have a material adverse effect on our financial condition and results of operations. For example, a new outbreak of Asian Bird Flu, or any other epidemic, may reduce the level of economic activity in affected areas, which
may lead to a reduction in our revenue if our clients cancel existing contracts or defer future expenditures. In addition, health or other government regulations may require temporary closure of our offices, or the offices of our customers or
partners, which will severely disrupt our business operations and have a material adverse effect on our financial condition and results of operations.

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

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

Most of our assets are located in China, any dividends or proceeds from liquidation are subject to the approval of the relevant Chinese government agencies.

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



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There have been recent incidents in which patients have experienced severe adverse reactions following the use of
pharmaceutical products manufactured in China.

There have been recent incidents reported in the Chinese media of a significant number of patients
experiencing severe adverse health consequences following their use of pharmaceutical products manufactured by certain pharmaceutical companies in China. A number of patients have become ill and a number of fatalities have been reported. For
example, several deaths were caused by drugs sold by the Second Pharmaceutical Factory of Qiqihaer, a Chinese drug manufacturer, in May 2006. Concerns over the safety of pharmaceutical products manufactured in China could have an adverse effect on
the sale of such products, including products manufactured by us. If in the future we become involved in incidents of the type described above, such problems could severely and adversely impact our product sales and reputation.

Anti-corruption measures taken by the government to correct corruptive practices in the pharmaceutical industry could adversely affect our sales and reputation.

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

Risks Related to Our Common Stock

Our common stock price may be extremely volatile, and you may not be able to resell your shares
at or above the price you paid for the stock.

Our common stock price has experienced large fluctuations. In addition, the trading prices of stocks for
companies in our industry in general have experienced extreme price fluctuations in recent years. Any negative change in the publics perception of the prospects of companies in our industry could depress our stock price regardless of our
results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. Market fluctuations, as well as general political and economic conditions such as terrorism, military
conflict, recession or interest rate or currency rate fluctuations, may also decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to various factors, including:



| |  | changes in laws or regulations applicable to our products;
|- |  | ----------------------------------------------------------



| |  | period to period fluctuations in our operating results;
|- |  | -------------------------------------------------------



| |  | announcements of new technological innovations or new products by us or our competitors;
|- |  | ----------------------------------------------------------------------------------------



| |  | changes in financial estimates or recommendations by securities analysts;
|- |  | -------------------------------------------------------------------------



| |  | conditions or trends in our industry;
|- |  | -------------------------------------



| |  | changes in the market valuations of other companies in our industry;
|- |  | --------------------------------------------------------------------



| |  | developments in domestic and international governmental policy or regulations;
|- |  | ------------------------------------------------------------------------------



| |  | announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  | additions or departures of key personnel;
|- |  | -----------------------------------------



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| |  | disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our
technologies;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | additional sales of our common stock by us; and
|- |  | -----------------------------------------------



| |  | sales and distributions of our common stock by our stockholders.
|- |  | ----------------------------------------------------------------

In the past, stockholders have often instituted securities class action litigation after periods of volatility in the market price of a companys securities. If a stockholder files a securities class action suit
against us, we would incur substantial legal fees and our managements attention and resources would be diverted from operating our business in order to respond to the litigation.

Some of our existing stockholders can exert control over us and may not make decisions that are in the best interest of all the stockholders.

Our officers, directors and holders of more than five percent of our outstanding shares of common stock, together control approximately 51.0% of the voting power of our stock, of which approximately 47.5% is
controlled by Tony Liu, our Chairman and Chief Executive Officer. In particular, Mr. Liu owns 1,000,000 shares of Series A preferred stock, which shares by their terms have aggregate voting power equal to 25.0% of the combined voting power of
our common and preferred stock. Moreover, this voting power cannot be diluted or reduced by the issuance of additional shares of common stock, meaning that the holder or holders of our Series A preferred stock will always possess 25.0% of the
aggregate voting power of our common and preferred stock. As a result, Mr. Liu, or these stockholders acting together, will be able to exert a significant degree of influence over our management and over matters requiring stockholder approval,
including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of our company and might affect the market price of our common stock, even
when a change may be in the best interests of all stockholders. In addition, the interests of our officers, directors and principal stockholders may not always coincide with our interests or the interests of other stockholders and, accordingly,
these control persons could cause us to enter into transactions or agreements that we would not otherwise consider.

Provisions of the Nevada Revised
Statutes may discourage a change of control.

We are incorporated in Nevada. Certain provisions of the Nevada Revised Statutes, or NRS, could delay or
make more difficult a change of control transaction or other business combination that may be beneficial to stockholders. We are subject to Nevadas Combinations With Interested Stockholders statutes (NRS Sections 78.411 through
78.444), which provide that specified persons who, together with affiliates and associates, own, or within three years did own, 10% or more of the outstanding voting stock of a Nevada corporation with at least 200 stockholders cannot engage in
specified business combinations with the corporation for a period of three years after the date on which the person became an interested stockholder, unless the combination or the transaction by which the person first became an interested
stockholder is approved by the corporations Board of Directors before the person first became an interested stockholder.

Nevadas
Acquisition of Controlling Interest statutes (NRS Sections 78.37878.3793) apply only to Nevada Corporations with at least 200 stockholders, including at least 100 stockholders of record who are Nevada residents, and which conduct
business directly or indirectly in Nevada. As of the date of this prospectus, we do not believe we have 100 stockholders of record who are residents of Nevada, although there can be no assurance that in the future the Acquisition of
Controlling Interest statutes will not apply to us. The Acquisition of Controlling Interest statutes provide that persons who acquire a controlling interest, as defined in NRS Section 78.3785, in a company may only
be given full voting rights in their shares if such rights are conferred by the disinterested stockholders of the company at an annual or special meeting. However, any disinterested stockholder that does not vote in favor of granting such voting
rights is entitled to demand that the company pay fair value for their shares, if the acquiring person has acquired at least a majority of all of the voting power of the company. As such, persons acquiring a controlling interest may not be able to
vote their shares.



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We may never pay any dividends to our stockholders.

We have not paid any cash dividends on shares of our common stock. We currently intend to retain all available funds and future earnings, if any, to support our operations and finance the growth and development of our
business. Our board of directors does not intend to distribute dividends in the foreseeable future. The declaration, payment and amount of any future dividends, if any, will be made at the discretion of the board of directors, and will depend upon,
among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors the board of directors considers relevant. There is no assurance that future dividends will be paid, and if
dividends are paid, there is no assurance with respect to the amount of any such dividend.

ITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

There have been no sales of equity securities
during the period covered by this report.

ITEM 3  DEFAULTS UPON SENIOR SECURITIES

There have been no material defaults.

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

There were no matters submitted to a vote of security
holders during the period covered by this report.

ITEM 5  OTHER INFORMATION

Not applicable.

ITEM 6  EXHIBITS

The following exhibits are filed as part of this Quarterly Report on Form 10-Q:



|            |  |                                                                                                                                                                         
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                             
|31.1        |  | Certification of Chief Executive Officer (Principal Executive Officer) pursuant to Rule 13a  14(a) of the Securities Exchange Act, as amended                          
|            | 
|31.2        |  | Certification of Chief Financial Officer (Principal Financial Officer) pursuant to Rule 13a  14(a) of the Securities Exchange Act, as amended                          
|            | 
|32.1        |  | Certification of Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer) pursuant to 18 U.S.C. 1350, as adopted.



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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                                      
|--------------------------------------
|AMERICAN ORIENTAL BIOENGINEERING, INC.
|                                      
|/s/ Tony Liu                          
|TONY LIU                              
|CHAIRMAN AND CHIEF EXECUTIVE OFFICER  
|DATED: August 08, 2007                
|                                      
|/s/ Yanchun Li                        
|YANCHUN LI                            
|CHIEF FINANCIAL OFFICER               
|DATED: August 08, 2007                



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