##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q





(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, 2008



| ̈ | 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





AMERICAN ORIENTAL BIOENGINEERING, INC.

(Exact Name of Registrant as specified
in Its Charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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)





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 6, 2008
|Preferred Stock, $0.001 par value   |  | 1,000,000                       
|Common Stock, $0.001 par value      |  | 78,249,264                      









---

##### Table of Contents

|                                                                                               |  |   
|---------------------------------------------------------------------------------------------- |  | --
|PART I  FINANCIAL INFORMATION                                                                 |  | 3 
|                                                                                               | 
|ITEM 1  FINANCIAL STATEMENTS                                                                  |  | 3 
|                                                                                               | 
|ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 20
|                                                                                               | 
|ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 32
|                                                                                               | 
|ITEM 4  CONTROLS AND PROCEDURES                                                               |  | 33
|                                                                                               | 
|PART II  OTHER INFORMATION                                                                    |  | 34
|                                                                                               | 
|ITEM 1  LEGAL PROCEEDINGS                                                                     |  | 34
|                                                                                               | 
|ITEM 1A  RISK FACTORS                                                                         |  | 34
|                                                                                               | 
|ITEM 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           |  | 34
|                                                                                               | 
|ITEM 3  DEFAULTS UPON SENIOR SECURITIES                                                       |  | 34
|                                                                                               | 
|ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |  | 34
|                                                                                               | 
|ITEM 5  OTHER INFORMATION                                                                     |  | 34
|                                                                                               | 
|ITEM 6  EXHIBITS                                                                              |  | 34



2



---

##### Table of Contents

PART I  FINANCIAL INFORMATION

ITEM 1  FINANCIAL STATEMENTS

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS



|                                                                                                                  |  |                         |             |                  |   |            
|----------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ----------- | ---------------- | - | -----------
|                                                                                                                  |  | JUNE 30,2008(UNAUDITED) |             | DECEMBER 31,2007
|CURRENT ASSETS                                                                                                    |  |                         |             |                  |   |            
|Cash and cash equivalents                                                                                         |  | $                       | 144,473,275 |                  | $ | 166,410,075
|Accounts receivable, net of reserve of $176,962 and $302,270 at June 30, 2008 and December 31, 2007, respectively |  |                         | 17,332,076  |                  |   | 16,494,619 
|Inventories, net                                                                                                  |  |                         | 18,968,955  |                  |   | 12,264,536 
|Advances to suppliers                                                                                             |  |                         | 2,984,896   |                  |   | 4,309,352  
|Notes receivable                                                                                                  |  |                         | 691,872     |                  |   | 2,259,616  
|Refundable deposit                                                                                                |  |                         | 6,368,222   |                  |   |           
|Other current assets                                                                                              |  |                         | 534,169     |                  |   | 5,134,118  
|                                                                                                                  |  |                         |             |                  |   |            
|Total Current Assets                                                                                              |  |                         | 191,353,465 |                  |   | 206,872,316
|                                                                                                                  |  |                         |             |                  |   |            
|LONG-TERM ASSETS                                                                                                  |  |                         |             |                  |   |            
|Plant and equipment, net                                                                                          |  |                         | 50,561,819  |                  |   | 48,496,760 
|Land use rights, net                                                                                              |  |                         | 48,732,647  |                  |   | 46,310,240 
|Deposit for long-term assets                                                                                      |  |                         | 34,852,986  |                  |   |           
|Construction-in-progress                                                                                          |  |                         | 776,947     |                  |   | 755,614    
|Deferred tax assets                                                                                               |  |                         | 1,866,111   |                  |   | 1,498,481  
|Other intangible assets, net                                                                                      |  |                         | 26,232,600  |                  |   | 26,972,166 
|Goodwill                                                                                                          |  |                         | 22,566,768  |                  |   | 22,566,768 
|Investment and advances in unconsolidated entities                                                                |  |                         | 19,318,730  |                  |   | 242,551    
|Other long-term assets                                                                                            |  |                         | 290,000     |                  |   |           
|                                                                                                                  |  |                         |             |                  |   |            
|Total Long-Term Assets                                                                                            |  |                         | 205,198,608 |                  |   | 146,842,580
|                                                                                                                  |  |                         |             |                  |   |            
|TOTAL ASSETS                                                                                                      |  | $                       | 396,552,073 |                  | $ | 353,714,896
|                                                                                                                  |  |                         |             |                  |   |            

See accompanying notes to the condensed consolidated financial statements



3



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS EQUITY



|                                                                                                                                                                             |  |                         |             |                  |   |            
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ----------- | ---------------- | - | -----------
|                                                                                                                                                                             |  | JUNE 30,2008(UNAUDITED) |             | DECEMBER 31,2007
|CURRENT LIABILITIES                                                                                                                                                          |  |                         |             |                  |   |            
|Accounts payable                                                                                                                                                             |  | $                       | 4,671,462   |                  | $ | 3,436,352  
|Other payables and accrued expenses                                                                                                                                          |  |                         | 8,281,952   |                  |   | 7,786,157  
|Taxes payable                                                                                                                                                                |  |                         | 3,766,436   |                  |   | 2,843,719  
|Short-term bank loans                                                                                                                                                        |  |                         | 6,694,025   |                  |   | 6,289,222  
|Current portion of long-term bank loans                                                                                                                                      |  |                         | 2,958,324   |                  |   | 2,374,565  
|Other liabilities                                                                                                                                                            |  |                         | 2,711,988   |                  |   | 3,621,030  
|Deferred tax liabilities                                                                                                                                                     |  |                         | 358,529     |                  |   | 109,733    
|                                                                                                                                                                             |  |                         |             |                  |   |            
|Total Current Liabilities                                                                                                                                                    |  |                         | 29,442,716  |                  |   | 26,460,778 
|                                                                                                                                                                             |  |                         |             |                  |   |            
|LONG-TERM LIABILITIES                                                                                                                                                        |  |                         |             |                  |   |            
|Long-term bank loans, net of current portion                                                                                                                                 |  |                         | 828,879     |                  |   | 1,263,483  
|Long-term notes payable                                                                                                                                                      |  |                         | 296,668     |                  |   | 286,365    
|Deferred tax liabilities                                                                                                                                                     |  |                         | 16,713,352  |                  |   | 12,621,180 
|                                                                                                                                                                             |  |                         |             |                  |   |            
|Total Long-Term Liabilities                                                                                                                                                  |  |                         | 17,838,899  |                  |   | 14,171,028 
|                                                                                                                                                                             |  |                         |             |                  |   |            
|TOTAL LIABILITIES                                                                                                                                                            |  |                         | 47,281,615  |                  |   | 40,631,806 
|                                                                                                                                                                             |  |                         |             |                  |   |            
|COMMITMENTS                                                                                                                                                                  |  |                         |             |                  |   |            
|SHAREHOLDERS EQUITY                                                                                                                                                         |  |                         |             |                  |   |            
|Preferred stock, $0.001 par value; 2,000,000 shares authorized; 1,000,000 shares issued and outstanding at June 30, 2008 and December 31,
2007, respectively                 |  |                         | 1,000       |                  |   | 1,000      
|Common stock, $0.001 par value; 150,000,000 shares authorized; 78,249,264 and 77,991,935 shares issued and outstanding at June 30, 2008
and December 31, 2007, respectively. |  |                         | 78,249      |                  |   | 77,992     
|Common stock to be issued                                                                                                                                                    |  |                         | 182,332     |                  |   | 1,611,333  
|Additional paid-in capital                                                                                                                                                   |  |                         | 195,253,082 |                  |   | 193,007,987
|Retained earnings (the restricted portion of retained earnings is $15,910,685 at June 30, 2008 and December 31, 2007,
respectively)                                          |  |                         | 125,399,613 |                  |   | 102,117,792
|Accumulated other comprehensive income                                                                                                                                       |  |                         | 28,356,182  |                  |   | 16,266,986 
|                                                                                                                                                                             |  |                         |             |                  |   |            
|Total Shareholders Equity                                                                                                                                                   |  |                         | 349,270,458 |                  |   | 313,083,090
|                                                                                                                                                                             |  |                         |             |                  |   |            
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                   |  | $                       | 396,552,073 |                  | $ | 353,714,896
|                                                                                                                                                                             |  |                         |             |                  |   |            

See accompanying notes to the condensed consolidated financial statements



4



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(UNAUDITED)



|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|------------------------------------------------------ |  | -------------------------- | ---------- | ------------------------ | ---- | - | ---------- |  | - | ---------- | - |  | - | ----------
|                                                       |  | THREE MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDEDJUNE 30,
|                                                       |  | 2008                       |            |                          | 2007 |   | 2008       |  |   | 2007      
|REVENUES                                               |  | $                          | 59,010,005 |                          |      | $ | 33,913,234 |  | $ | 97,778,603 |   |  | $ | 59,662,608
|COST OF GOODS SOLD                                     |  |                            | 18,928,447 |                          |      |   | 10,210,485 |  |   | 31,406,083 |   |  |   | 18,240,539
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|GROSS PROFIT                                           |  |                            | 40,081,558 |                          |      |   | 23,702,749 |  |   | 66,372,520 |   |  |   | 41,422,069
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Selling and marketing                                  |  |                            | 7,687,892  |                          |      |   | 3,886,564  |  |   | 12,717,600 |   |  |   | 6,590,035 
|Advertising                                            |  |                            | 7,452,231  |                          |      |   | 5,412,510  |  |   | 11,846,572 |   |  |   | 9,237,855 
|General and administrative                             |  |                            | 5,253,274  |                          |      |   | 2,557,805  |  |   | 9,165,957  |   |  |   | 5,495,949 
|Depreciation and amortization                          |  |                            | 1,010,461  |                          |      |   | 341,562    |  |   | 1,987,671  |   |  |   | 675,836   
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Total operating expenses                               |  |                            | 21,403,858 |                          |      |   | 12,198,441 |  |   | 35,717,800 |   |  |   | 21,999,675
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|INCOME FROM OPERATIONS                                 |  |                            | 18,677,700 |                          |      |   | 11,504,308 |  |   | 30,654,720 |   |  |   | 19,422,394
|                                                       |  |                            |            |                         
|EQUITY IN EARNINGS (LOSS) FROM UNCONSOLIDATED ENTITIES |  |                            | (640,008   | )                        |      |   | 3,888      |  |   | (641,067   | ) |  |   | 11,000    
|INTEREST INCOME (EXPENSE), NET                         |  |                            | (30,616    | )                        |      |   | 43,048     |  |   | (13,769    | ) |  |   | 17,238    
|OTHER INCOME (EXPENSE), NET                            |  |                            | (255,770   | )                        |      |   | 56,952     |  |   | (356,502   | ) |  |   | 131,958   
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|INCOME BEFORE INCOME TAXES                             |  |                            | 17,751,306 |                          |      |   | 11,608,196 |  |   | 29,643,382 |   |  |   | 19,582,590
|INCOME TAXES                                           |  |                            | 3,891,614  |                          |      |   | 1,939,825  |  |   | 6,361,562  |   |  |   | 3,464,773 
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|NET INCOME                                             |  |                            | 13,859,692 |                          |      |   | 9,668,371  |  |   | 23,281,820 |   |  |   | 16,117,817
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|OTHER COMPREHENSIVE INCOME                             |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|                                                       |  |                            |            |                         
|Foreign currency translation gain, net of tax          |  |                            | 5,154,761  |                          |      |   | 1,468,243  |  |   | 12,089,196 |   |  |   | 2,279,042 
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|TOTAL OTHER COMPREHENSIVE INCOME, NET OF TAX           |  |                            | 5,154,761  |                          |      |   | 1,468,243  |  |   | 12,089,196 |   |  |   | 2,279,042 
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|COMPREHENSIVE INCOME                                   |  | $                          | 19,014,453 |                          |      | $ | 11,136,614 |  | $ | 35,371,016 |   |  | $ | 18,396,859
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|NET INCOME PER SHARE                                   |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|BASIC                                                  |  | $                          | 0.18       |                          |      | $ | 0.15       |  | $ | 0.30       |   |  | $ | 0.25      
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|DILUTED                                                |  | $                          | 0.18       |                          |      | $ | 0.15       |  | $ | 0.30       |   |  | $ | 0.24      
|                                                       |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING          |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|BASIC                                                  |  |                            | 78,223,659 |                          |      |   | 65,144,311 |  |   | 78,207,405 |   |  |   | 64,877,916
|DILUTED                                                |  |                            | 78,223,659 |                          |      |   | 66,600,080 |  |   | 78,208,181 |   |  |   | 66,483,294

See accompanying notes to the condensed consolidated financial statements



5



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(UNAUDITED)



|                                                                                  |  |                           |             |   |      |   |             |  
|--------------------------------------------------------------------------------- |  | ------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                                  |  | SIX MONTHS ENDED JUNE 30, |            
|                                                                                  |  | 2008                      |             |   | 2007 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                           |             |   |      |   |             |  
|Net income                                                                        |  | $                         | 23,281,820  |   |      | $ | 16,117,817  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                           |             |   |      |   |             |  
|Depreciation and amortization                                                     |  |                           | 4,641,379   |   |      |   | 1,515,934   |  
|Loss on disposal of plant and equipment                                           |  |                           | (7,657      | ) |      |   |            |  
|Amortization of deferred consulting expenses                                      |  |                           | 104,500     |   |      |   | 264,100     |  
|Provision (reversal) for doubtful accounts                                        |  |                           | (140,250    | ) |      |   | 50,398      |  
|Provision (reversal) for slow moving inventories                                  |  |                           | (175,627    | ) |      |   | (75,239     | )
|Deferred taxes                                                                    |  |                           | 714,100     |   |      |   | 192,865     |  
|Common stock to be issued for services                                            |  |                           | 250,333     |   |      |   | 108,833     |  
|Stock option compensation expense                                                 |  |                           | 374,019     |   |      |   | 65,340      |  
|Equity income from unconsolidated entities                                        |  |                           | 641,101     |   |      |   | (10,999     | )
|Changes in operating assets and liabilities, net of effects of acquisition:       |  |                           |             |   |      |   |             |  
|(Increase) Decrease In:                                                           |  |                           |             |   |      |   |             |  
|Accounts receivable                                                               |  |                           | (697,207    | ) |      |   | (777,050    | )
|Notes receivable                                                                  |  |                           | 1,567,744   |   |      |   | 2,543,005   |  
|Inventories                                                                       |  |                           | (6,538,693  | ) |      |   | (1,371,699  | )
|Advances to suppliers                                                             |  |                           | 1,324,457   |   |      |   | (1,453,861  | )
|Other assets                                                                      |  |                           | 1,208,187   |   |      |   | 365,544     |  
|Increase (Decrease) In:                                                           |  |                           |             |   |      |   |             |  
|Accounts payable                                                                  |  |                           | 1,235,110   |   |      |   | 734,805     |  
|Other payables and accrued expenses                                               |  |                           | 495,796     |   |      |   | (1,897,810  | )
|Taxes payable                                                                     |  |                           | 922,717     |   |      |   | (461,975    | )
|Customer deposits                                                                 |  |                           | (2,253,528  | ) |      |   | (108,091    | )
|Other liabilities                                                                 |  |                           | 1,426,448   |   |      |   | 205,524     |  
|                                                                                  |  |                           |             |   |      |   |             |  
|Net cash provided by operating activities                                         |  |                           | 28,374,749  |   |      |   | 16,007,441  |  
|                                                                                  |  |                           |             |   |      |   |             |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                           |             |   |      |   |             |  
|Purchases of construction in progress                                             |  |                           | (223,742    | ) |      |   | (488,063    | )
|Purchases of plant and equipment                                                  |  |                           | (391,877    | ) |      |   | (953,637    | )
|Purchases of other intangible assets                                              |  |                           | (95,900     | ) |      |   |            |  
|Refundable deposit                                                                |  |                           | (2,888,960  | ) |      |   |            |  
|Deposit for long-term assets                                                      |  |                           | (34,852,986 | ) |      |   |            |  
|Cost of investment in unconsolidated entity                                       |  |                           | (18,000,000 | ) |      |   |            |  
|Due from affiliated company                                                       |  |                           | (1,657,535  | ) |      |   |            |  
|                                                                                  |  |                           |             |   |      |   |             |  
|Net cash used in investing activities                                             |  |                           | (58,111,000 | ) |      |   | (1,441,700  | )
|                                                                                  |  |                           |             |   |      |   |             |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |                           |             |   |      |   |             |  
|Proceeds from short-term bank loans                                               |  |                           | 3,524,627   |   |      |   | 1,920,680   |  
|Prepayments of short-term bank loans                                              |  |                           | (3,551,083  | ) |      |   | (1,938,641  | )
|Repayment of notes payable                                                        |  |                           | (61,951     | ) |      |   |            |  
|Repayments of capital lease                                                       |  |                           | (10,011     | ) |      |   | (7,355      | )
|Deferred financing costs                                                          |  |                           | (290,000    | ) |      |   |            |  
|Payment for offering expense                                                      |  |                           |            |   |      |   | (25,121     | )
|Cash contribution from shareholder                                                |  |                           |            |   |      |   | 150,900     |  
|Proceeds from exercise of warrants                                                |  |                           |            |   |      |   | 3,960,164   |  
|                                                                                  |  |                           |             |   |      |   |             |  
|Net cash provided by financing activities                                         |  |                           | (388,418    | ) |      |   | 4,060,627   |  
|                                                                                  |  |                           |             |   |      |   |             |  
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                              |  |                           | (30,124,669 | ) |      |   | 18,626,368  |  
|Effect of exchange rate changes on cash                                           |  |                           | 8,187,869   |   |      |   | 2,039,014   |  
|Cash and cash equivalents, beginning of period                                    |  |                           | 166,410,075 |   |      |   | 87,784,419  |  
|                                                                                  |  |                           |             |   |      |   |             |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                          |  | $                         | 144,473,275 |   |      | $ | 108,449,801 |  
|                                                                                  |  |                           |             |   |      |   |             |  

See accompanying notes to the condensed consolidated financial statements



6



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(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, 2007
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
| | - |  | -------------------------------------------------------------



| |  |  | Collectability is reasonably assured.
| | - |  | -------------------------------------

Stock
Based Compensation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.



7



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



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, which tends to have very low turnover. 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.

New Accounting PronouncementIn December 2007, the FASB issued SFAS
No. 141 (R), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 141 (R) requires an acquirer to measure the identifiable assets acquired, the liabilities
assumed, and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No.160 clarifies that a noncontrolling interest in a
subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 141 (R) and SFAS No. 160 are
effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. We have not yet determined the effect on our consolidated financial statements, if any, upon adoption of SFAS
No. 141 (R) or SFAS No. 160. We are aware that our accounting for minority interest will change and we are considering those effects now but believe the effects will only be a reclassification of minority interest from mezzanine
equity to our stockholders equity section in the balance sheet. In any case, we do not believe the implementation of SFAS 160 will be material to our financial position. SFAS 141 (R) will significantly affect the accounting for future
business combinations and we will determine the accounting as new combinations occur.

In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial Statements. This Statement establishes accounting and reporting standards that require the ownership interests in subsidiaries non-parent owners be clearly presented in the equity
section of the balance sheet; requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; requires that changes
in a parents ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently; requires that when a subsidiary is deconsolidated, any retained noncontrolling equity investment in
the former subsidiary be initially measured at fair value and the gain or loss on the deconsolidation of the subsidiary be measured using the fair value of any noncontrolling equity; requires that entities provide disclosures that clearly identify
the interests of the parent and the interests of the noncontrolling owners. This Statement is effective as of the beginning of an entitys first fiscal year that begins after December 15, 2008. The Company has not determined the impact, if
any, SFAS No. 160 will have on its financial statements.



8



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



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.
As of June 30, 2008, the Company has 132,000 outstanding vested stock options, with an exercise price above market, are excluded from the Companys diluted computation as their effect would be anti-dilutive.

Basic and diluted earnings per share are calculated as follows:



|                                            |  |                            |            |                          |   |            |  |      |            |  |   |           
|------------------------------------------- |  | -------------------------- | ---------- | ------------------------ | - | ---------- |  | ---- | ---------- |  | - | ----------
|                                            |  | THREE MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDEDJUNE 30,
|                                            |  | 2008                       |            | 2007                     |   | 2008       |  | 2007
|Basic:                                      |  |                            |            |                          |   |            |  |      |            |  |   |           
|Income applicable to common shareholders    |  | $                          | 13,859,692 |                          | $ | 9,668,371  |  | $    | 23,281,820 |  | $ | 16,117,817
|                                            |  |                            |            |                         
|Weighted average shares outstanding         |  |                            | 78,223,659 |                          |   | 65,144,311 |  |      | 78,207,405 |  |   | 64,877,916
|                                            |  |                            |            |                          |   |            |  |      |            |  |   |           
|Basic earnings per share                    |  | $                          | 0.18       |                          | $ | 0.15       |  | $    | 0.30       |  | $ | 0.25      
|                                            |  |                            |            |                          |   |            |  |      |            |  |   |           
|Diluted:                                    |  |                            |            |                          |   |            |  |      |            |  |   |           
|Income applicable to common shareholders    |  | $                          | 13,859,692 |                          | $ | 9,668,371  |  | $    | 23,281,820 |  | $ | 16,117,817
|                                            |  |                            |            |                         
|Weighted average shares outstanding         |  |                            | 78,223,659 |                          |   | 65,144,311 |  |      | 78,207,405 |  |   | 64,877,916
|Effect of dilutive securities:              |  |                            |            |                          |   |            |  |      |            |  |   |           
|Stock options                               |  |                            |           |                          |   | 79,833     |  |      |           |  |   | 81,083    
|Warrants                                    |  |                            |           |                          |   | 1,375,936  |  |      | 776        |  |   | 1,524,295 
|                                            |  |                            |            |                          |   |            |  |      |            |  |   |           
|Diluted weighted average shares outstanding |  |                            | 78,223,659 |                          |   | 66,600,080 |  |      | 78,208,181 |  |   | 66,483,294
|                                            |  |                            |            |                          |   |            |  |      |            |  |   |           
|Diluted earnings per share                  |  | $                          | 0.18       |                          | $ | 0.15       |  | $    | 0.30       |  | $ | 0.24      
|                                            |  |                            |            |                          |   |            |  |      |            |  |   |           

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



9



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



(PRC). 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.



|                                          |  |        |  |       
|----------------------------------------- |  | ------ |  | ------
|                                          |  | 2008   |  | 2007  
|Quarter end RMB : US$ exchange rate       |  | 6.8718 |  | 7.6248
|Average quarterly RMB : US$ exchange rate |  | 6.9470 |  | 7.6829

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 30,2008 |            |   | December 31,2007 |  
|                                            |  | (Unaudited)  |            |   |                  |  
|Raw materials                               |  | $            | 9,019,346  |   |                  | $ | 7,509,497  |  
|Work-in-progress                            |  |              | 3,595,827  |   |                  |   | 2,685,053  |  
|Finished goods                              |  |              | 6,391,910  |   |                  |   | 2,307,413  |  
|                                            |  |              |            |   |                  |   |            |  
|                                            |  |              | 19,007,083 |   |                  |   | 12,501,963 |  
|Less: provision for slow moving inventories |  |              | (38,128    | ) |                  |   | (237,427   | )
|                                            |  |              |            |   |                  |   |            |  
|Inventories, net                            |  | $            | 18,968,955 |   |                  | $ | 12,264,536 |  
|                                            |  |              |            |   |                  |   |            |  

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, 2008 and December 31, 2007:



|                               |  |              |            |   |                  |   |            |  
|------------------------------ |  | ------------ | ---------- | - | ---------------- | - | ---------- | -
|                               |  | June 30,2008 |            |   | December 31,2007 |  
|                               |  | (Unaudited)  |            |   |                  |  
|Cost of land use rights        |  | $            | 51,278,578 |   |                  | $ | 48,177,647 |  
|Less: Accumulated amortization |  |              | (2,545,931 | ) |                  |   | (1,867,407 | )
|                               |  |              |            |   |                  |   |            |  
|Land use rights, net           |  | $            | 48,732,647 |   |                  | $ | 46,310,240 |  
|                               |  |              |            |   |                  |   |            |  

Amortization expense for the three months ended June 30, 2008 and 2007 was $276,143 and $186,421,
respectively. Amortization expense for the six months ended June 30, 2008 and 2007 was $543,766 and $370,993, respectively. As of June 30, 2008, the net book value of land use rights pledged as collateral was $26,357,706. See Note 13.

NOTE 9  OTHER INTANGIBLE ASSETS, NET

Other
intangible assets include product licenses, trademarks, patents and proprietary technology. The cost of the product licenses are amortized over their estimated useful lives of 10 to 12 years; the cost of trademarks are amortized over their
registered useful lives of 4 to 10 years; the cost of patents are amortized over their



10



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



protection period of 7 to 8 years; the cost of proprietary technology are amortized over their protection period of 10 years and the cost of software are
amortized over their estimated useful life of 10 years. Other intangible assets are summarized as follows:



|                               |  |              |            |   |                  |   |            |  
|------------------------------ |  | ------------ | ---------- | - | ---------------- | - | ---------- | -
|                               |  | June 30,2008 |            |   | December 31,2007 |  
|                               |  | (Unaudited)  |            |   |                  |  
|At cost:                       |  |              |            |   |                  |   |            |  
|Product licenses               |  | $            | 16,792,357 |   |                  | $ | 15,742,705 |  
|Trademarks                     |  |              | 10,531,618 |   |                  |   | 9,894,747  |  
|Patents                        |  |              | 3,474,195  |   |                  |   | 3,264,102  |  
|Proprietary technology         |  |              | 280,942    |   |                  |   | 263,954    |  
|Software                       |  |              | 62,605     |   |                  |   |           |  
|                               |  |              |            |   |                  |   |            |  
|                               |  |              | 31,141,717 |   |                  |   | 29,165,508 |  
|Less: Accumulated amortization |  |              | (4,909,117 | ) |                  |   | (2,193,342 | )
|                               |  |              |            |   |                  |   |            |  
|Other intangible assets, net   |  | $            | 26,232,600 |   |                  | $ | 26,972,166 |  
|                               |  |              |            |   |                  |   |            |  

Amortization expense for the three months ended June 30, 2008 and 2007 was $1,273,624 and $24,405,
respectively. Amortization expense for the six months ended June 30, 2008 and 2007 was $2,507,195 and $48,568, respectively.

NOTE 10  PLANT
AND EQUIPMENT

Plant and equipment consist of the following:



|                                |  |              |             |   |                  |   |             |  
|------------------------------- |  | ------------ | ----------- | - | ---------------- | - | ----------- | -
|                                |  | June 30,2008 |             |   | December 31,2007 |  
|                                |  | (Unaudited)  |             |   |                  |  
|At cost:                        |  |              |             |   |                  |   |             |  
|Buildings                       |  | $            | 43,565,376  |   |                  | $ | 41,017,380  |  
|Machinery and equipment         |  |              | 19,303,280  |   |                  |   | 17,949,890  |  
|Motor vehicles                  |  |              | 1,531,885   |   |                  |   | 1,320,091   |  
|Office equipment                |  |              | 1,300,983   |   |                  |   | 1,137,140   |  
|Other equipment                 |  |              | 545,497     |   |                  |   | 446,326     |  
|Leasehold improvement           |  |              | 115,322     |   |                  |   | 108,348     |  
|                                |  |              |             |   |                  |   |             |  
|                                |  |              | 66,362,343  |   |                  |   | 61,979,175  |  
|                                |  |              |             |   |                  |   |             |  
|Less : Accumulated depreciation |  |              |             |   |                  |   |             |  
|Buildings                       |  |              | (4,071,352  | ) |                  |   | (3,305,219  | )
|Machinery and equipment         |  |              | (9,956,040  | ) |                  |   | (8,774,745  | )
|Motor vehicles                  |  |              | (868,810    | ) |                  |   | (694,256    | )
|Office equipment                |  |              | (653,012    | ) |                  |   | (510,926    | )
|Other equipment                 |  |              | (158,343    | ) |                  |   | (118,528    | )
|Leasehold improvement           |  |              | (92,967     | ) |                  |   | (78,741     | )
|                                |  |              |             |   |                  |   |             |  
|                                |  |              | (15,800,524 | ) |                  |   | (13,482,415 | )
|                                |  |              |             |   |                  |   |             |  
|Plant and equipment, net        |  | $            | 50,561,819  |   |                  | $ | 48,496,760  |  
|                                |  |              |             |   |                  |   |             |  



11



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



Depreciation expense for the three months ended June 30, 2008 and 2007 was $808,138 and $553,290, respectively.
Depreciation expense for the six months ended June 30, 2008 and 2007 was $1,590,158 and $1,096,373, respectively. As of June 30, 2008, the net book value of plant and equipment pledged as collateral for a bank loan was $13,475,626. See
Note 13.

NOTE 11  INVESTMENTS AND ADVANCES IN UNCONSOLIDATED ENTITIES

Long-term investment and advance include our equity investment in China Aoxing Pharmaceutical Company, Inc. (China Aoxing) from April 15, 2008 and Guanxi Qili Color Printing Co Ltd.
(Qili). China Aoxing is a China-based pharmaceutical company specializing in research, development, manufacturing and distribution of narcotic and pain-management products in China. Qili is a colour printing company focusing on the
printing of external packaging materials. The Company, and through its subsidiary, owns 38% equity interest in China Aoxing and 40% equity interest in Qili. Both investments are accounted for using equity accounting method and the cost of
investments approximate our estimate of the underlying equity in net assets at time of the investments. If the final valuation derives different amounts from our estimate, we will adjust these amounts to goodwill. The following table summarizes the
long-term investment and advances as of June 30, 2008:



|                                  |  |              |            |   |                  |   |        
|--------------------------------- |  | ------------ | ---------- | - | ---------------- | - | -------
|                                  |  | June 30,2008 |            |   | December 31,2007
|                                  |  | (Unaudited)  |            |   |                 
|Cost of investment:               |  |              |            |   |                  |   |        
|China Aoxing                      |  | $            | 18,000,000 |   |                  | $ |       
|Qili                              |  |              | 86,067     |   |                  |   | 86,067 
|                                  |  |             
|Share of equity income (loss):    |  |              |            |   |                  |   |        
|China Aoxing                      |  |              | (641,215   | ) |                  |   |       
|Qili                              |  |              | 36,172     |   |                  |   | 28,672 
|                                  |  |             
|Advances:                         |  |              |            |   |                  |   |        
|China Aoxing                      |  |              | 1,741,400  |   |                  |   |       
|Qili                              |  |              | 96,306     |   |                  |   | 127,812
|                                  |  |              |            |   |                  |   |        
|Long-term investment and advances |  | $            | 19,318,730 |   |                  | $ | 242,551
|                                  |  |              |            |   |                  |   |        

The advance to China Aoxing is a partial payment of a RMB30 million, or approximately US$4.3 million, convertible
promissory note from China Aoxing. As of June 30, 2008, RMB18 million, or approximately US$2.6 million of the note payment was still outstanding. The note bears interest at a rate of 8% payable quarterly in arrears and matures in one year.
China Aoxing may elect to make the quarterly loan payments in cash or to convert the payments into shares of its common stock. The Company also has the option to receive payment in shares of China Aoxings common stock if China Aoxing is either
unable to repay the loan in cash or consents to the conversion of its payment obligations into shares of its common stock.

NOTE 12  DEPOSIT FOR
LONG-TERM ASSETS

Deposit for long term assets is a refundable deposit to acquire a land use right and buildings located in the PRC. The
long-lived or physical assets to be acquired will be for use in the Companys normal business operations and is not intended for resale by the Company. The deposit will be reclassified to the respective accounts under the long lived
assets upon the transfers of legal title.



12



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



NOTE 13  DEBT

Short-term bank loans are obtained from local banks with interest rates ranging from 7.098% to 7.511% per annum. Long-term bank loans include a mortgage loan with 5.5% interest per annum and is repayable over 15 years. The current
portion of the long-term bank loans also includes a bank loan from Changchun Xinan Pharmaceutical Company Ltd (CCXA) which bears interest from 8.19% to 8.541% per annum, and is repayable by June 2009. All the short-term and long
term bank loans are secured by fixed assets and land use rights owned by the Company. Also see Notes 8 and 10.

Notes payable have interest rates ranging
form 7.056% to 7.83% per annum. All notes payable are non-secured and repayable over one year.

Interest expense for the three months ended
June 30, 2008 and 2007 was $200,503 and $213,961, respectively. Interest expense for the six months ended June 30, 2008 and 2007 was $393,741 and $441,119, respectively.

NOTE 14  SHAREHOLDERS EQUITY

A. Issuance of Common stock

The Company entered into two consulting agreements during the first six months of 2008 and issued 26,748 shares of common stock as part of the consulting fees. The
Company recorded a total of deferred consulting expenses of $260,000, based on the market value of the common stock at the date of grants, which has been and will be amortized over a one-year service period. Of the total value, $140,000 was
amortized through June 30, 2008.

B. Stock Options

As part of the 2008 Compensation review and analysis, on April 9, 2008 the Compensation Committee of the Board of Directors of the Company approved grant of stock options to the Companys principal executive officer,
principal financial officer and certain other executives. Stock options for 1,137,257 shares of common stock at a per share exercise price of $8.35 were granted under the 2006 Plan and will vest ratably over a five year period. The Company valued
the stock options at $1,990,200. The value of the options was estimated using the Black Scholes Model with an expected volatility of 18.9%, expected life of 5 years and risk-free interest rate of 1.95 %.

On May 23, 2008, the Company granted stock options for 100,000 shares of common stock at a per share exercise price of $11.20 to a Companys senior member of
management under the 2006 Plan and will vest ratably over a five year period. The Company valued the stock options at $256,000. The value of the options was estimated using the Black Scholes Model with an expected volatility of 18.9%, expected life
of 5 years and risk-free interest rate of 2.7 %.

The Company recorded total stock option compensation expenses of $238,898 and $374,019 for the three and
six month period ended June 30, 2008. Of the total value of the old and new option grants, $4,263,760 has not yet been recognized and will be amortized over the requisite service period.



13



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



The following table summarizes the stock option activities of the Company:



|                                  |  |           |  |                                |      
|--------------------------------- |  | --------- |  | ------------------------------ | -----
|                                  |  | Activity  |  | Weighted AverageExercise Price
|Outstanding as of January 1, 2008 |  | 974,500   |  | $                              | 10.03
|Granted                           |  | 1,237,257 |  | $                              | 8.58 
|Exercised                         |  |          |  |                                |     
|Cancelled                         |  |          |  |                                |     
|                                  |  |           |  |                                |      
|Outstanding as of June 30, 2008   |  | 2,211,757 |  | $                              | 9.22 
|                                  |  |           |  |                                |      

The following table summarizes information about stock options outstanding as of June 30, 2008:



|                         |  |                     |  |                              |       |                                                     |   |                 |         |                              |   |      
|------------------------ |  | ------------------- |  | ---------------------------- | ----- | --------------------------------------------------- | - | --------------- | ------- | ---------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable         
|Range of Exercise Prices |  | Numberof Shares     |  | WeightedAverageExercisePrice |       | Weighted AverageRemainingContractual Life(in years) |   | Numberof Shares |         | WeightedAverageExercisePrice
|$8.54-$10.74             |  | 974,500             |  | $                            | 10.03 |                                                     | 4 |                 | 132,000 |                              | $ | 10.74
|$8.35-$11.20             |  | 1,237,257           |  | $                            | 8.58  |                                                     | 5 |                 |        |                              |   |     
|                         |  |                     |  |                              |       |                                                     |   |                 |         |                              |   |      
|                         |  | 2,211,757           |  |                              |       |                                                     |   |                 |        |                              |   |      
|                         |  |                     |  |                              |       |                                                     |   |                 |         |                              |   |      

The weighted average fair value per share of the 2,211,757 options issued under the Plan is $2.24 per share. All
the options granted have no intrinsic value at June 30 2008. As of June 30, 2008, the Company has 132,000 outstanding vested stock options, with an exercise price above market, are excluded from the Companys diluted computation.

C. Common Stock to be Issued

For the three and six
month period ended June 30, 2008, the Company recorded general and administrative expenses of $94,082 and $182,332, respectively, for stock compensation in connection with the services rendered by the Companys independent directors. A
total of 18,768 shares of common stock are issuable to independent directors as of June 30, 2008.

NOTE 15  COMMITMENTS

As of June 30, 2008, the Company entered into an unconditional capital commitment for purchase and construction of manufacturing facilities in PRC for $292,113
within one year and $19,862 after one year.

As of June 30, 2008, the Company entered into unconditional purchase commitments for raw materials,
packing materials and advertising for $1,085,239 within one year and $6,037 after one year.

As of June 30, 2008, the Company had remaining
outstanding commitments with respect to its non-cancelable operating leases for its office in Shenzhen and some regional representative offices in China of $97,484 within one year and $27,367 after one year.



14



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



NOTE 16  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 pharmaceutical products and nutraceutical products, the Companys chief operating decision maker reviews and evaluates combined financial
information to decide how to allocate resources and to assess performance.

For the three and six month period ended June 30, 2008 and 2007, the
Companys revenue from pharmaceutical products and nutraceutical products, are as follows:



|                        |  |                            |            |                          |   |            |  |      |            |  |   |           
|----------------------- |  | -------------------------- | ---------- | ------------------------ | - | ---------- |  | ---- | ---------- |  | - | ----------
|                        |  | THREE MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDEDJUNE 30,
|                        |  | 2008                       |            | 2007                     |   | 2008       |  | 2007
|Pharmaceutical Products |  | $                          | 49,792,442 |                          | $ | 26,002,968 |  | $    | 81,651,824 |  | $ | 44,578,676
|Nutraceutical Products  |  |                            | 9,217,563  |                          |   | 7,910,266  |  |      | 16,126,779 |  |   | 15,083,932
|                        |  |                            |            |                          |   |            |  |      |            |  |   |           
|TOTAL                   |  | $                          | 59,010,005 |                          | $ | 33,913,234 |  | $    | 97,778,603 |  | $ | 59,662,608
|                        |  |                            |            |                          |   |            |  |      |            |  |   |           

NOTE 17 TAXES

(a) Corporate Income Tax (CIT)

The Company has not recorded a provision for U.S. federal income tax for the quarter ended
June 30, 2008 due to the net operating loss carry forward in the United States. On March 16, 2007, the National Peoples Congress of China approved the new Corporate Income Tax Law of the Peoples Republic of China (the New
CIT Law), which is effective from January 1, 2008.

Prior to January 1, 2008, the CIT rate applicable to our subsidiaries in the PRC ranged
from 0% to 33%. Guangxi Ling Feng Pharmaceutical Company Limited (GLP), our wholly owned subsidiary, 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 Bioengineering Co. Ltd (Three Happiness), one of our other wholly owned subsidiaries, on the other hand, enjoys a
favorable tax rate of 15% as it is located in a special economic development zone and is considered a high technology company by the Chinese government. Guangxi Boke Pharmaceutical Limited (Boke) also enjoys a favorable tax rate of 15%
as it is located in a Western province of China. Our three remaining wholly owned subsidiaries do not qualify for any tax concession and have a 33% tax rate.

Under the new CIT law, the corporate income tax rate applicable to the Company starting from January 1, 2008 is 25%, replacing the current applicable tax rate of 33%. Some of the tax concession granted to eligible companies prior to
the new CIT law is grand fathered. The new CIT Law has an impact on the deferred tax assets and liabilities of the Company. The Company adjusted deferred tax balances as of June 30, 2008 based on our current applicable tax rate and will
continue to assess the impact of such new law in the future. Effects arising from the enforcement of the new CIT Law were reflected into the accounts by best estimation method.



15



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



The Companys tax expense differs from the expected tax expense as follows:



|                            |  |                            |            |                          |      |           |      |   |            |      |  |   |          
|--------------------------- |  | -------------------------- | ---------- | ------------------------ | ---- | --------- | ---- | - | ---------- | ---- |  | - | ---------
|                            |  | THREE MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDEDJUNE 30,
|                            |  | 2008                       |            |                          | 2007 |           | 2008 |   |            | 2007
|Computed expected expense |  | $                          | 5,265,036  |                          |      | 1,929,184 |      | $ | 8,636,155  |      |  | $ | 3,444,778
|Favorable tax rate effect   |  |                            | (1,389,576 | )                        |      |          |      |   | (2,258,254 | )    |  |   |         
|Permanent difference        |  |                            | 16,154     |                          |      | 10,641    |      |   | (16,339    | )    |  |   | 19,995   
|                            |  |                            |            |                          |      |           |      |   |            |      |  |   |          
|Income tax expense          |  | $                          | 3,891,614  |                          |      | 1,939,825 |      | $ | 6,361,562  |      |  | $ | 3,464,773
|                            |  |                            |            |                          |      |           |      |   |            |      |  |   |          

The provisions for income taxes are summarized as follows:



|         |  |                            |           |                          |           |      |   |           |      |  |          
|-------- |  | -------------------------- | --------- | ------------------------ | --------- | ---- | - | --------- | ---- |  | ---------
|         |  | THREE MONTHS ENDEDJUNE 30, |           | SIX MONTHS ENDEDJUNE 30,
|         |  | 2008                       |           | 2007                     |           | 2008 |   |           | 2007
|Current  |  | $                          | 3,866,137 |                          | 1,915,065 |      | $ | 6,415,276 |      |  | 3,448,954
|Deferred |  |                            | 25,477    |                          | 24,760    |      |   | (53,714   | )    |  | 15,819   
|         |  |                            |           |                          |           |      |   |           |      |  |          
|Total    |  | $                          | 3,891,614 |                          | 1,939,825 |      | $ | 6,361,562 |      |  | 3,464,773
|         |  |                            |           |                          |           |      |   |           |      |  |          

The tax effects of temporary differences that give rise to the Companys net deferred tax liabilities are as
follows:



|                               |  |              |             |   |                  |   |             |  
|------------------------------ |  | ------------ | ----------- | - | ---------------- | - | ----------- | -
|                               |  | June 30,2008 |             |   | December 31,2007 |  
|                               |  | (Unaudited)  |             |   |                  |  
|Deferred tax assets            |  |              |             |   |                  |   |             |  
|Bad debt                       |  | $            | 227,092     |   |                  | $ | 211,551     |  
|Amortization                   |  |              | 150,736     |   |                  |   | 98,239      |  
|Other costs                    |  |              | 1,159,584   |   |                  |   | 801,840     |  
|Stock provision                |  |              | 280,660     |   |                  |   | 289,511     |  
|Depreciation                   |  |              | 48,039      |   |                  |   | 97,340      |  
|                               |  |              |             |   |                  |   |             |  
|Total deferred tax assets      |  |              | 1,866,111   |   |                  |   | 1,498,481   |  
|                               |  |              |             |   |                  |   |             |  
|Deferred tax liabilities       |  |              |             |   |                  |   |             |  
|Over accrual of welfare        |  |              | (171,636    | ) |                  |   | (146,154    | )
|Amortization                   |  |              | (256,115    | ) |                  |   | (208,519    | )
|Depreciation                   |  |              | (84,445     | ) |                  |   | (51,976     | )
|Government grant               |  |              | (944,765    | ) |                  |   | (887,633    | )
|GLP acquisition                |  |              | (3,821,477  | ) |                  |   | (3,590,384  | )
|CCXA acquisition               |  |              | (4,644,714  | ) |                  |   | (4,340,893  | )
|Boke acquisition               |  |              | (3,244,482  | ) |                  |   | (3,298,341  | )
|Other                          |  |              | (286,479    | ) |                  |   | (97,280     | )
|Other comprehensive income     |  |              | (3,259,239  | ) |                  |   |            |  
|                               |  |              |             |   |                  |   |             |  
|Total deferred tax liabilities |  |              | (16,713,352 | ) |                  |   | (12,621,180 | )
|                               |  |              |             |   |                  |   |             |  
|Net deferred tax liabilities   |  | $            | (14,847,241 | ) |                  | $ | (11,122,699 | )
|                               |  |              |             |   |                  |   |             |  



16



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



All deferred tax assets are long-term in nature. In addition to the total deferred tax liability listed above at
June 30, 2008 is a short-term deferred tax liability of $358,529.

The Company adopted the provisions of Financial Accounting Standards Board
(FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109, (FIN 48), on January 1, 2007. The Company did not have any
material unrecognized tax benefits and there was no effect on its financial condition or results of operations as a result of implementing FIN 48.



|(b) | Tax holiday
|--- | -----------

The Company enjoys certain tax holiday under the new CIT law;
the income tax expenses for the three and six months ended June 30, 2008 were partly offset by tax concessions available to our subsidiaries including GLP, Boke and Three Happiness. The combined effects of the income tax expense reduction available
to us are as follows:



|                                               |  |                                 |           |                               |   |          
|---------------------------------------------- |  | ------------------------------- | --------- | ----------------------------- | - | ---------
|                                               |  | Three Months EndedJune 30, 2008 |           | Six Months EndedJune 30, 2008
|Tax holiday effect                             |  | $                               | 1,389,576 |                               | $ | 2,258,254
|Basic net income per share exclude tax holiday |  | $                               | 0.16      |                               | $ | 0.27     



|(c) | Value Added Tax (VAT)
|--- | -----------------------

Enterprises or individuals who sell
commodities, engage in repair and maintenance or import or export goods in the PRC are subject to a value added tax in accordance with the PRC laws. The value added tax standard rate is 17% of the gross sales price. A credit is available whereby VAT
paid on the purchases of semi-finished products or raw materials used in the production of the Companys finished products can be used to offset the VAT due on the sales of the finished products.

The VAT payable balance of $3,016,899 and $3,722,621 at June 30, 2008 and December 31, 2007 respectively are included in Other payables and accrued expenses in
the accompanying condensed consolidated balance sheets.

NOTE 18  SUBSEQUENT EVENTS

On July 15, 2008, the Company closed a private offering and issued $115 million aggregate principal amount of 5.00% Convertible Senior Notes due 2015 (the
Notes). The Notes were sold to qualified institutional buyers in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. The net proceeds from the sale of the Notes was approximately
$110.0 million, after deducting the placement agents commission and estimated offering expenses payable by the Company. In connection with the offering of the Notes, the Company also entered into a prepaid forward share repurchase contract
with an affiliate of the lead placement agent (Merrill affiliate). Pursuant to the prepaid forward share repurchase contract, the Company paid approximately $30 million to the Merrill affiliate to fund the purchase of 3.7 million
shares of common stock for settlement at or about maturity of the notes, subject to Merrill affiliates right to settle earlier.

The following is a
brief summary of certain terms of this offering.



| |  |  | Total offering is $115,000,000 aggregate principal amount of 5.00% Convertible Senior Notes due on July 15, 2015.
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | Interest at 5.00% per year, payable semiannually in arrears in cash.
| | - |  | --------------------------------------------------------------------



| |  |  | The notes are convertible, at the option of the holder, at any time prior to the close of business on the second business day preceding the maturity date based on
an initial conversion rate of 107.6195 shares per $1,000 principal amount of notes, which represents an initial conversion price of approximately $9.29 per share. The conversion rate is subject to certain adjustments. In particular, holders who
convert their notes in connection with certain fundamental changes may be entitled to a make whole premium in the form of additional shares of our common stock.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



17



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



| |  |  | The initial conversion rate may be adjusted on January 15, 2009 if the volume weighted average price (VWAP) of our common stock for each of the 30
consecutive trading days ending on January 15, 2009 is less than $8.08 per share, then the conversion rate will be increased as a one-time purchase price adjustment such that the conversion price as adjusted would represent the greater of
(1) 115.0% of such arithmetic average of the daily VWAP and (2) $8.08.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Holders may require the Company to purchase all or a portion of their notes on July 15, 2013 for cash at a price equal to 100% of the principal amount of the
notes to be purchased, plus accrued and unpaid interest, if any, to, but excluding, the purchase date.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | If a fundamental change occurs, holders will have the right to require the Company to purchase for cash all or any portion of their notes. The fundamental change
purchase price will be 100% of the principal amount of the notes to be purchased plus accrued and unpaid interest, if any, to, but excluding, the fundamental change purchase date.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The notes will be direct unsecured, unsubordinated obligations and will rank equal in right of payment to all of the Companys existing and future unsecured
and unsubordinated indebtedness. The notes will be effectively subordinated to all of the Companys existing and future secured indebtedness (to the extent of the value of the assets securing that indebtedness).
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company will file with the SEC a shelf registration statement with respect to the resale of the notes and the shares of the Company common stock issuable upon
conversion of the notes if the restrictive legend has not been removed and the notes are not freely tradable as of the 366th day after the date the notes are issued. The Company will use commercially reasonable efforts to cause the shelf
registration statement to become effective within 60 days after making such filing and will keep such shelf registration statement effective until the earlier of (i) the sale pursuant to the shelf registration statement of all of the notes and
all of the shares of common stock issuable upon conversion of the notes or (ii) the date when holders of the notes and the common stock issuable upon conversion of the notes are able to sell all such securities to the public in accordance with
Rule 144 under the Securities Act where no conditions of Rule 144 are then applicable and such securities do not bear any restrictive legend relating to the Securities Act. The Company will be required to pay additional interest, subject to some
limitations, to the holders of the notes if the Company fails to comply with the obligations to register the notes and the common stock issuable upon conversion of the notes or the registration statement does not become effective within the
specified time.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Accounting for the Notes and the prepaid forward share repurchase contract:



| |  |  | In connection with the issuance of the Notes, we incurred issuance costs, which primarily consisted of investment banker fees and legal and other professional fees.
These costs will be classified within Other Assets and will be amortized as interest expense using the effective interest method over the term from issuance through the first date that the holders can require repurchase of the Notes, which is
July 15, 2013.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company evaluated the terms of the redemption feature and the conversion rate adjustment feature of the Notes under the applicable accounting literature,
including SFAS No. 133, Accounting for Derivative Instruments and Heading Activities, and EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock,
and concluded that none of the features should be separately accounted for as derivatives.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Notes will be included in diluted EPS calculations using the if-converted method described in SFAS No. 128, Earnings per Share.
Under this method, interest on the debt, net of tax, is added back to the EPS numerator, and the shares that may be issued upon conversion are added to the EPS denominator, unless the result of this process is anti-dilutive.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The prepaid forward shares repurchase contract permits the Company to purchase a targeted number of
| | - |  | ---------------------------------------------------------------------------------------------------



18



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



| | shares immediately with a fixed purchase price for settlement at or about the maturity of the Notes. The stock repurchase to be accounted as an equity
transaction, similar to a treasury stock transaction, would result in an immediate reduction of the outstanding shares used to calculate the weighted-average common shares outstanding for both basic and diluted EPS. The effect of the forward
contract on diluted EPS would be calculated in accordance with Statement 128, as interpreted by Topic No. D-72, Effect of Contracts That May Be Settled in Stock or Cash on the Computation of Diluted Earnings per Share.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



19



---

##### Table of Contents

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As Of June 30, 2008

(UNAUDITED)



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,
2007, and (2) the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2007. Readers should carefully review the risk factors disclosed in the Companys Form 10-K for the year ended December 31, 2007 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 2007 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, 2008, the
Company provided a $176,962 reserve against accounts receivable. Managements estimate of the appropriate reserve on accounts receivable at June 30, 2008 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, 2008, the Company provided an allowance against its inventories amounting to $38,128. 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.



20



---

##### Table of Contents

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.

RECENT ACCOUNTING PRONOUNCEMENT

In December 2007, the FASB issued SFAS No. 141 (R), Business Combinations, and SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS No. 141 (R) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their fair values on the acquisition
date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No.160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of
earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 141 (R) and SFAS No. 160 are effective for financial statements issued for fiscal years beginning after December 15, 2008. Early
adoption is prohibited. We have not yet determined the effect on our consolidated financial statements, if any, upon adoption of SFAS No. 141 (R) or SFAS No. 160. We are aware that our accounting for minority interest will change and
we are considering those effects now but believe we will only be a reclassification of minority interest from mezzanine equity to our stockholders equity section in the balance sheet, in any case we do not believe the implementation of SFAS
160 will be material to our financial position. SFAS 141 (R) will significantly affect the accounting for future business combinations and we will determine the accounting as new combinations are determined.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. This Statement establishes accounting and
reporting standards that require the ownership interests in subsidiaries non-parent owners be clearly presented in the equity section of the balance sheet; requires the amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; requires that changes in a parents ownership interest while the parent retains its controlling financial interest in its
subsidiary be accounted for consistently; requires that when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value and the gain or loss on the deconsolidation of
the subsidiary be measured using the fair value of any noncontrolling equity; requires that entities provide disclosures that clearly identify the interests of the parent and the interests of the noncontrolling owners. This Statement is effective as
of the beginning of an entitys first fiscal year that begins after December 15, 2008. The Company has not determined the impact, if any, SFAS No. 160 will have on its financial statements.



21



---

##### Table of Contents

RESULTS OF OPERATIONS  THREE MONTHS ENDED JUNE 30, 2008 AS COMPARED TO THREE MONTHS ENDED JUNE 30, 2007

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, 2008 and 2007:



|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  
|----------------------------------------------------- |  | -------------------------- | ---------- | -------------------------- | ---- | - | ---------- |  | ----- | ---- |  | ----- | -
|                                                      |  | THREE MONTHS ENDEDJUNE 30, |            | THREE MONTHS ENDEDJUNE 30, |     
|                                                      |  | 2008                       |            |                            | 2007 |   | 2008       |  |       | 2007 | 
|REVENUES                                              |  | $                          | 59,010,005 |                            |      | $ | 33,913,234 |  | 100   | %    |  | 100   | %
|COST OF GOODS SOLD                                    |  |                            | 18,928,447 |                            |      |   | 10,210,485 |  | 32.08 |      |  | 30.11 |  
|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  
|GROSS PROFIT                                          |  |                            | 40,081,558 |                            |      |   | 23,702,749 |  | 67.92 |      |  | 69.89 |  
|Selling and marketing                                 |  |                            | 7,687,892  |                            |      |   | 3,886,564  |  | 13.03 |      |  | 11.46 |  
|Advertising                                           |  |                            | 7,452,231  |                            |      |   | 5,412,510  |  | 12.63 |      |  | 15.96 |  
|General and administrative                            |  |                            | 5,253,274  |                            |      |   | 2,557,805  |  | 8.90  |      |  | 7.54  |  
|Depreciation and amortization                         |  |                            | 1,010,461  |                            |      |   | 341,562    |  | 1.71  |      |  | 1.01  |  
|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  
|Total operating expenses                              |  |                            | 21,403,858 |                            |      |   | 12,198,441 |  | 36.27 |      |  | 35.97 |  
|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  
|INCOME FROM OPERATIONS                                |  |                            | 18,677,700 |                            |      |   | 11,504,308 |  | 31.65 |      |  | 33.92 |  
|Equity in earning (loss) from unconsolidated entities |  |                            | (640,008   | )                          |      |   | 3,888      |  | (1.08 | )    |  | 0.01  |  
|Interest income (expense), net                        |  |                            | (30,616    | )                          |      |   | 43,048     |  | (0.05 | )    |  | 0.13  |  
|Other income (expense), net                           |  |                            | (255,770   | )                          |      |   | 56,952     |  | (0.43 | )    |  | 0.17  |  
|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  
|INCOME BEFORE INCOME TAXES                            |  |                            | 17,751,306 |                            |      |   | 11,608,196 |  | 30.08 |      |  | 34.23 |  
|Income taxes                                          |  |                            | 3,891,614  |                            |      |   | 1,939,825  |  | 6.59  |      |  | 5.72  |  
|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  
|NET INCOME                                            |  | $                          | 13,859,692 |                            |      | $ | 9,668,371  |  | 23.49 | %    |  | 28.51 | %
|                                                      |  |                            |            |                            |      |   |            |  |       |      |  |       |  

Revenues

Revenues for the second quarter of 2008 were $59,010,005, an increase of $25,096,771 over revenues for the second quarter of 2007. Revenues by product categories were as follows:



|                        |  |                            |            |           |   |            |  |            |            |  |    |  
|----------------------- |  | -------------------------- | ---------- | --------- | - | ---------- |  | ---------- | ---------- |  | -- | -
|                        |  | THREE MONTHS ENDEDJUNE 30, |            | Increase/ |   | Increase/  | 
|                        |  | 2008                       |            | 2007      |   | (Decrease) |  | (Decrease) |           
|Pharmaceutical products |  | $                          | 49,792,442 |           | $ | 26,002,968 |  | $          | 23,789,474 |  | 91 | %
|Nutraceutical products  |  |                            | 9,217,563  |           |   | 7,910,266  |  |            | 1,307,297  |  | 17 | %
|                        |  |                            |            |           |   |            |  |            |            |  |    |  
|TOTAL                   |  | $                          | 59,010,005 |           | $ | 33,913,234 |  | $          | 25,096,771 |  | 74 | %
|                        |  |                            |            |           |   |            |  |            |            |  |    |  

Sales of our pharmaceutical products increased by $23,789,474, or 91%, as compared to the same period during 2007
primarily due to the following factors:



| |  |  | The sales of our prescription pharmaceutical products increased from $11,526,585 during the second quarter of 2007 to $20,425,161 in the same period of 2008, or a
77% increase. This is primarily due to the increase in sales of our Shuanghuanglian Injection Powder and Cease Enuresis Soft Gel supported by our continuing marketing efforts, increasing brand recognition and effective pricing strategy and our
distribution to previously unaddressed rural market;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



22



---

##### Table of Contents

| |  |  | The sales of our OTC pharmaceutical products increased from $14,476,384 to $29,367,281, or a 103% increase. This was attributable to the increase in sales of our
Jinji series and Jinji Yimucao product that was launched early 2007 supported by our marketing campaign to enhance recognition of such new product; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The contribution by our newly acquired subsidiaries, CCXA and Boke, of $5,847,695 and $7,609,351, respectively to our revenue for the quarter ended June 30,
2008. CCXA and Boke were not our subsidiaries during the same period of last year.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sales from our nutraceutical products increased to
$9,217,563 in the second quarter of 2008 from $7,910,266 in the same period during 2007, representing a growth of 17%. This increase was mainly attributable to the increase in sales of peptide tablets and peptide powder.

Cost of Goods Sold and Gross Profit

Cost of goods sold was
$18,928,447 for the three months ended June 30, 2008, compared to $10,210,485 for the three months ended June 30, 2007. Expressed as a percentage of revenues, cost of goods sold was 32% for the three months ended June 30, 2008,
compared to 30% for the three months ended June 30, 2007. The increase in cost of goods sold as a percentage of revenues was mainly attributable to the integration of CCXA which has lower gross margins. Cost of goods sold for the quarters ended
June 30, 2008 and 2007 by product categories were as follows:



|                        |  |                            |            |           |   |            |  |            |           |  |     |  
|----------------------- |  | -------------------------- | ---------- | --------- | - | ---------- |  | ---------- | --------- |  | --- | -
|                        |  | THREE MONTHS ENDEDJUNE 30, |            | Increase/ |   | Increase/  | 
|                        |  | 2008                       |            | 2007      |   | (Decrease) |  | (Decrease) |          
|Pharmaceutical products |  | $                          | 15,307,572 |           | $ | 7,278,150  |  | $          | 8,029,422 |  | 110 | %
|Nutraceutical products  |  |                            | 3,620,875  |           |   | 2,932,335  |  |            | 688,540   |  | 23  | %
|                        |  |                            |            |           |   |            |  |            |           |  |     |  
|TOTAL                   |  | $                          | 18,928,447 |           | $ | 10,210,485 |  | $          | 8,717,962 |  | 85  | %
|                        |  |                            |            |           |   |            |  |            |           |  |     |  

The cost of goods sold of pharmaceutical and nutraceutical products increased by 110% and 23%, respectively, in
the three months ended June 30, 2008 compared to the same period in 2007. These increases were attributable to our increase in sales.

Gross profit as
a percentage of net revenues decreased from 69.89% in the comparable period of the prior year to 67.92% in the second quarter of 2008 due to the increasing in cost of goods sold as a percentage of revenues discussed above.



23



---

##### Table of Contents

Selling and Marketing

Selling and marketing expenses, including distribution expenses, increased from $3,886,564 in the three months ended June 30, 2007 to $7,687,892 in the same period of 2008, representing a 98% increase. The details of our selling and
marketing expenses were as follows:



|                               |  |                            |           |           |   |            |  |            |           |  |     |  
|------------------------------ |  | -------------------------- | --------- | --------- | - | ---------- |  | ---------- | --------- |  | --- | -
|                               |  | THREE MONTHS ENDEDJUNE 30, |           | Increase/ |   | Increase/  | 
|                               |  | 2008                       |           | 2007      |   | (Decrease) |  | (Decrease) |          
|Promotional materials and fees |  | $                          | 4,084,853 |           | $ | 1,458,503  |  | $          | 2,626,350 |  | 180 | %
|Payroll                        |  |                            | 1,395,716 |           |   | 1,004,415  |  |            | 391,301   |  | 39  | %
|Shipping                       |  |                            | 618,512   |           |   | 569,645    |  |            | 48,867    |  | 9   | %
|Sales conferences              |  |                            | 610,511   |           |   | 97,743     |  |            | 512,768   |  | 525 | %
|Traveling                      |  |                            | 501,722   |           |   | 441,022    |  |            | 60,700    |  | 14  | %
|Offices supplies               |  |                            | 270,765   |           |   | 218,736    |  |            | 52,029    |  | 24  | %
|Other                          |  |                            | 205,813   |           |   | 96,500     |  |            | 109,313   |  | 113 | %
|                               |  |                            |           |           |   |            |  |            |           |  |     |  
|TOTAL                          |  | $                          | 7,687,892 |           | $ | 3,886,564  |  | $          | 3,801,328 |  | 98  | %
|                               |  |                            |           |           |   |            |  |            |           |  |     |  

The increase in selling and marketing expenses in the quarter ended June 30, 2008 compared to the same
quarter during 2007 was primarily due to the following factors:



| |  |  | Promotional materials and fees increased 180% from $1,458,503 to $4,084,853 during the second quarter of 2008 as compared to the same period of 2007. This was
primarily due to the increase in our promotion activities and initiatives to support the continuous growth of our revenue.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The increase in the payroll expenses was due to the increase in hiring of sales and marketing professionals in the three months ended June 30 2008 to support
future growth of our businesses as well as the integration of CCXA and Boke. CCXA and Boke were not our subsidiaries during the same period last year. The new labor law which became effective starting January 1, 2008 also contributed to the
increase.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The increase in sales conference expenses was due to the increase in promotional sales seminars in GLP and HSPL during the second quarter of 2008 as compared to the
same period of 2007.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The increase in traveling expenses reflected increased spending in marketing conferences to increase market awareness of our brand and products.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------

Advertising

Advertising expenses
increased by $2,039,721, from $5,412,510 in the second quarter of 2007 to $7,452,231 in the same quarter of 2008. The increase in advertising expenses resulted from the increase in general advertising cost and our increase in promotional efforts to
promote AOBOs brand, such as the Jinji and Boke series of products.

Advertising expenses as a percentage of revenue decreased from 16% in the second
quarter of 2007 to 13% in the same quarter of 2008. As the general advertising cost on media in China continue to increase, we decreased media advertising activities but increased other promotional activities and direct sales efforts to support the
continuous growth of our revenue.



24



---

##### Table of Contents

General and Administrative

General and administrative expenses increased from $2,557,805 in the second quarter of 2007 to $5,253,274 in the same quarter of 2008, or a 105% increase. The details of general and administrative expenses were as follows:



|                                         |  |                            |           |                     |      |   |                     |  |   |           |   |  |        |   
|---------------------------------------- |  | -------------------------- | --------- | ------------------- | ---- | - | ------------------- |  | - | --------- | - |  | ------ | --
|                                         |  | THREE MONTHS ENDEDJUNE 30, |           | Increase/(Decrease) |      |   | Increase/(Decrease) | 
|                                         |  | 2008                       |           |                     | 2007 |   |                    
|Payroll                                  |  | $                          | 1,122,654 |                     |      | $ | 509,113             |  | $ | 613,541   |   |  | 121    | % 
|Professional fees  legal and consulting |  |                            | 796,558   |                     |      |   | 89,232              |  |   | 707,326   |   |  | 793    | % 
|Staff welfare and insurance              |  |                            | 496,508   |                     |      |   | 151,528             |  |   | 344,980   |   |  | 228    | % 
|Professional fees  accounting           |  |                            | 432,875   |                     |      |   | 28,943              |  |   | 403,932   |   |  | 1,396  | % 
|Directors remuneration                  |  |                            | 423,333   |                     |      |   | 163,083             |  |   | 260,250   |   |  | 160    | % 
|Stock compensation  directors           |  |                            | 332,980   |                     |      |   | 136,673             |  |   | 196,307   |   |  | 144    | % 
|Research and development                 |  |                            | 272,977   |                     |      |   | 203,847             |  |   | 69,130    |   |  | 34     | % 
|Trip and traveling                       |  |                            | 269,306   |                     |      |   | 245,825             |  |   | 23,481    |   |  | 10     | % 
|Office supplies                          |  |                            | 183,792   |                     |      |   | 121,177             |  |   | 62,615    |   |  | 52     | % 
|Vehicles & utilities                     |  |                            | 118,593   |                     |      |   | 91,580              |  |   | 27,013    |   |  | 29     | % 
|Investors relation and listing expenses  |  |                            | 86,414    |                     |      |   | 80,363              |  |   | 6,051     |   |  | 8      | % 
|Office rental                            |  |                            | 51,842    |                     |      |   | 84,498              |  |   | (32,656   | ) |  | 39     | % 
|Stock compensation  consultants         |  |                            | 48,000    |                     |      |   | 148,300             |  |   | (100,300  | ) |  | (68    | %)
|Provision for bad debts                  |  |                            | (140,344  | )                   |      |   | 11,135              |  |   | (151,479  | ) |  | (1,360 | %)
|Miscellaneous                            |  |                            | 757,786   |                     |      |   | 492,508             |  |   | 265,278   |   |  | 54     | % 
|                                         |  |                            |           |                     |      |   |                     |  |   |           |   |  |        |   
|TOTAL                                    |  | $                          | 5,253,274 |                     |      | $ | 2,557,805           |  | $ | 2,695,469 |   |  | 105    | % 
|                                         |  |                            |           |                     |      |   |                     |  |   |           |   |  |        |   

The increase in general and administrative expenses in the three months ended June 30, 2008 compared to the
same period during 2007 was primarily due to the following factors:



| |  |  | Payroll expenses increased by $613,541, or 121% compared with the second quarter during 2007, as a result of the increased average salary for administrative
employees and the integration of CCXA and Boke. CCXA and Boke were not our subsidiaries during the second quarter of 2007.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Legal and consulting related professional fees increased by $707,326, or 793%. The increase was mainly related to our fund raising activities during the second
quarter of 2008.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Staff welfare and insurance increased by $344,980 or 228% from the second quarter of 2007. This was due to the increase in number of employees from the integration
of CCXA and Boke that incurred more welfare and related insurance cost. The increase was also attributable to the additional welfare and insurance coverage which are mandatory under the new labor law.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accounting related professional fees increased from $28,943 to $432,875 or 1,396%, due primarily to the increase in accounting fees relating to our fund raising
activities during the second quarter of 2008 and the increase in audit fees relating to our increased number of subsidiaries being audited.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Directors remuneration and stock compensation increased by $260,250 and $196,307, or 160% and 144% respectively, as compared to the same quarter during 2007.
This was mainly a result of our performance bonus accrual for the executives and a new compensation plan for 2008.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We made specific provisions for bad debts based on the age of the 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. We reversed $140,344 provision for bad debts during the quarter because of our improved ageing of our accounts
receivables due to our better credit control.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other expenses increased by $265,278 during the second quarter of 2008 compared with the same quarter of 2007. This increase was primarily due to increases in local
taxes and conference fees.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



---

##### Table of Contents

Depreciation and Amortization

Depreciation and amortization expenses increased by $668,899, or 196%, in the quarter ended June 30, 2008 compared to the same quarter during 2007. The increase was due to the integration of Boke with a net book value of $4,323,439 in
fixed assets and $21,285,586 in intangible assets as well as the integration of CCXA with a net book value of $11,094,329 in fixed assets and $17,120,111 in intangible assets. Boke and CCXA were not our subsidiaries during the second quarter of
2007.

Equity in earning (loss) from unconsolidated entities

Equity in loss from unconsolidated entities was $640,008 for the three months ended June 30, 2008 compared to a net earning of $3,888 for the same period during 2007. This was mainly due to the recognition of the share of equity loss
of $641,215 from our new investment in China Aoxing from April 2008.

Interest Income (expense), Net

Net interest expense was $30,616 for the three months ended June 30, 2008, compared to net interest income of $43,048 for the three months ended June 30, 2007.
Decrease in net interest income for the second quarter of 2008 was because of additional interest expense recorded from CCXA and Boke, both were not our subsidiaries during the second quarter of 2007.

Other Income (expense), Net

Other expense was $255,770 for the three
months ended June 30, 2008 compared to a net income of $56,952 for the three months ended June 30, 2007. This was primarily due to our donation of $168,641 related to the Sichuan earthquake relief during the second quarter of 2008.

Income Taxes

Income tax expense for the quarter ended
June 30, 2008 was $3,891,614, compared to $1,939,825 for the quarter ended June 30, 2007. The Companys effective tax rate for this quarter was 22%.

RESULTS OF OPERATIONS  SIX MONTHS ENDED JUNE 30, 2008 AS COMPARED TO SIX MONTHS ENDED JUNE 30, 2007

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, 2008 and 2007:



|                                                      |  |                          |            |                          |      |   |            |  |       |      |  |       |  
|----------------------------------------------------- |  | ------------------------ | ---------- | ------------------------ | ---- | - | ---------- |  | ----- | ---- |  | ----- | -
|                                                      |  | SIX MONTHS ENDEDJUNE 30, |            | SIX MONTHS ENDEDJUNE 30, |     
|                                                      |  | 2008                     |            |                          | 2007 |   | 2008       |  |       | 2007 | 
|REVENUES                                              |  | $                        | 97,778,603 |                          |      | $ | 59,662,608 |  | 100   | %    |  | 100   | %
|COST OF GOODS SOLD                                    |  |                          | 31,406,083 |                          |      |   | 18,240,539 |  | 32.12 |      |  | 30.57 |  
|                                                      |  |                          |            |                          |      |   |            |  |       |      |  |       |  
|GROSS PROFIT                                          |  |                          | 66,372,520 |                          |      |   | 41,422,069 |  | 67.88 |      |  | 69.43 |  
|Selling and marketing                                 |  |                          | 12,717,600 |                          |      |   | 6,590,035  |  | 13.01 |      |  | 11.05 |  
|Advertising                                           |  |                          | 11,846,572 |                          |      |   | 9,237,855  |  | 12.12 |      |  | 15.48 |  
|General and administrative                            |  |                          | 9,165,957  |                          |      |   | 5,495,949  |  | 9.37  |      |  | 9.21  |  
|Depreciation and amortization                         |  |                          | 1,987,671  |                          |      |   | 675,836    |  | 2.03  |      |  | 1.13  |  
|                                                      |  |                          |            |                          |      |   |            |  |       |      |  |       |  
|Total operating expenses                              |  |                          | 35,717,800 |                          |      |   | 21,999,675 |  | 36.53 |      |  | 36.87 |  
|INCOME FROM OPERATIONS                                |  |                          | 30,654,720 |                          |      |   | 19,422,394 |  | 31.35 |      |  | 32.55 |  
|Equity in earning (loss) from unconsolidated entities |  |                          | (641,067   | )                        |      |   | 11,000     |  | (0.66 | )    |  | 0.02  |  
|Interest income, net                                  |  |                          | (13,769    | )                        |      |   | 17,238     |  | (0.01 | )    |  | 0.03  |  
|Other income, net                                     |  |                          | (356,502   | )                        |      |   | 131,958    |  | (0.36 | )    |  | 0.22  |  
|                                                      |  |                          |            |                          |      |   |            |  |       |      |  |       |  
|INCOME BEFORE INCOME TAXES                            |  |                          | 29,643,382 |                          |      |   | 19,582,590 |  | 30.32 |      |  | 32.82 |  
|Income taxes                                          |  |                          | 6,361,562  |                          |      |   | 3,464,773  |  | 6.51  |      |  | 5.81  |  
|                                                      |  |                          |            |                          |      |   |            |  |       |      |  |       |  
|NET INCOME                                            |  | $                        | 23,281,820 |                          |      | $ | 16,117,817 |  | 23.81 | %    |  | 27.01 | %
|                                                      |  |                          |            |                          |      |   |            |  |       |      |  |       |  



26



---

##### Table of Contents

Revenues

Revenues
for the six months ended June 30, 2008 were $97,778,603, increased by $38,115,995, as compared to the same period during 2007. Revenues by product categories were as follows:



|                        |  |                          |            |                     |   |                     |  |   |            |  |    |  
|----------------------- |  | ------------------------ | ---------- | ------------------- | - | ------------------- |  | - | ---------- |  | -- | -
|                        |  | SIX MONTHS ENDEDJUNE 30, |            | Increase/(Decrease) |   | Increase/(Decrease) | 
|                        |  | 2008                     |            | 2007                |   |                    
|Pharmaceutical products |  | $                        | 81,651,824 |                     | $ | 44,578,676          |  | $ | 37,073,148 |  | 83 | %
|Nutraceutical products  |  |                          | 16,126,779 |                     |   | 15,083,932          |  |   | 1,042,847  |  | 7  | %
|                        |  |                          |            |                     |   |                     |  |   |            |  |    |  
|TOTAL                   |  | $                        | 97,778,603 |                     | $ | 59,662,608          |  | $ | 38,115,995 |  | 64 | %
|                        |  |                          |            |                     |   |                     |  |   |            |  |    |  

Sales of our pharmaceutical products increased by $37,073,148 or 83%, as compared to the same period during 2007
primarily due to the following factors:



| |  |  | The sales of our prescription pharmaceutical products increased from $21,203,417 during the first six months of 2007 to $31,058,564 in the same period of 2008, or a
46% increase. This is primarily due to the increase in sales of our Shuanghuanglian Injection Powder and Cease Enuresis Soft Gel supported by our continuing marketing efforts, increasing brand recognition and effective pricing strategy , and our
distribution to the unaddressed rural market;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The sales of our OTC pharmaceutical products increased from $23,355,967 to $50,593,261, or a 117% increase. This was attributable to the increase in sales of our
Jinji series and Jinji Yimucao product that was launched in early 2007 and as a result of our marketing campaigns to enhance recognition of such product; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The contribution by our newly acquired subsidiaries, CCXA and Boke, of $10,170,148 and $13,326,470, respectively to our revenue for the six months ended June 60,
2008, respectively. CCXA and Boke were not our subsidiaries during the same period of last year.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sales from our nutraceutical products
increased to $16,126,779 in the six months ended June 30, 2008 from $15,083,932 in the same period during 2007, representing a growth of 7%. This increase was mainly attributable to the increase in sales of peptide coffee and peptide powder.



27



---

##### Table of Contents

Cost of Goods Sold and Gross Profit

Cost of goods sold was $31,406,083 for the six months ended June 30, 2008, compared to $18,240,539 for the six months ended June 30, 2007. Expressed as a percentage of revenues, cost of goods sold was 32.12%
for the six months ended June 30, 2008, compared to 30.57% for the six months ended June 30, 2007. The increase in cost of goods sold as a percentage of revenues was mainly attributable to the integration of CCXA which has lower gross
margins. Cost of goods sold for the six months ended June 30, 2008 and 2007 by product categories were as follows:



|                        |  |                          |            |                     |   |                     |  |   |            |  |    |  
|----------------------- |  | ------------------------ | ---------- | ------------------- | - | ------------------- |  | - | ---------- |  | -- | -
|                        |  | SIX MONTHS ENDEDJUNE 30, |            | Increase/(Decrease) |   | Increase/(Decrease) | 
|                        |  | 2008                     |            | 2007                |   |                    
|Pharmaceutical products |  | $                        | 25,097,208 |                     | $ | 12,758,789          |  | $ | 12,338,419 |  | 97 | %
|Nutraceutical products  |  |                          | 6,308,875  |                     |   | 5,481,750           |  |   | 827,125    |  | 15 | %
|                        |  |                          |            |                     |   |                     |  |   |            |  |    |  
|TOTAL                   |  | $                        | 31,406,083 |                     | $ | 18,240,539          |  | $ | 13,165,544 |  | 72 | %
|                        |  |                          |            |                     |   |                     |  |   |            |  |    |  

The cost of goods sold of pharmaceutical products and nutraceutical products increased by 97% and 15%,
respectively, in the six months ended June 30, 2008 compared to the same period of 2007. These increases were attributable to our increase in sales.

Gross profit as a percentage of net revenues decreased from 69.43% in the comparable period of the prior year to 67.88% due to the increase in cost of goods sold as a percentage of revenues discussed above.

Selling and Marketing

Selling and marketing expenses, including
distribution expenses, increased from $6,590,035 during the six months ended June 30, 2007 to $12,717,600 in the same period of 2008, representing a 93% increase. The details of our selling and marketing expenses were as follows:



|                               |  |                          |            |                     |   |                     |  |   |           |  |     |  
|------------------------------ |  | ------------------------ | ---------- | ------------------- | - | ------------------- |  | - | --------- |  | --- | -
|                               |  | SIX MONTHS ENDEDJUNE 30, |            | Increase/(Decrease) |   | Increase/(Decrease) | 
|                               |  | 2008                     |            | 2007                |   |                    
|Promotional materials and fees |  | $                        | 5,483,559  |                     | $ | 2,191,160           |  | $ | 3,292,399 |  | 150 | %
|Payroll                        |  |                          | 2,808,937  |                     |   | 1,622,208           |  |   | 1,186,729 |  | 73  | %
|Shipping                       |  |                          | 1,464,589  |                     |   | 969,398             |  |   | 495,191   |  | 51  | %
|Trip and traveling             |  |                          | 1,337,513  |                     |   | 749,327             |  |   | 588,186   |  | 78  | %
|Sales conferences              |  |                          | 787,214    |                     |   | 590,357             |  |   | 196,857   |  | 33  | %
|Offices supplies               |  |                          | 470,484    |                     |   | 264,613             |  |   | 205,871   |  | 78  | %
|Other                          |  |                          | 365,304    |                     |   | 202,972             |  |   | 162,332   |  | 80  | %
|                               |  |                          |            |                     |   |                     |  |   |           |  |     |  
|TOTAL                          |  | $                        | 12,717,600 |                     | $ | 6,590,035           |  | $ | 6,127,565 |  | 93  | %
|                               |  |                          |            |                     |   |                     |  |   |           |  |     |  

The increase in selling and marketing expenses in the six months ended June 30, 2008 compared to the same
period during 2007 was primarily due to the following factors:



| |  |  | Promotional materials and fees increased 150% from $2,191,160 to $5,483,559 during the first six months of 2008 as compared to the same period of 2007. This was
primarily due to the increase in our promotion activities and initiatives to support the continuous growth of our revenue.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The increase in the payroll expenses was due to the increase in hiring of sales and marketing professionals in the first six months of 2008 to support future growth
of our businesses as well as the integration of CCXA and Boke. CCXA and Boke were not our subsidiaries during the same period last year. The new labor law which became effective starting January 1, 2008 also contributed to the increase.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



---

##### Table of Contents

| |  |  | The increase in traveling expenses reflect increased spending in marketing conferences to increase market awareness of our brand and products.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The increase in sales conferences was due to the increase in promotional sales seminars in GLP and HSPL during the first six months of 2008 as compared to the same
period of 2007.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Advertising

Advertising expenses increased by $2,608,717, from $9,237,855 in the six months ended June 30, 2007 to $11,846,572 in the same period during 2008. The increase in advertising expenses was resulted from the increase in general
advertising cost and our increase in promotional efforts to promote AOBOs brand, such as Jinji and Boke series of products.

Advertising expenses as
a percentage of revenue decreased from 15% in the first six months of 2007 to 12% in the same period of 2008. As the general advertising cost on media in China continue to increase, we decreased media advertising activities but increased other
promotional activities and direct sales effort to support the continuous growth of our revenue.

General and Administrative

General and administrative expenses increased from $5,495,949 in the first six months of 2007 to $9,165,957 in the same period of 2008, or a 67% increase. The details of
general and administrative expenses were as follows:



|                                         |  |                          |           |                     |      |   |                     |  |   |           |   |  |      |   
|---------------------------------------- |  | ------------------------ | --------- | ------------------- | ---- | - | ------------------- |  | - | --------- | - |  | ---- | --
|                                         |  | SIX MONTHS ENDEDJUNE 30, |           | Increase/(Decrease) |      |   | Increase/(Decrease) | 
|                                         |  | 2008                     |           |                     | 2007 |   |                    
|Payroll                                  |  | $                        | 1,865,961 |                     |      | $ | 960,143             |  | $ | 905,818   |   |  | 94   | % 
|Professional fees  accounting           |  |                          | 1,190,877 |                     |      |   | 559,938             |  |   | 630,939   |   |  | 113  | % 
|Professional fees  legal and consulting |  |                          | 847,855   |                     |      |   | 234,714             |  |   | 613,141   |   |  | 261  | % 
|Staff welfare and insurance              |  |                          | 820,920   |                     |      |   | 319,531             |  |   | 501,389   |   |  | 157  | % 
|Directors remuneration                  |  |                          | 603,333   |                     |      |   | 292,333             |  |   | 311,000   |   |  | 106  | % 
|Stock compensation  directors           |  |                          | 556,351   |                     |      |   | 174,173             |  |   | 382,178   |   |  | 219  | % 
|Stock compensation  consultants         |  |                          | 104,500   |                     |      |   | 264,100             |  |   | (159,600  | ) |  | (60  | %)
|Office rental                            |  |                          | 112,402   |                     |      |   | 180,796             |  |   | (68,394   | ) |  | (38  | %)
|Investors relation and listing expenses  |  |                          | 146,065   |                     |      |   | 175,785             |  |   | (29,720   | ) |  | (17  | %)
|Office supplies                          |  |                          | 362,364   |                     |      |   | 344,293             |  |   | 18,071    |   |  | 5    | % 
|Vehicles & utilities                     |  |                          | 281,504   |                     |      |   | 186,471             |  |   | 95,033    |   |  | 51   | % 
|Research                                 |  |                          | 488,413   |                     |      |   | 380,662             |  |   | 107,751   |   |  | 28   | % 
|Trip and traveling                       |  |                          | 530,767   |                     |      |   | 486,749             |  |   | 44,018    |   |  | 9    | % 
|Provision for bad debts                  |  |                          | (143,109  | )                   |      |   | 50,398              |  |   | (193,507  | ) |  | (384 | %)
|Miscellaneous                            |  |                          | 1,397,754 |                     |      |   | 885,863             |  |   | 511,891   |   |  | 58   | % 
|                                         |  |                          |           |                     |      |   |                     |  |   |           |   |  |      |   
|TOTAL                                    |  | $                        | 9,165,957 |                     |      | $ | 5,495,949           |  | $ | 3,670,008 |   |  | 67   | % 
|                                         |  |                          |           |                     |      |   |                     |  |   |           |   |  |      |   



29



---

##### Table of Contents

The increase in general and administrative expenses in the six months ended June 30, 2008 compared to the same
period during 2007 was primarily due to the following factors:



| |  |  | Payroll expenses increased by $905,818, or 94% compared with the first six months during 2007, because of the increased average salary for administrative employees
and the integration of CCXA and Boke. CCXA and Boke were not our subsidiaries during the second quarter of 2007.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accounting related professional fees increased from $559,938 to $1,190,877 or 113%, due primarily to the increase in accounting fees relating to our fund raising
activities during the second quarter of 2008 and the increase in audit fees relating to our increased number of subsidiaries being audited.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Legal and consulting related professional fees increased by $613,141, or 261%. The increase was mainly related to our fund raising activities during the second
quarter of 2008.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Staff welfare and insurance increased by $501,389 or 157% from the first six months of 2007. This was due to the increase in number of employees from the
integration of CCXA and Boke that incurred more welfare and related insurance cost. The increase was also attributable to the additional welfare and insurance coverage, which are mandatory under the new labor law.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Directors remuneration and stock compensation increased by $311,000 and $382,178, or 106% and 219% respectively, as compared to the same period during 2007.
This was mainly a result of our performance bonus accrual for the executives and a new compensation plan for 2008.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We made specific 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. We reversed $143,754 provision for bad debts during the period because of our improved ageing of our accounts
receivables due to our better credit control.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Miscellaneous expenses increased by $511,891 during the first six months of 2008 compared with the same period of 2007. This increase was primarily due to increases
in local taxes and conference expenses.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Depreciation and Amortization

Depreciation and amortization expenses increased by $1,311,835, or 194%, in the six months ended June 30, 2008 compared to the same period during 2007. The increase
was due to the integration of Boke with the net book value of $4,323,439 in fixed assets and $21,285,586 in intangible assets as well as the integration of CCXA with the net book value of $11,094,329 in fixed assets and $17,120,111 in intangible
assets. Boke and CCXA were not our subsidiaries during the first six months of 2007.

Equity in earning (loss) from unconsolidated entities

Equity in loss from unconsolidated entities was $641,067 for the six months ended June 30, 2008 compared to a net earning of $11,000 for the same
period during 2007. This was mainly due to the recognition of the share of equity loss of $641,215 from our new investment in China Aoxing from April 2008.

Interest Income (expense), Net

Net interest expense was $13,769 for the six months ended June 30, 2008, compared to net interest
income of $17,238 for the six months ended June 30, 2007. Decrease in net interest income for first six months of 2008 was because of additional interest expense were recorded from CCXA and Boke, both were not our subsidiaries during the first
six months of 2007.



30



---

##### Table of Contents

Other Income (expense), Net

Other expense was $356,502 for the six months ended June 30, 2008 compared to a net income of $131,958 for the six months ended June 30, 2007. This was primarily due to our donation of $168,641 for the Sichuan earthquake relief
during the second quarter of 2008.

Income Taxes

Income tax expense for the six months ended June 30, 2008 was $6,361,562, compared to $3,464,773 for the six months ended June 30, 2007. The Companys effective tax rate during the six months ended June 30, 2008 was 21%.

LIQUIDITY AND CAPITAL RESOURCES

Cash

Our cash balance at June 30, 2008, was $144,473,275, representing a decrease of $21,936,800, or 13%, compared with our cash balance of
$166,410,075 at December 31, 2007. The decrease was mainly attributable to our payment for fixed assets partially offset by cash provided by operating activities.

On July 15, 2008, the Company closed a private offering and issued $115 million aggregate principal amount of Convertible Senior Notes due 2015 (the Notes). The Notes are being sold to qualified
institutional buyers in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. The net proceeds from the sale of the Notes are approximately $110.0 million, after deducting the placement agents
commission and estimated offering expenses payable by the company. In connection with the offering of the Notes, the Company also entered into a prepaid forward share repurchase contract with an affiliate of the placement agents, which the Company
refer to as the counterparty. Pursuant to the prepaid forward share repurchase contract, the Company repurchased from the counterparty 3.7 million shares of common stock for settlement at or about the maturity of the notes, subject to the
counterpartys right to settle earlier. The Company used approximately $30.0 million of the net proceeds of the offering to fund the cost of the prepaid forward share repurchase transaction.

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

For the purpose of future acquisitions, it is very important to have cash in local currency in a China bank to demonstrate our financial
strength and capability to acquire potential companies in cash with funds that are available immediately. Because of the anticipated appreciation of Renminbi, interest rates in China are lower than other foreign currencies and 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 the flexibility in executing our acquisition strategy.

Cash Flow

Cash flows from operations during the six months ended June 30, 2008 amounted to $28,374,749, representing an increase of approximately 77% compared with cash flows
from operations of $16,007,441 in the same period of 2007. The increased cash flow was due primarily to the increase in our net income by 44%, to $23,281,820 in the first six months of 2008, compared with net income of $16,117,817 in the same period
last year. The increased cash flow was also due in part to a decrease in notes receivable by $1,567,744 and advance to suppliers by $1,324,457, as well as increase in accounts payable and tax payable of $1,235,110 and $922,717, respectively. The
increase in accounts payable was due to the better credit terms obtained from our vendors.



31



---

##### Table of Contents

These increases were partly offset by an increase and our inventories of $6,538,693 to support increased production
activities. The increased cash flow was also offset by a decrease in customer deposit of $2,253,528.

Our cash flows used in investing activities amounted
to $58,111,000 in the six months ended June 30, 2008. During that period, we paid $34,852,986 as deposit for long-term assets and $18,000,000 for the acquisition of the equity share in China Aoxing. We also paid $391,877 for purchases of plant
and equipment and spent $223,742 on construction-in-progress.

Our cash flows from financing activities amounted to $388,418 in the six months ended
June 30, 2008. During that period, we repaid $26,456 bank loans and paid $290,000 for our financing activities during the second quarter of 2008.

Working Capital

Our working capital decreased by $18,500,789 to $161,910,749 at June 30, 2008 as compared to $180,411,538 at
December 31, 2007, primarily due to our decrease in cash of $21,936,800, notes receivable of $1,567,744, advances to suppliers of $1,324,456 and partly offset by an increase of $6,704,419 in inventories, $1,235,110 in accounts payable and
$922,717 in tax 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.

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 a material 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, 2008 were denominated in Renminbi
(RMB), the currency of China, and were converted into US dollars at the exchange rate of 6.8718 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 $12,089,196 during the six months ended June 30, 2008. 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.



32



---

##### Table of Contents

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 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 2008 that have materially affected, or are reasonably likely to materially affect the Companys internal control over financial reporting.



33



---

##### Table of Contents

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 our Annual Report on Form 10-K for the year ended
December 31, 2007, we disclosed new risks and material changes from risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2006. There have been no material changes or new risks during the quarter ended
June 30, 2008 to be disclosed. We hereby incorporate by reference the risk factors set forth in Item 1A of the Annual Report of Form 10-K for the year ended December 31, 2007.

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                                                                                                                                                             
|3.2         |  | Amended and Restated By-laws                                                                                                                                            
|            | 
|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.



34



---

##### Table of Contents

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 11, 2008                
|                                      
|/s/ Yanchun Li                        
|YANCHUN LI                            
|CHIEF FINANCIAL OFFICER               
|DATED: August 11, 2008                



35