Aoxing Pharmaceutical (AOXG) 10-Q 2009 Q1 Quarterly report

United States

Securities and Exchange Commission

Washington, D. C. 20549

FORM 10-Q

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

            For the quarterly period ended September 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. 0-24185

CHINA AOXING PHARMACEUTICAL COMPANY, INC.

(Name of Small Business Issuer in its Charter)

Florida	65-0636168__
(State or Other Jurisdiction of	(I.R.S. Employer I.D. No.)
incorporation or organization)

40 Wall Street, 28thFloor, New York, NY 10006

(Address of Principal Executive Offices)

Issuer's Telephone Number: (646) 512-5662

Indicate  by check mark  whether the  Registrant  (1) has filed all reports required to be filed by Sections 13 or 15(d) of the  Securities Exchange Act of 1934  during  the  preceding  12 months (or for such shorter  period  that the Registrant was required to file such reports),  and (2) has been subject to such filing requirements for the past 90 days.

Yes X                    No ___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

Large accelerated filer__   Accelerated filer __    Non-accelerated filer__  Small reporting company_X_

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

APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:

November 14, 2008

Common Stock: 82,699,555

CHINA AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	September 30, 2008			June 30, 2008
	(Unaudited)
ASSETS
CURRENT ASSETS:
Cash	$	1,299,275		$	1,565,513
Accounts receivable		2,802,649			2,536,047
Inventories		678,765			848,959
Prepaid expenses and sundry current assets		410,748			303,208
TOTAL CURRENT ASSETS		5,191,437			5,253,727
LONG-TERM ASSETS:
Property and equipment, net of accumulated depreciation		30,056,983			30,331,143
Goodwill		18,902,282			18,904,845
Other intangible assets		1,634,099			1,635,375
TOTAL LONG-TERM ASSETS		50,593,364			50,871,363
TOTAL ASSETS	$	55,784,801		$	56,125,090
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings	$	3,648,720		$	2,042,600
Accounts payable		3,600,336			3,544,795
Current portion of loan payable – other		160,840			380,070
Loan from stockholders		112,051			112,068
Accrued expenses and taxes payable		3,449,153			4,851,314
Current portion of notes payable – bank		5,836,000			7,545,239
TOTAL CURRENT LIABILITIES		16,807,100			18,476,086
LONG-TERM DEBT – BANK		249,271			-
–  STOCKHOLDER		4,098,035			4,098,687
–  OTHER		3,499,131			3,127,643
CONVERTIBLE DEBENTURES		889,392			1,098,362
MINORITY INTEREST		79,830			24,598
WARRANT AND DERIVATIVE LIABILITIES		3,848,357			4,161,678
STOCKHOLDERS’ EQUITY:
Common stock, par value $0.001
100,000,000 shares authorized
81,564,555 and 81,089,911 shares issued and outstanding		81,565			81,090
Preferred stock, par value $0.001
300,000 shares authorized
277,018 shares issued and outstanding		277			277
Additional paid-in capital		37,272,662			36,749,956
Accumulated deficit		(11,688,059	)		(12,314,178	)
Other comprehensive income		647,240			620,891
TOTAL STOCKHOLDERS’ EQUITY		26,313,685			25,138,036
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	55,784,801		$	56,125,090

See notes to financial statements

CHINA AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

	Three Months Ended September 30,
	2008			2007
	(Unaudited)			(Restated)
SALES	$	3,598,065		$	1,380,294
COST OF SALES		1,937,345			625,653
GROSS PROFIT		1,660,720			754,641
OPERATING EXPENSES:
Research and development		266,329			57,262
General and administrative		1,192,892			538,290
Selling expense		631,018			276,813
Depreciation and amortization		144,458			118,812
TOTAL OPERATING EXPENSES		2,234,697			991,177
LOSS FROM OPERATIONS		(573,977	)		(236,536	)
OTHER INCOME (EXPENSES):
Interest expense		(475,494	)		(695,561	)
Change in fair value of warrant and derivative liabilities		147,727			2,675,652
Gain on foreign currency transaction		203,037			-
Forgiveness of debt		1,459,751			-
INCOME BEFORE MINORITY INTEREST AND INCOME TAXES		761,044			1,743,555
MINORITY INTEREST IN (INCOME) LOSSES OF SUBSIDIARY		(55,232	)		18,606
INCOME BEFORE INCOME TAXES		705,812			1,762,161
INCOME TAXES		79,693			-
NET INCOME		626,119			1,762,161
OTHER COMPREHENSIVE INCOME:
Foreign currency translation adjustment		26,349			44,288
COMPREHENSIVE INCOME	$	652,468		$	1,806,449
Basic and diluted earnings (loss) per common share	$	0.008		$	0.04
Weighted average number of shares outstanding		81,205,779			40,098,373

See notes to financial statements

CHINA AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Three Months Ended September 30,
	2008			2007
	(Unaudited)			(Restated)
OPERATING ACTIVITIES:
Net income (loss)	$	626,119		$	1,762,161
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		311,599			177,072
Forgiveness of debt		(1,459,751	)		-
Non-cash interest expense related to convertible debentures and warrants		81,030			436,258
Stock issued for services		-			179,932
Change in fair value of warrants and derivative liabilities		(147,727	)		(2,675,652	)
Minority interest		55,232			(18,606	)
Changes in operating assets and liabilities:
Accounts receivable		(267,123	)		(41,757	)
Inventories		170,019			(98,856	)
Prepaid expenses and sundry current assets		(107,574	)		(81,737	)
Accounts payable		56,269			(270,300	)
Accrued expenses, taxes and sundry current liabilities		61,415			331,933
NET CASH USED IN OPERATING ACTIVITIES		(620,492	)		(299,552	)
INVESTING ACTIVITIES:
Acquisition of property and equipment, net		(55,975	)		(9,915	)
NET CASH USED IN INVESTING ACTIVITIES		(55,975	)		(9,915	)
FINANCING ACTIVITIES:
Repayment of bank borrowings		(1,458,417	)		-
Other borrowings		1,759,460			67,284
Loans from stockholders		-			(463,378	)
Sale of convertible debentures		-			160,000
NET CASH PROVIDED BY FINANCING ACTIVITIES		301,043			(236,094	)
EFFECT OF EXCHANGE RATE ON CASH		109,486			65,155
DECREASE IN CASH		(265,938	)		(480,406	)
CASH – BEGINNING OF PERIOD		1,565,213			1,511,127
CASH – END OF PERIOD	$	1,299,275		$	1,030,721
Non-cash financing activities:
Conversion of convertible debentures	$	290,000		$	360,000
Common stock issued as payment for accrued interest	$	25,570		$	25,829

See notes to financial statements

CHINA AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2008

1          BASIS OF PRESENTATION

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X relating to smaller reporting companies.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending June 30, 2009.

The balance sheet at June 30, 2008 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.

Use of estimates in the preparation of financial statements

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 net revenue and expenses during each reporting period.  Actual results could differ from those estimates.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2008 filed on October 14, 2008.

2          BUSINESS DESCRIPTION AND BASIS OF CONSOLIDATION

China Aoxing Pharmaceutical Co., Inc. (“the Company”), through its subsidiaries, is a vertically integrated pharmaceutical company specializing in research, development, manufacturing and marketing of a variety of narcotics and pain management pharmaceutical products in generic and innovative formulations.  The Company has two operating subsidiaries: Hebei Aoxing Pharmaceutical Co., Inc. (“Hebei”), which at September 30, 2008 is 95% owned by the Company, and Shijazhuang Lerentang Pharmaceutical Company, Ltd. (“LRT”), which is 100% owned by Hebei.  Both subsidiaries were organized under the laws of the People’s Republic of China (“PRC”).

Since 2002, Hebei has been engaged in developing its analgesic products, building its facilities and obtaining the requisite licenses from the Chinese Government.  LRT manufactures a line of pain management drugs in pills, tablets, capsules, oral solutions and other formulations

The consolidated financial statements include the accounts of the Company and all of its subsidiaries. At September 30, 2008 the Company owned 95% of Hebei, which owned 100% of LRT.  The consolidated accounts include 100% of the assets and liabilities of Hebei and the ownership interest of minority investors are recorded as minority interest.  All significant inter-company accounts and transactions have been eliminated.  These financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America.  The Company’s functional currency is the Chinese Renminbi (RMB); however, the accompanying consolidated financial statements have been translated and presented in United States Dollars (USD).

3          RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

During the fiscal year 2008, the Company determined that the manner in which it historically accounted for the conversion feature and embedded put option of certain of its convertible debentures during the fiscal year 2006 through the fiscal year 2007 was not in accordance with SFAS No. 133, as amended, and EITF Issue No. 00-19.  The Company determined that the conversion feature was an embedded derivative instrument pursuant to SFAS No. 133.  The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair values as of the inception date of the convertible debenture agreements and at fair value as of each subsequent balance sheet date.  Any change in fair value was required to be recorded as non-operating, non-cash income or expense at each balance sheet date.  If the fair value of the derivatives was higher at the subsequent balance sheet date, the Company was required to record a non-operating, non-cash charge.  If the fair value of the derivatives was lower at the subsequent balance sheet date, the Company was required to record non-operating, non-cash income.  Accordingly, in connection with the restatement adjustments, the Company has approximately reflected the non-operating, non-cash income or expense resulting from the changes in fair value.  The Company had previously not recorded the embedded derivative instruments as liabilities and did not record the related changes in fair value.

The following tables represent a summary of the effects of the restatement adjustments on the Company’s consolidated statements of operations and cash flows for the three months ended September 30, 2007.

		Statement of Operations
		Previously Reported			Adjustments			As Restated
Three months ended September 30, 2007
Interest expense	$	259,303		$	436,258		$	695,561
Amortization of deferred interest	$	519,915		$	(519,915	)	$	-
Gain in fair value change on derivative liabilities	$	-		$	2,675,652		$	2,675,652
Minority interest	$	-		$	18,606		$	18,606
Income (loss) before minority interest	$	(1,015,754	)	$	(2,759,309	)	$	1,743,555
Net income (loss)	$	(1,015,754	)	$	2,777,915		$	1,762,161
Basic and diluted earnings per share	$	(0.03	)	$	0.07		$	0.04

		Statement of Cash Flows
		Previously Reported			Adjustments			As Restated
Year ended June 30, 2007
Net income (loss)	$	(1,015,754	)	$	2,759,309		$	1,762,161
Amortization of deferred interest	$	519,915		$	(519,915	)	$	-
Non-cash interest expense related to convertible debentures and warrants	$	-		$	436,258		$	436,258
Minority interest	$	-		$	(18,606	)	$	(18,606	)
Change in fair value of warrant and derivative liabilities	$	-		$	(2,675,652	)	$	(2,675,652	)

4          ACQUISITION OF LRT

On April 16, 2008, Hebei acquired 100% of the registered capital of LRT for approximately 85 million RMB including related expenses (approximately $12.4 million) and 8 million shares of common stock valued at $10,480,000.  The Company paid the cash portion of the purchase price with funds received from its simultaneous sale of common stock to American Oriental Bioengineering, Inc.

5          DERIVATIVE FINANCIAL INSTRUMENTS

The Company’s derivative financial instruments consist of embedded derivatives related to the convertible debentures (see Note 13). These embedded derivatives include conversion options. The Company determined that the features were embedded derivative instruments pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, and Emerging Issues Task Force (“EITF”) Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair values as of the inception date of the debt agreements and at fair value as of each subsequent balance sheet date.  Any change in fair value was recorded as non-operating, non-cash income or expense at each balance sheet date.  If the fair value of the derivatives was higher at the subsequent balance sheet date, the Company recorded a non-operating, non-cash charge.  If the fair value of the derivatives was lower at the subsequent balance sheet date, the Company recorded non-operating, non-cash income.

During the three months ended September 30, 2008 and 2007, the Company recognized other income of approximately $148,000 and $2,675,000, respectively, relating to recording the warrant and derivative liabilities at fair value.  At September 30, 2008 and June 30, 2008 there were approximately $3,848,000 and $4,161,000, respectively, of warrant and derivative liabilities, as the related debt instruments were not settled.

The Company’s derivative instruments were valued using the Black-Scholes option pricing model, using the following assumptions during the three months ended September 30, 2008:

Estimated dividends	None
Expected volatility	194%
Risk-free interest rate	2.0 – 2.28%
Expected term (years)	1.58 – 2.96

6          GOING CONCERN

As noted in the accompanying financial statements, at September 30, 2008 the Company has a deficiency in working capital of $11,615,663.  The uncertainties caused by this condition raise substantial doubt as to the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Company is exploring various alternatives to improve its financial position and continue to meet its obligations. Management is focusing on improving its operations and seeking additional debt and/or equity financing. There can be no assurance that any of these efforts will be fruitful.

7          NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements”.  This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  The standard applies under other accounting pronouncements that require or permit fair value measurements with certain exceptions, SFAS 157 was effective for the Company as of January 1, 2008.  The adoption of SFAS 157 did not have a material effect on the Company’s financial position or results of operations.

In December 2007, the FASB issued a revision of SFAS No. 141, Business Combinations (“SFAS 141(R).  This accounting standard requires an acquirer to recognize and measure the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exception.  In addition, SFAS 141(R) requires that acquisition-related costs will be generally expensed as incurred.  SFAS 141(R) also expands the disclosure requirements for business combinations.  SFAS 141(R) will be effective for the Company prospectively on July 1, 2009.

8          SHORT-TERM BORROWINGS

Short-term borrowings consist of the following at September 30, 2008:

Non-interest bearing note payable to a local government, due three months after the Company is listed on the NASDAQ	$	291,754
Short-term borrowing due to a related party, bearing interest at 8% per annum and due May 26, 2009.  Repayment of this loan, including accrued interest, can be paid in cash or converted to common stock.  Any amounts due on May 26, 2009 that have not been converted to common stock will be paid in cash.		3,356,966
	$	3,648,720

9          LOANS PAYABLE – OTHER

Loans payable – other consist of the following:

Loans from unrelated third parties maturing on various dates through June 30, 2009 and bearing interest at an average rate of 10%	$	160,840
Loan payable bearing interest at 10% per annum and maturing on December 31, 2009		3,499,131
		3,659,971
Less current portion		160,840
	$	3,499,131

10        LOAN FROM STOCKHOLDER

Loan from stockholder consists of the following:

Loan payable bearing interest at 10% per annum and maturing on December 13, 2011.	$	4,098,035
Loans maturing on various dates through June 30, 2009, bearing interest at an average rate of 10%		112,051
		4,210,086
Less current portion		112,051
	$	4,098,035

11 NOTE PAYABLE – BANK

Note payable – bank bears interest at 5.58% , is due December 31, 2008, is collateralized by a first security interest in substantially all assets of the Company and guaranteed by a vendor of the Company.

On August 27, 2008, the Company entered into an agreement with the Bank of China (“BC”) to renegotiate the terms of this loan.

According to this agreement, the loan matures as follows:

December 31, 2008	$	2,918,000
June 30, 2009		2,918,000
December 31, 2009		249,271
	$	6,085,271

12        MINORITY INTEREST

As of June 30, 2007 the Company owned 60% of the issued and outstanding common stock of Hebei. On May 1, 2008 the Company acquired an additional 35% interest for $3,420,000.  In accordance with FASB Statement 141, the Company has accounted for the additional investment under the purchase method of accounting, resulting in goodwill of $2,790,236.  The purchase price allocation is preliminary and a final determination of required purchase accounting adjustments will be made upon the Company receiving a valuation of the assets acquired and liabilities assumed.

13 CONVERTIBLE DEBENTURES

Convertible debentures outstanding as of September 30, 2008, are as follows:

Convertible debentures issued	3,289,000
Less amounts converted to common stock	(2,116,000	)
	1,173,000
Less debt discount	283,608
Balance – September 30, 2008	889,392

The terms of the convertible debentures include certain features that are considered embedded derivative financial instruments, such as a conversion feature which provides for the conversion of the debentures into shares of the Company’s common stock at a rate which is variable. Because the debentures are not conventional convertible debt, the Company is required to record the derivative financial instruments and the warrants issued in connection with the convertible debentures at their fair values as of the issuance date of each of the debentures.

 The initial fair values assigned to the embedded derivatives related to convertible debentures issued during the three months ended September 30, 2008 and 2007 were $0 and $51,652.

The Company recorded the fair value of the derivative instruments and warrants as a debt discount which will be amortized to interest expense over the term of the convertible debentures. During the three months ended September 30, 2008 and 2007, the Company recorded interest expense of $81,030 and $256,258, respectively, related to the amortization of the debt discount. If the total fair value of the derivative instruments and warrants was in excess of the proceeds received on the convertible debentures, the Company recorded the excess as additional interest expense. The Company recorded additional interest expense of $0 and $180,000 during the three months ended September 30, 2008 and 2007, respectively, related to the fair values of derivative instruments and warrants in excess of proceeds received.

14        WARRANTS

The following table summarizes the information relating to the warrants issued in connection with the sale of securities referred to in Note 13 above:

	Number Outstanding		Weighted Average
	September 30,		Remaining Contractual
Exercise Price	2008	2007	Life (Years)
$2.50	1,058,000	1,058,000	2.96
3.50	1,058,000	1,058,000	2.96
4.50	1,058,000	1,058,000	2.96
5.50	1,058,000	1,058,000	2.96
2.00	493,733	423,200	2.96
	4,725,733	4,655,200

15        VULNERABILITY DUE TO OPERATIONS IN PRC

The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC.  Although the PRC government has been pursuing economic reform policies for more than twenty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRCs political, economic and social conditions.  There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.

Substantially all of the Company’s businesses are transacted in RMB, which is not freely convertible.  The People’s Bank of China or other banks are authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China.  Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.

Since the Company has its primary operations in the PRC, the majority of its revenues will be settled in RMB, not U.S. Dollars. Due to certain restrictions on currency exchanges that exist in the PRC, the Company’s ability to use revenue generated in RMB to pay any dividend payments to its shareholders outside of China may be limited.

The Company’s business depends on maintaining licenses of its current products from the China State Food and Drug Administration.  Obtaining licenses for additional products can be expensive and is usually time consuming.  Failure to obtain the necessary licenses when needed can cause the Company’s business plan to be delayed.  If the delays prevent the Company from generating positive cash flow or introducing a significant number of products, there will be a material adverse effect on the Company.

In September 2006, PRC changed the laws regarding transfer of equity in PRC companies in exchange for equity in non-PRC companies.  Approvals and registrations for such transfers are required and penalties may be imposed if the requirements are not met.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk are primarily cash and cash equivalents.

16 SUBSEQUENT EVENT

In October 2008 the company issued 1,135,000 shares of its common stock valued at $1,089,600 to member of its board of directors and management as compensation.

 ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS

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,” “China Aoxing believes,” “management believes” and similar language. The forward-looking statements are based on the current expectations of China Aoxing and are subject to certain risks, uncertainties and assumptions, including those set forth in the discussion under “Management’s Discussion” 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.

Outline of Our Business

China Aoxing is a leading vertically integrated pharmaceutical company specializing in research, development, manufacturing and marketing of a broad range of narcotics and pain management pharmaceutical products. Our broad product line is comprised of prescription and over-the-counter pharmaceutical products.  Our pharmaceutical products have been approved by the Chinese State Food and Drug Administration (“SFDA”), based on demonstrated safety and efficacy. We sell our products primarily to hospitals, clinics, pharmacies and retail in most of the provinces of China, including rural areas and major cities.

§ Our subsidiary, LRT, currently markets a wide assortment of traditional Chinese medicines, including its leading seller, Zhongtongan.  At the same time our subsidiary, Hebei Aoxing, is currently licensed to market the following products:Naloxone Hydrochloride injectables, which we have marketed since February 2007 for the treatment of acute alcoholism and acute poisoning by opioid and non-opioid drugs; and

§ Shuanghuangliang capsules, a cough and cold treatment based on principles of traditional Chinese medicine, which we have marketed since December 2006.

Currently, Hebei Aoxing is also licensed to carry on the following late stage research and development:

§ A clinical study of the use of Tilidine Hydrochloride tablets and capsules for treatment of moderate to severe pain associated with cancer and surgery, involving approximately 400 patients in several health centers in China;

§ A clinical study of the use Codeine Phosphate Compound Medicine for treatment of cold and flu symptoms, involving approximately 300 patients at several health centers in China;

§ A joint project with the National Institute of Drug Dependence at Beijing University to develop a sublingual Buprenorphine combo tablet to treat opioid dependence; and

§ An application to the SFDA for a license to produce Pholcodine cough syrup, based on Hebei Aoxing’s existing designation as manufacturer of the active ingredient in Pholcodine.

In addition, Hebei Aoxing is involved in pre-licensing stages of development of a wide variety of other prescription and non-prescription pharmaceutical products.

Results of Operations

Revenues for the three months ended September 30, 2008 were $3,598,065, a 161% increase over the the revenues of $1,380,294 realized during the first three months ended September 30, 2007.  The increase in revenue was attributable to the contribution of $2,607,298 from our newly acquired subsidiary LRT.  Among the revenue contributors were Naloxone Hydrochloride injectable, Shuanghuangliang Capsules, and Zhongtongan.

Our cost of sales was $1,937,345 for three months ended September 30, 2008, which was 210% greater than the $625,653 in costs incurred during the three month ended September 30, 2007.   The increase resulted in a reduction in our gross margin ratio from 54.6% in the three months ended September 30, 2007 to 46.1% in the three months ended September 30, 2008.  The primary reason for the reduction in gross margin was the fact that the Beijing Olympics occurred during the quarter.  The proximity of our factory to the Olympic lead to markedly higher utility and logistics costs occurred during the period.  We expect that gross margin will return to its previous standards in future periods.

Gross profit increased by $906,079 during the three months ended September 30, 2008, a 120% increase over three months ended September 30, 2007.  This increase reflected higher net sales as a result of the contribution of our newly acquired subsidiary, LRT.  This was offset by the higher cost of sales percentages.

Research and development expenses increased from $57,262 during the three month ended September 30, 2007 to $266,329 during the three month ended September 30, 2008, a 365% increase.  The increase occurred because we applied a portion of the capital obtained in April 2008 to accelerated clinical development, with additional capital investment for pipeline products, including Tilidine, Codeine phosphate and other programs.

General and administrative expenses increased from $538,290 in the three months ended September 30, 2007 to $1,192,892 during the three months ended September 30, 2008, a 122% increase.  The primary reason for the increase was the consolidation of LRT with our operations.  In addition, we incurred additional expenses related to our ongoing  business expansion, including increased office rent, overhead expenses, legal, accounting, investor relations and other services,.

Selling expenses in the amount of $631,018 during the three months ended September 30, 2008 were a 128% increase over the $276,813 spent on selling during the three months ended September 30, 2007.  The increase was primarily due to the consolidation of LRT’s selling expenses with ours, as well as the expenses arising from our establishment of new sales and marketing headquarters in Beijing.

Depreciation and amortization expense increased from $118,812 in three months ended September 30, 2007 to $144,458 in three months ended September 30, 2008, or an increase of 21.6%, partially due to the integration and consolidation of fixed assets of LRT. LRT was not our subsidiary in 2007.

Our loss from operations was $573,977 and $236,536, respectively, during the three months ended September 30, 2008 and 2007.  The 143% increase in the loss was primarily due to increased expenditures associated with our business expansion.  This trend is likely to continue for the foreseeable future, until our products receive production approval by the China SFDA and gain reasonable scale in the market place.

Our interest expense during the three month ended September 30, 2008, $475,494, was $220,067 lower than the interest expense we recorded in the three months ended September 30, 2007.  The improvement resulted from a reduction in the interest charges related to the 10% and 8% convertible debentures that we issued during the 2007 and 2008 fiscal years.  As a large number of the debentures have been converted to common stock, we realized reduced interest expenses.  In addition, during the three months ended September 30, 2007 we incurred a $180,000 interest expense related to the difference between the fair values of the debentures and warrants that were issued and the net proceeds received from the investors.

On August 27, 2008, Hebei Aoxing entered an agreement with the Bank of China, which extended the maturity dates of our loans to December 31, 2009, after reducing the outstanding principal and accrued interest payment to the amount of $6,085,271.  As a result of this modification of the debt instruments, the Company recorded the forgiveness of debt in the amount of 10 million RMB, or $1,459,751.

Income tax expense for the three months ended September 30, 2008 was $79,693, compared to $0 for the three months ended September 30, 2007.  The Company’s effective tax rate during the three months ended September 30, 2008 was 11.3%.

Our net income for the three months ended September 30, 2008 was $626,119. This represented a significant reduction from the $1,762,161 in net income that we realized during the three months ended September 30, 2007.  .  However, the $1,762,161 in net income for the three months ended in September 30, 2007 was significantly attributed to the change in fair value of warrant and derivative liabilities in the amount of $2,675,625 during that period.

Our business operates entirely in Chinese Renminbi, but we report our results in our SEC filings in U.S. Dollars.  The conversion of our accounts from RMB to Dollars results in translation adjustments.  While our net income is added to the retained earnings on our balance sheet; the translation adjustments are added to a line item on our balance sheet labeled “other comprehensive income,” since it is more reflective of changes in the relative values of U.S. and Chinese currencies than of the success of our business.  During the three months ended September 30, 2008, the effect of converting our financial results to Dollars was to add $26,349 to our other comprehensive income.

Liquidity and Capital Resources

Our operations during the three months ended September 30, 2008 consumed $620,492.  The discrepancy between our net income for the quarter and our net loss of cash resulted from the fact that $1.4 million of our net income was attributable to the debt reduction afforded to us by the Bank of China.  In addition, the negative cash from operations reflected the expenses that we are incurring in our ongoing business expansion.

Our cash flows from financing activities amounted to $301,043 during the three months ended September 30, 2008.  During that period, we reduced our obligation to the Bank of China in the amount of 10 million RMB, or $1,458, 417, with the proceed from short term borrowing, mainly from AOB, in the amount of $1,759,460.

At September 30, 2008 we had a working capital deficit of $11,615,663.  The primary reason for the deficit is the custom of Chinese banks of conducting long-term lending relationships using short-term loans.  As a result, almost the entirety of our debt to the Bank of China is recorded as a current liability, although we fully expect that our credit with the Bank will be extended indefinitely.  In addition, we have an obligation to pay $3.6 million to American Oriental Bioengineering (“AOB”) in May 2009.  Since that company is our largest shareholder, we expect that debt will also be refinanced or converted to stock.  For these reasons, we believe that we have sufficient liquidity to carry on our operations and implement our business plan.

The capital injection that we received from AOB greatly improved the liquidity of the Company as we continue to develop our  pharmaceutical products.  Nevertheless, we will continue to  explore various alternatives to improve our financial position and secure sources of financing.  Among the possibilities being explored are new credit facilities, a new equity raise, new arrangements to license intellectual property, and a sale of selected property rights.  At the present time we have no commitment from any source for additional funds.

Impact of Accounting Pronouncements

New accounting rules and disclosure requirements can significantly impact the comparability of our financial statements.  We believe the following new accounting pronouncements are relevant to the readers of our financial statements.

In December 2007, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”. This Statement requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquirer at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No. 141(R) is effective as of the beginning of the Company’s first fiscal year beginning on or after December 15, 2008. The Company does not expect application of SFAS No. 141 (R) to have a material effect on its financial statements.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51”. This Statement clarifies that a noncontrolling interest in a subsidiary should be reported as equity in consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 160 is effective as of the beginning of the Company’s first fiscal year that begins on or after December 15, 2008. The Company does not expect application of SFAS No. 160 to have a material effect on its financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, which requires additional disclosures about the objectives of the derivative instruments and hedging activities, the method of accounting for such instruments under SFAS No. 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on our financial position, financial performance, and cash flows. SFAS No. 161 is effective beginning January 1, 2009. We are currently assessing the potential impact that adoption of SFAS No. 161 may have on our financial statements.

 In June 2008, the FASB issued FASB Staff Position on Emerging Issues Task Force Issue 03-6, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share (“EPS”) pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of FSP EITF 03-6-1. Early application is not permitted. Management is currently evaluating the impact FSP EITF 03-6-1 will have on the Company’s EPS calculations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.

Risk Factors that May Affect Future Results

Our business, financial condition, operating results and prospects are subject to the following risks. Additional risks and uncertainties not presently foreseeable to us may also impair our business operations. If any of the following risks is realized, our business, financial condition or operating results could be materially adversely affected. In such case, the trading price of our common stock could decline, and our stockholders may lose all or part of their investment in the shares of our common stock.  You should carefully consider the risks described below before buying our common stock.  If any of the risks described below actually occurs, that event could cause the market value of our common stock to decline, and you could lose all or part of your investment.

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

We started to book our product revenues in late 2006, and only reached a sales volume of $7,066,053 for the year ended June 30, 2008, which was mainly derived from a few products approved by the China SFDA.  We expect that these products will continue to account for a majority of our sales in the near future. Because of our dependence on a few products, any disruption in, or compromise of, our manufacturing operations, sales operations or distribution channels, relating to any of these products could result in our failure to meet shipping and delivery deadlines or meet quality standards, which in turn could result in the cancellation of purchase orders, refusal to accept deliveries or a reduction in purchase prices, any of which could have a material adverse effect on our financial condition and results of operations.

We lack sufficient capital to fully carry out our business plan.

In order to make our operations cost-efficient, it is necessary that we expand our operations.  At the present time, however, our capital resources are sparse.  At September 30, 2008 we had $5,191,437 in current assets, compared to $16,807,100 in current liabilities.  We are exploring various alternatives to improve our financial position and secure other sources of financing.  Such possibilities include a new credit facility, new equity raise, new arrangements to license intellectual property, the sales of selected property rights.   

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

We compete with other companies, many of whom are developing, or can be expected to develop, products similar to ours. Some of our competitors are more established than we are, have greater brand recognition of products that compete with ours, have more financial, technical, marketing and other resources than we presently possess and a larger customer base.

 These competitors may be able to respond more quickly to new or changing opportunities and customer requirements and may be able to undertake more extensive promotional activities, offer more attractive terms to customers or adopt more aggressive pricing policies. Our commercial opportunity will be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer side effects, are less expensive or have more attractive product characteristics than our current products or products that we may develop in the future. We cannot assure you that we will be able to compete effectively with current or future competitors or that the competitive pressures we face will not harm our business.

Most of our pipeline products contain narcotic ingredients. As a result of reports of misuse or abuse of prescription narcotics, the sale of such drugs may be subject to new regulation, which may prove difficult or expensive to comply with, and we and other pharmaceutical companies may face lawsuits.

Most of our core pipeline products contain narcotic ingredients. Misuse or abuse of such drugs can lead to physical or other harm. For example, in the past two years, reportedly widespread misuse or abuse of OxyContin®, a product of Purdue Pharma L.P., or Purdue, containing the narcotic oxycodone, resulted in the strengthening of warnings on its labeling. In addition, we believe that Purdue, the manufacturer of OxyContin®, faces or did face numerous lawsuits, including class action lawsuits, related to OxyContin® misuse or abuse. We may be subject to litigation similar to the OxyContin® suits related to our generic version of oxycodone or any other narcotic containing product that we market.

The China SFDA and Department of Health may impose new regulations concerning the manufacture, storage, transportation and sale of prescription narcotics. Such regulations may include new labeling requirements, the development and implementation of formal risk minimization action plans, restrictions on prescription and sale of these products.  The Chinese government and its agencies could require companies to formulate risk evaluation and mitigation strategies to ensure a drug’s benefits outweigh its risks.  In addition, the government and its agencies have authority to regulate distribution and may modify their regulations with respect to prescription narcotics in an attempt to curb abuse. In either case, any such new regulations or requirements may be difficult and expensive for us to comply with, may delay our introduction of new products, may adversely affect our net sales and may have a material adverse effect on our business, results of operations and financial condition.

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

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

Replacing key employees may be difficult and costly and may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to develop and commercialize products successfully. We do not maintain “key person” insurance policies on the lives of these individuals or the lives of any of our other employees. The Company has entered into employment agreements with these individuals. We will need to hire additional personnel as we expand our commercial activities. We may not be able to attract or retain qualified management on acceptable terms in the future due to the intense competition for qualified personnel in our industry. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede these objectives.

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

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

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

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

We may face difficulties in implementing our growth strategy.

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

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

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

We may be unable to secure the government licenses that are necessary for us to engage in the sale of analgesic pharmaceuticals.

The manufacture and marketing of narcotic drugs is highly regulated in China.  Prior to marketing any of our products, we are required to satisfy several government protocols, and receive several licenses from the national and local governments.  Obtaining these licenses can be expensive and it is usually time consuming.  If we are unable to obtain the necessary licenses when we need to have them, our business plan will be delayed.  If the delays prevent us from generating positive cash flow or introducing a significant number of products, our business may fail.

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

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

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

We currently sell our products in China. China will remain our primary market for the foreseeable future. If we expand into additional countries, our risk of intellectual property infringement may be heightened. Laws and enforcement mechanisms in other countries may not protect proprietary rights to the same extent as China.  The measures we take to protect our proprietary rights may be inadequate, and we cannot give you any assurance that our competitors will not independently develop formulations and processes that are substantially equivalent or superior to our own or copy our products.

We are dependent on third parties to supply all raw materials used in our products and to provide services for certain core aspects of our business. Any interruption or failure by these suppliers, distributors and collaboration partners to meet their obligations pursuant to various agreements with us could have a material adverse effect on our business, results of operations and financial condition.

We rely on third parties to supply all raw materials used in our products. In addition, we rely on third party suppliers, distributors and collaboration partners to provide services for certain core aspects of our business, including manufacturing, warehousing, distribution, customer service support, medical affairs services, clinical studies, sales and other technical and financial services. All third party suppliers and contractors are subject to the China SFDA, and government agency requirements. Our business and financial viability are dependent on the regulatory compliance of these third parties, and on the strength, validity and terms of our various contracts with these third party manufacturers, distributors and collaboration partners. Any interruption or failure by these suppliers, distributors and collaboration partners to meet their obligations pursuant to various agreements with us could have a material adverse effect on our business, financial condition and results of operations.

We are dependent upon third parties to provide us with various estimates as a basis for our financial reporting. While we undertake certain procedures to review the reasonability of this information, we cannot obtain absolute assurance over the accounting methods and controls over the information provided to us by third parties. As a result we are at risk of them providing us with erroneous data which could have a material adverse impact on our business.

The government limits the availability of the active ingredients used in many of our current products and products in development and, as a result, our procurement quota may not be sufficient to meet commercial demand or complete clinical trials.

The Chinese government and SFDA regulate the access and supplies of chemical compounds in some of our current products and products in development, including oxycodone, codeine, buprenorphine, Tilidine. Consequently, their manufacture, shipment, storage, sale and use are subject to a high degree of regulation.

Furthermore, the government limits the availability of the active ingredients used in many of our current products and products in development and, as a result, our procurement quota of these active ingredients may not be sufficient to meet commercial demand or complete clinical trials. We must annually apply to the government agencies for procurement quota in order to obtain these substances. Any delay or refusal by the agencies in establishing our procurement quota for controlled substances could delay or stop our clinical trials, product launches or could cause trade inventory disruptions for those products that have already been launched, which could have a material adverse effect on our business, financial position and results of operations.

Timing and results of clinical trials to demonstrate the safety and efficacy of products as well as the SFDA’s approval of products are uncertain.

Before obtaining regulatory approvals for the sale of our products, , we must demonstrate through preclinical studies and clinical trials that the product is safe and effective for each intended use. Preclinical and clinical studies may fail to demonstrate the safety and effectiveness of a product. A failure to demonstrate safety and efficacy would result in our failure to obtain regulatory approvals.

The rate of patient enrollment sometimes delays completion of clinical studies. There is substantial competition to enroll patients in clinical, and such competition has delayed clinical development of our products in the past. Delays in planned patient enrollment can result in increased development costs and delays in regulatory approval. In addition, we rely on collaboration partners that may control or make changes in trial protocol and design enhancements that may also delay clinical trials. We cannot assure you that we will not experience delays or undesired results in these or any other of our clinical trials.

We cannot assure you that the SFDA or other regulatory agencies will approve any products developed by us, on a timely basis, if at all, or, if granted, that such approval will not subject the marketing of our products to certain limits on indicated use. Any limitation on use imposed by the SFDA or delay in or failure to obtain SFDA approvals of products developed by us would adversely affect the marketing of these products and our ability to generate product revenue, as well as adversely affect the price of our common stock.

Before obtaining regulatory approvals for certain generic products, we must conduct limited clinical or other trials to show comparability to the branded products. A failure to obtain satisfactory results in these trials would prevent us from obtaining required regulatory approvals.

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

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

• decreased demand for our products;

• adverse publicity resulting in injury to our reputation;

• product liability claims and significant litigation costs;

• substantial monetary awards to or costly settlements with consumers;

• product recalls;

• loss of revenues; or

• the inability to commercialize future products.

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

We have significant goodwill and other intangible assets. Consequently, potential impairment of goodwill and other intangibles may significantly impact our profitability.

Goodwill and other intangibles represent a significant portion of our assets and stockholders’ equity. As of September 30, 2008, goodwill and other intangibles comprised approximately 36.8% of our total assets. Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, prescribes a two-step method for determining goodwill impairment. In the first step, we determine the fair value of our one reporting unit. If the net book value of our reporting unit exceeds the fair value, we would then perform the second step of the impairment test which requires allocation of our reporting unit’s fair value to all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. An impairment charge will be recognized only when the implied fair value of our reporting unit’s goodwill is less than its carrying amount. Our other intangible assets, consisting of licenses and patents, are assessed for impairment, in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. The impairment testing involves comparing the carrying amount of the asset to the forecasted undiscounted future cash flows of the product. In the event the carrying value of the asset exceeds the undiscounted future cash flows of the product and the carrying value is not considered recoverable, impairment exists. An impairment loss is measured as the excess of the asset’s carrying value over its fair value, calculated using a discounted future cash flow method. An impairment loss would be recognized in net income in the period that the impairment occurs.

Events giving rise to impairment are an inherent risk in the pharmaceutical industry and cannot be predicted. As a result of the significance of goodwill and other intangible assets, our results of operations and financial position in a future period could be negatively impacted should an impairment of goodwill or other intangible assets occur.

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

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

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

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

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

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

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

The manufacture and sale of pharmaceutical products in China is heavily regulated by many state, provincial and local authorities. These regulations significantly increase the difficulty and costs involved in obtaining and maintaining regulatory approvals for marketing new and existing products. Our future growth and profitability depend to a large extent on our ability to obtain regulatory approvals. Additionally, the law could change so as to prohibit the use of certain pharmaceuticals. If one of our products becomes prohibited, this change would cease the productivity of that product. The China National Development and Reform Commission, or CNDRC, has recently implemented price adjustments on many marketed pharmaceutical products. We have no control over such governmental policies, which may impact the pricing and profitability of our products.

The State Food and Drug Administration of China requires pharmaceutical manufacturers to obtain Good Manufacturing Practices, or GMP, certifications. We have received our certifications. However, should we fail to receive or maintain the GMP certifications in the future, we would no longer be able to manufacture pharmaceuticals in China, and our businesses would be materially and adversely affected.   Moreover, the laws and regulations regarding acquisitions in the pharmaceutical industry in China may change, which could significantly impact our ability to grow through acquisitions.

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

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

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

The pharmaceutical industry is heavily regulated, which creates uncertainty about our ability to bring new products to market and imposes substantial compliance costs on our business.

The China SFDA as well as Department of Health impose substantial requirements on the development, manufacture, labeling, sale, distribution, marketing, advertising, promotion and introduction of therapeutic narcotic pharmaceutical products through lengthy and detailed laboratory and clinical testing and other costly and time-consuming procedures. The submission of a drug application alone does not guarantee that the SFDA will grant approval to market the product.  Satisfaction of SFDA requirements typically takes a number of years, varies substantially based upon the type, complexity and novelty of the pharmaceutical product and is subject to uncertainty. The drug approval process varies in time, could take several years from the date of application. The timing for the approval process is difficult to estimate and can vary significantly.

The current SFDA standards of approving pharmaceutical products are more stringent than those that were applied in the past. These standards were not applied to many established products currently on the market, including certain narcotics products. We cannot assure you that the SFDA or other regulatory agencies will approve any products developed by us, on a timely basis, if at all, or, if granted, that approval will not entail limiting the indicated uses for which we may market the product, which could limit the potential market for any of these products.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

• changes in laws or regulations applicable to our products;

• period to period fluctuations in our operating results;

• announcements of new technological innovations or new products by us or our competitors;

• changes in financial estimates or recommendations by securities analysts;

• conditions or trends in our industry;

• changes in the market valuations of other companies in our industry;

• developments in domestic and international governmental policy or regulations;

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

• additions or departures of key personnel;

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

• additional sales of our common stock by us; and

• sales and distributions of our common stock by our stockholders.

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

We may have difficulty establishing adequate management and financial controls in China.

The People’s Republic of China has only recently begun to adopt the management and financial reporting concepts and practices with which investors in the United States are familiar.  We may have difficulty in hiring and retaining employees in China who have the experience necessary to implement the kind of management and financial controls that are expected of a United States public company.  If we cannot establish such controls, we may experience difficulty in collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet U.S. standards.

We may never pay any dividends to our stockholders.

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

Capital outflow policies in China may hamper our ability to pay dividends to shareholders in the United States.

The People’s Republic of China has adopted currency and capital transfer regulations. These regulations require that we comply with complex regulations for the movement of capital. Although Chinese governmental policies were introduced in 1996 to allow the convertibility of RMB into foreign currency for current account items, conversion of RMB into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of the State Administration of Foreign Exchange. We may be unable to obtain all of the required conversion approvals for our operations, and Chinese regulatory authorities may impose greater restrictions on the convertibility of the RMB in the future. Because most of our future revenues will be in RMB, any inability to obtain the requisite approvals or any future restrictions on currency exchanges will limit our ability to fund our business activities outside China or to pay dividends to our shareholders.

Our business development would be hindered if we lost the services of our Chairman.

Juan Yue Han is the Chief Executive Officer of China Aoxing and of its operating subsidiary, Hebei Aoxing Pharmaceutical Group.  Mr. Yue is responsible for strategizing not only our business plan but also the means of financing it.  If Mr. Yue were to leave Hebei Aoxing or become unable to fulfill his responsibilities, our business would be imperiled.  At the very least, there would be a delay in the development of Hebei Aoxing until a suitable replacement for Mr. Yue could be retained.

China Aoxing is not likely to hold annual shareholder meetings in the next few years.

Management does not expect to hold annual meetings of shareholders in the next few years, due to the expense involved.  The current members of the Board of Directors were appointed to that position by the previous directors.  If other directors are added to the Board in the future, it is likely that the current directors will appoint them.  As a result, the shareholders of China Aoxing will have no effective means of exercising control over the operations of the Company.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4.    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2008.  Pursuant to Rule13a-15(e) promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, “disclosure controls and procedures” means controls and other procedures that are designed to insure that information required to be disclosed by China Aoxing in the reports that it files with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time limits specified in the Commission’s rules.  “Disclosure controls and procedures” include, without limitation, controls and procedures designed to insure that information China Aoxing is required to disclose in the reports it files with the Commission is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure.  Based on his evaluation, our Chief Executive Officer and Chief Financial Officer concluded that China Aoxing’s system of disclosure controls and procedures was effective as of September 30, 2008 for the purposes described in this paragraph.

Changes in Internal Controls.  There was no change in internal controls over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act or 1934) identified in connection with the evaluation described in the preceding paragraph that occurred during China Aoxing’s first fiscal quarter that has materially affected or is reasonably likely to materially affect China Aoxing’s internal control over financial reporting.

PART II   -   OTHER INFORMATION

Item 1.  Changes in Securities and Small Business Issuer Purchase of Equity Securities

(c) Unregistered sales of equity securities

None

 (e) Purchases of equity securities

The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the 1st  quarter of fiscal 2009.

Item 2.                 Exhibits

31.1 Rule 13a-14(a) Certification – CEO

31.2	Rule 13a-14(a) Certification – CFO
32	Rule 13a-14(b) Certification

SIGNATURES

Pursuant to 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.

CHINA AOXING PHARMACEUTICAL COMPANY, INC.

Date: November 17, 2008	By:	/s/ Juan Yue Han
		Juan Yue Han, Chief Executive Officer
Date: November 17, 2008	By:	/s/ Hongyue Hao
		Hongyue Hao, Acting Chief  Financial Officer