Skystar Bio-pharmaceutical 10Q 2009 Q2 Quarterly report

The accompanying notes are an integral part of these consolidated financial statements.

	Six months ended June 30,
	2009			2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	947,847		$	490,286
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation		225,953			217,378
Amortization		77,070			74,583
Amortization of deferred financing costs		—			101,815
Amortization of discount on debentures		—			406,538
Amortization of deferred compensation		—			62,758
Inducement cost for debentures converted		—			257,775
Default premium on debentures		—			490,713
Common stock issued for services		30,521			99,900
Common stock to be issued to related parties for compensation		78,024			—
Inducement cost for debt settlement		—			42,081
Change in fair value of warrant liability		1,442,156			—
Change in operating assets and liabilities
Accounts receivable		(1,412,505	)		(1,405,631	)
Inventories		(5,164,998	)		(2,197,924	)
Deposits and prepaid expenses		2,158,970			(2,163,863	)
Other receivables		(43,532	)		(33,447	)
Accounts payable		(197,071	)		174,345
Accrued expenses		(207,294	)		436,050
Deposits from customers		(164,796	)		90,686
Taxes payable		2,386,654			1,339,210
Other payables		18,229			(4,206	)
Net cash provided by (used in) operating activities		175,228			(1,520,953	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Refund of long-term prepayments		2,711,545			—
Proceeds from short-term investments		43,971			—
Additions to loans receivable		(1,685,555	)		—
Proceeds from loans receivable		—			671,364
Purchases of plant and equipment		—			(76,775	)
Payments on construction-in-progress		(1,792,941	)		—
Net cash (used in) provided by investing activities		(722,980	)		594,589

CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease (increase) in restricted cash		80,662			(500	)
Principal payments on short-term loans from shareholders		(307,798	)		(425,911	)
Due to related parties		420,038			487,428
Repayments to related companies		—			(47,453	)
Proceeds from shareholders loans		—			297,864
Proceeds from short-term loans		205,198			—
Net cash provided by financing activities		398,100			311,428

EFFECT OF EXCHANGE RATE CHANGES ON CASH		(16,203	)		26,887

DECREASE IN CASH		(165,855	)		(588,049	)

CASH, beginning of period		576,409			771,492

CASH, end of period	$	410,554		$	183,443

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$	40,448		$	—
Cash paid for income taxes	$	—		$	2,645
Non-cash investing and financing activities
Long-term prepayment transferred to construction-in-progress	$	1,025,257		$	—
Issuance of common stock for debt settlement	$	—		$	178,839
Debentures converted to common stock	$	—		$	982,003
Interest expense capitalized as construction-in-progress	$	40,050		$	—

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Organization and description of business

Note 1 - ORGANIZATION

Skystar Bio-Pharmaceutical Company (“Skystar” or the “Company”), was incorporated in Nevada on September 24, 1998. Since its acquisition on November 7, 2005 of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), a Cayman Islands company, the Company has been engaged in research, development, production, marketing and sales of veterinary healthcare and medical care products. All current operations of the Company are in the People’s Republic of China (“China” or the “PRC”).

All of the Company’s operations are carried out by Xian Tianxing Bio-Pharmaceutical Co., Limited (“Xian Tianxing”), a PRC joint stock company that the Company controls through contractual arrangements originally between Skystar Cayman and Xian Tianxing. On March 10, 2008, the Company entered into a series of agreements transferring all of the rights and obligations of Skystar Cayman under the contractual arrangements to Sida Biotechnology (Xian) Co., Ltd. (“Sida”), a PRC company. Sida is the wholly-owned subsidiary of Fortunate Time International Limited (“Fortunate Time”), a Hong Kong company and wholly-owned subsidiary of Skystar Cayman. Xian Tianxing also has a wholly-owned subsidiary, Shanghai Siqiang Biotechnological Co., Ltd. (“Shanghai Siqiang”), a PRC company.

As a result of these contractual arrangements, which obligates Sida to absorb all of the risk of loss from Xian Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xian Tianxing as a variable interest entity (“VIE”) under Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” Accordingly, the Company consolidates Xian Tianxing’s results, assets and liabilities.

Sida was established by Fortunate Time on July 10, 2007, with registered capital of $5,000,000. Fortunate Time invested $2,000,000 into Sida on July 20, 2007, which amount is payable to Skystar Cayman. On July 9, 2009, Fortunate Time invested the remaining $3,000,000 into Sida. Xi’an High Technology District approved Sida’s application to increase its registered capital to $15,000,000 on July 13, 2009. On July 15, 2009, Sida received the $10,000,000 additional registered capital from Fortunate Time. Funds from Fortunate Time for $13,000,000 was from the cash proceeds of the equity offering which is further discussed in Note 15.

Hereinafter, Skystar, Skystar Cayman, Fortunate Time, Sida, Xian Tianxing and Shanghai Siqiang are sometimes collectively referred to as the “Company.”

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The unaudited consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. The information furnished herein reflects all adjustments (consisting of normal recurring accruals and adjustments) which are, in the opinion of management, necessary to fairly present the operating results for the respective periods. Certain information and footnote disclosures normally present in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K. The results for the six months ended June 30, 2009, are not necessarily indicative of the results to be expected for the full year ending December 31, 2009.

Basis of presentation

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and have been consistently applied.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. For example, the Company estimates its allowance for doubtful accounts and useful lives of plant and equipment. Because of the use of estimates inherent in the financial reporting process, actual results could materially differ from those estimates upon which the carrying values were based.

Use of estimates

Principles of consolidation

The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, Skystar Cayman, Fortunate Time, and Sida, and its VIEs, Xian Tianxing and Shanghai Siqiang. All significant inter-company transactions and balances among the Company, its subsidiaries and VIEs have been eliminated in consolidation.

Foreign currency translation

The Company uses the United States dollar (“U.S. dollar”) for financial reporting purposes and the Chinese Renminbi (“RMB”) as their function currency. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency, being the primary currency of the economic environment in which their operations are conducted.

The Company translates the subsidiaries’ and VIEs’ assets and liabilities into U.S. dollars using the applicable exchange rates prevailing at the balance sheet dates, and the statements of operations and cash flows are translated at average exchange rates during the reporting period. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the subsidiaries’ and VIEs’ financial statements are recorded as accumulated other comprehensive income.

The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People's Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People's Bank of China. The rates of exchange quoted by the People’s Bank of China on June 30, 2009 and December 31, 2008 were US $1.00 to RMB 6.83 and RMB 6.82, respectively. The average translation rates of US $1.00 to RMB 6.25 and RMB 6.97 was applied to the income statement accounts for the six-month periods ended June 30, 2009 and 2008, respectively. For the three-month period ended June 30, 2009 and 2008, the average translation rates were $1.00 to RMB 6.82 and RMB 7.05, respectively.

Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents and signed contracts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Fair values of financial instruments

Statement of Financial Accounting Standards (“SFAS”) 107, “Disclosure about Fair Value of Financial Instruments,” defines financial instruments and requires fair value disclosure of applicable financial instruments. SFAS 157, “Fair Value Measurements,” adopted January 1, 2008, defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures. Short-term investments, receivables, payables, short-term loans, and warrant liability qualify as financial instruments. Management concluded the carrying values of these financial instruments are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, their stated interest rate approximates rates currently available. The three levels of valuation hierarchy are defined as follows:

•	Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

•	Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

•	Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The Company analyzes all financial instruments with features of both liabilities and equity under SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” and Emerging Issues Task Force (“EITF”) 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”

Effective January 1, 2009, the Company adopted the provisions of EITF 07-5, "Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock,” which is effective for financial statements for fiscal years beginning after December 15, 2008 and which replaced the previous guidance on this topic in EITF 01-6. Paragraph 11(a) of SFAS 133 specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception.

As a result of adopting EITF 07-5, 154,550 warrants previously treated as equity pursuant to the derivative treatment exemption are no longer afforded equity treatment because the strike price of the warrants is denominated in U.S. dollars, a currency other than the Company’s functional currency, the Chinese Renminbi. As a result, the warrants are not considered indexed to the Company’s own stock, and as such, all future changes in the fair value of these warrants will be recognized currently in earnings until such time as the warrants are exercised or expired.

As such, effective January 1, 2009, the Company reclassified the fair value of these warrants from equity to liability, as if these warrants were treated as a derivative liability since their issuance in February 2007. On January 1, 2009, the Company reclassified from additional paid-in capital, as a cumulative effect adjustment, $230,877 to beginning retained earnings and $877,631 to warrant liability to recognize the fair value of such warrants. The Company recognized losses of $1,480,484 and $1,442,156 from the change in fair value of the warrant liability for the three months and six months ended June 30, 2009, respectively.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

These common stock purchase warrants do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants using the Black-Scholes Option Pricing Model (“Black-Scholes Model”) using the following assumptions:

	Warrants - 97,500						Warrants - 57,050
	June 30, 2009			January 1, 2009			June 30, 2009			January 1, 2009
	(Unaudited)						(Unaudited)
Stock price	$	17.94		$	9.50		$	17.94		$	9.50
Exercise price	$	12.00		$	12.00		$	10.00		$	10.00
Annual dividend yield		—			—			—			—
Expected term (years)		0.67			1.20			2.67			3.20
Risk-free interest rate		0.000	%		0.875	%		1.375	%		1.125	%
Expected volatility		292	%		140	%		170	%		130	%

Expected volatility is based on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the term of the warrants. The Company believes this method produces an estimate that is representative of future volatility over the expected term of these warrants. The Company has no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the warrants.

As required by SFAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Depending on the product and the terms of the transaction, the fair values of notes payable and warrant liability were modeled using a series of techniques, including closed-form analytic formula, such as the Black-Scholes Model, which does not entail material subjectivity because the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.

The fair value of the 154,550 warrants was determined using the Black-Scholes Model, defined in SFAS 157 as level 2 inputs, and recorded the change in earnings. As a result, the warrant liability is carried on the consolidated balance sheets at fair value.

The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2009:

	Carrying Value at June 30, 2009		Fair Value Measurement at June 30, 2009
			Level 1		Level 2		Level 3
Short-term investments	$	307,650	$	307,650	$	—	$	—
Warrant liability	$	2,319,787	$	—	$	2,319,787	$	—

Other than the short-term investments and warrant liability carried at fair value, the Company did not identify any other assets and liabilities that are required to be presented on the balance sheet at fair value in accordance with SFAS 157.

Revenue recognition

Revenue of the Company is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No allowance for sales returns is made on these consolidated financial statements as sales returns are de minimis based on historical experience.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

There are two types of sales upon which revenue is recognized:

a.	Credit sales: Revenue is recognized when the products have been delivered to the customers.

b.	Full payment before delivering: Revenue is recognized when the products have been delivered to customers.

Shipping and handling costs related to costs of goods sold are included in selling expenses, which totaled $218,734 and $85,084 for the three months ended June 30, 2009 and 2008, respectively and $309,741 and $123,888 for the six months ended June 30, 2009 and 2008, respectively.

The Company’s revenues and cost of revenues by product line were as follows for the three and six months ended June 30, 2009 and 2008:

	Three months ended June 30,				Six months ended June 30,
	2009		2008		2009		2008
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Revenues
Micro-organism	$	1,735,534	$	1,151,600	$	2,628,827	$	1,941,255
Veterinary Medications		3,913,444		2,934,247		6,515,940		4,604,001
Feed Additives		281,461		176,627		463,772		270,181
Vaccines		312,999		215,720		458,465		349,111
Total Revenues		6,243,438		4,478,194		10,067,004		7,164,548

Cost of Revenues
Micro-organism		513,310		349,299		773,847		585,126
Veterinary Medications		2,276,216		1,713,460		3,869,025		2,712,944
Feed Additives		121,367		79,927		198,806		126,640
Vaccines		47,944		23,798		63,517		39,193
Total Cost of Revenues		2,958,837		2,166,484		4,905,195		3,463,903
Gross Profit	$	3,284,601	$	2,311,710	$	5,161,809	$	3,700,645

Cash

Cash includes cash on hand, demand deposits with banks and liquid investments with an original maturity of three months or less.

Restricted cash

Restricted cash is comprised of amounts received from the PRC government as subsidies and set aside for specific uses (see Note 14). Restricted cash is maintained as bank deposits and reflected as current assets based on the expected period when such funds will be put into their specific uses.

Short-term investments

Short-term investments are comprised of securities classified as available-for-sale, held by a private investment trust company for investing activities with a fixed rate of return on investment. Available-for-sale securities are carried at fair value, with unrealized gains or losses reported in other comprehensive income, net of tax. Realized gains or losses are included in the results of operations. There was no unrealized gain or loss relating to short-term investments for the three and six months ended June 30, 2009 and 2008, and as such, no such amounts were included in other comprehensive income for such periods.

The Company entered into an investment agreement with an unrelated party in 2007 to invest certain funds in the Chinese stock market. The nature of the investment is available-for-sale with certain guaranteed returns such as 7.2% interest through August 1, 2008 and 5.0% interest after August 1, 2008 for one year. There are no restrictions or penalties for early withdrawals prior to maturity. The investment matured on July 31, 2009 and the investment principal of $307,650 and accrued interest of $22,660 was received by the Company on August 3, 2009.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Accounts receivable and other receivables

Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, bad debt percentages determined by management based on historical experience, as well as current economic climate, are applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against allowance for doubtful accounts when identified.

Inventories

Inventories are stated at the lower of cost or market, as determined on a moving weighted-average basis. Inventories include purchases and related costs incurred in bringing the inventories to their present location and condition. Management reviews inventories for obsolescence and cost in excess of net realizable value at least annually and records a reserve against the inventory and additional cost of goods sold when the carrying value exceeds net realizable value.

Plant and equipment

Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance and repairs which do not improve or extend the useful lives of the assets are charged to operations as incurred, while renewals and betterments are capitalized. Gains and losses on disposals are included in the results of operations. Estimated useful lives of the assets are as follows:

	Estimated Useful Life
Buildings	20-40 years
Machinery and equipment	10 years
Computer, office equipment and furniture	5 years
Vehicles	5-10 years

Management assesses the carrying value of plant and equipment annually, more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management believes that, as of June 30, 2009 and December 31, 2008, there was no impairment for its plant and equipment.

Construction-in-progress

Construction-in-progress includes direct costs of construction of a factory building. Interest incurred during the period of construction, if significant, is capitalized. All other interest is expensed as incurred. Construction-in-progress is not depreciated until such time the assets are completed and put into service.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Land Use Rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on a straight-line basis over its 50-year term.

Intangible assets

Technological Know-How — Purchased technological know-how includes confidential formulas, manufacturing processes, technical and procedural manuals, and is amortized using the straight-line method over the expected useful life of five years, which reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.

Impairment of Intangible Assets — The Company evaluates the carrying value of intangible assets annually, or more often when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of June 30, 2009, there was no impairment of its intangible assets.

Comprehensive income

SFAS 130, “Reporting Comprehensive Income,” requires disclosure of all components of comprehensive income and loss on an annual and interim basis. Comprehensive income and loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The accompanying consolidated financial statements include the provisions of SFAS 130. Accumulated other comprehensive income is comprised of the changes in foreign currency exchange rates.

Research and development costs

Research and development costs are charged to operations as incurred and include salaries, professional fees and technical support fees related to such efforts.

Advertising costs

Advertising costs are charged to operations currently. Advertising costs totaled to $36,921 and $10,931 for the three months ended June 30, 2009 and 2008, respectively, and $75,857 and $25,068 for the six months ended June 30, 2009 and 2008, respectively.

Income taxes

The Company accounts for income taxes in accordance with the SFAS 109, “Accounting for Income Taxes,” and FIN 48, “Accounting for Uncertainty in Income Taxes.” SFAS 109 requires a company to use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Under SFAS 109, the effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized. There was no deferred tax amount as of June 30, 2009 and December 31, 2008.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

In accordance with FIN 48, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. The adoption had no effect on the Company’s consolidated financial statements.

The Company’s operations are subject to income and transaction taxes in the United States and in the PRC jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.

The Company does not anticipate any events which could cause a change to these uncertainties.

Stock-based compensation

The Company records stock-based compensation in accordance with SFAS 123R, “Share-Based Payment.” SFAS 123R requires companies to measure compensation cost of stock-based employee compensation at fair value at the grant date and recognize the expense over the employee’s requisite service period. Under SFAS 123R, the Company’s volatility is based on the historical volatility of the Company’s stock or the expected volatility of similar companies. The expected life assumption is primarily based on historical exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. SFAS 123R allows the “simplified” method to determine the term of employee options when certain information is not available. Because the Company does not have a history of employee stock options, the Company used the “simplified” method to estimate the expected life of the options.

Stock-based compensation granted to non-employees is determined in accordance with EITF 96-18, “Accounting for Equity Instruments that are issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services,” which incorporates the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

The Company uses the Black-Scholes Model which was developed for use in estimating the fair value of options. This models requires the input of highly complex and subjective variables including the expected life of options granted and the Company’s expected stock price volatility over a period equal to or greater than the expected life of the options. Because changes in the subjective assumptions can materially affect the estimated value of the Company’s employee stock options, it is management’s opinion that the Black-Scholes Model may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined in accordance with SFAS 123R using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Earnings per share

Earnings per share is calculated in accordance with the SFAS 128, “Earnings Per Share.” Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including convertible preferred shares, and stock options were converted or exercised. Further, SFAS 128 requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period, or retroactively if the stock dividends or stock splits occur after the end of the period but before the release of the financial statements, by considering it outstanding of the entirety of each period presented. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

All share and per share amounts used in the Company's consolidated financial statements and notes thereto have been retroactively restated to reflect the 10-for-1 reverse stock split effectuated on May 12, 2009.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on previously reported net income or cash flows.

Recently issued accounting pronouncements

SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities – An Amendment of SFAS No. 133,” became effective for the Company on January 1, 2009. SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. The adoption of SFAS 161 did not have a material impact on the Company’s consolidated financial statements.

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS 128, “Earnings per Share.” The FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. The FSP is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The adoption of EITF 03-6-1 did not have a material impact on the Company’s consolidated financial statements.

In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” FSP FAS 157-3 clarifies the application of SFAS 157 in an inactive market, without changing its existing principles. The FSP was effective immediately upon issuance. The adoption of FSP FAS 157-3 did not have an effect on the Company’s consolidated financial statements.

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

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP FAS 157-4 amends SFAS 157 and provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased and also includes guidance on identifying circumstances that indicate a transaction is not orderly for fair value measurements. This FSP is to be applied prospectively with retrospective application not permitted. This FSP is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting this FSP must also early adopt FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” Additionally, if an entity elects to early adopt either FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” or FSP FAS 115-2 and FAS 124-2, it must also elect to early adopt this FSP. Management is currently evaluating this new FSP but does not believe that it will have a significant impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1. This FSP amends SFAS 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments not measured on the balance sheet at fair value in interim financial statements as well as in annual financial statements. Prior to this FSP, fair values for these assets and liabilities were only disclosed annually. This FSP applies to all financial instruments within the scope of SFAS 107 and requires all entities to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments. This FSP is effective for interim periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity may early adopt this FSP only if it also elects to early adopt FSP FAS 157-4 and FSP FAS 115-2 and FAS 124-2. This FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. The Company adopted the provisions of this FSP.

In May 2009, the FASB issued SFAS 165, “Subsequent Events,” which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 also requires entities to disclose the date through which subsequent events were evaluated as well as the rationale for why that date was selected. SFAS 165 is effective for interim and annual periods ending after June 15, 2009, and accordingly, the Company adopted this Standard during the second quarter of 2009. SFAS 165 requires that public entities evaluate subsequent events through the date that the financial statements are issued. We have evaluated subsequent events through the time of filing these financial statements with the SEC.

In June 2009, the FASB issued SFAS 166, “Accounting for Transfers of Financial Assets – an amendment of FASB No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 166 amends the criteria for a transfer of a financial asset to be accounted for as a sale, redefines a participating interest for transfers of portions of financial assets, eliminates the qualifying special-purpose entity concept and provides for new disclosures. SFAS 166 is effective for the Company beginning in 2010.

In June 2009, the FASB issued SFAS 167, “Amendments to FASB Interpretation No. 46(R),” which modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. SFAS 167 clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. SFAS 167 requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. SFAS 167 also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. SFAS 167 is effective for fiscal years beginning after November 15, 2009, and the Company is currently assessing the impact of adopting SFAS 167.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

In June 2009, the FASB issued SFAS 168, “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles - A Replacement of FASB Statement No. 162.” SFAS 168 establishes the FASB Accounting Standards Codification™ (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. The Codification is effective for interim and annual periods ending after September 15, 2009, and as of the effective date, all existing accounting standard documents will be superseded. The Codification is effective for the Company in the third quarter of 2009, and accordingly, the Quarterly Report on Form 10-Q for the quarter ending September 30, 2009 and all subsequent public filings will reference the Codification as the sole source of authoritative literature.

Note 3 - CONCENTRATIONS AND CREDIT RISK

The Company’s operations are all carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

Financial instruments, which subject the Company to concentration of credit risk, consist of cash. The Company maintains balances at financial institutions which, from time to time, may exceed federally- insured limits for the banks located in the United States. Balances at financial institutions or state owned banks within the PRC are not covered by insurance. As of June 30, 2009 and December 31, 2008, the Company had deposits in excess of federally-insured limits (including restricted cash) of $8,902 and $448,082 respectively. The Company has not experienced any losses in such accounts.

For the three months and six months ended June 30, 2009 and 2008, all of the Company’s sales occurred in the PRC. No major customers accounted for more than 10% of the Company’s total revenues. In addition, all accounts receivable at June 30, 2009 and December 31, 2008 also arose in the PRC.

The Company’s two largest vendors accounted for approximately 44.9% of the Company’s total purchases for the three months ended June 30, 2009, while the Company’s three largest vendors accounted for 51.6% of the Company’s total purchases for the three months ended June 30, 2008. The Company’s two largest vendors accounted for approximately 34.4% of the Company’s total purchases for the six months ended June 30, 2009, while the Company’s three largest vendors accounted for 55.9% of the Company’s total purchases for the six months ended June 30, 2008. As of June 30, 2009, there were no amounts due to those two largest vendors.

The Company had one product that accounted for 15.5% and 13.1% of the Company’s total revenues for the three months and six months ended June 30, 2009, respectively. Revenue from sales of this product accounted for 6.3% and 10.0 % of the total revenue for the three months and six months ended June 30, 2008, respectively.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Note 4 - - ACCOUNTS RECEIVABLE, NET

Accounts receivable consisted of the following:

	June 30, 2009			December 31, 2008
	(Unaudited)
Account receivable	$	4,160,037		$	2,751,959
Allowance for bad debts		(327,410	)		(327,857	)
Account receivable, net	$	3,832,627		$	2,424,102

The following table presents the movement of allowance for doubtful accounts as of June 30, 2009 and December 31, 2008:

Allowance for bad debt, December 31, 2007	$	199,639
Addition		114,239
Recovery		—
Translation adjustment		13,979
Allowance for bad debt, December 31, 2008		327,857
Addition		—
Recovery		—
Translation adjustment		(447	)
Allowance for bad debt, June 30, 2009	$	327,410

Note 5 - INVENTORIES

Inventories consist of the following:

	June 30, 2009		December 31, 2008
	(Unaudited)
Raw materials	$	5,154,154	$	2,087,428
Packing materials		490,733		165,077
Work-in-process		42,607		2,446
Finished goods		2,537,345		811,538
Other		19,544		19,571
Total	$	8,244,383	$	3,086,060

The Company periodically reviews its reserves for slow moving and obsolete inventories. As of June 30, 2009 and December 31, 2008, the Company believes that no such reserves were necessary.

Note 6 - DEPOSITS AND PREPAID EXPENSES

Deposits and prepaid expenses are comprised of the following:

	June 30, 2009		December 31, 2008
	(Unaudited)
Prepayment for raw materials purchasing	$	2,383,783	$	4,210,618
Prepayment for packaging materials purchasing		295,277		499,755
Prepayment for advertisement fee		—		89,436
Prepayment for due diligence fee		—		73,350
Other		35,199		5,692
Total	$	2,714,259	$	4,878,851

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Note 7 – LOANS RECEIVABLE

Loans receivable consist of the following:

	June 30, 2009		December 31, 2008
	(Unaudited)
Shaanxi Xinbangdike Technology Developing Company (1)	$	660,935	$	295,087
Other loans receivable (2)		1,318,500		—
Total loans receivables	$	1,979,435	$	295,087

(1) Loan to Shaanxi Xinbangdike Technology Development Company is non-interest bearing, unsecured and due on demand.

(2) Loans to five vendors are non-interest bearing and unsecured, and due on September 30, 2009.

Note 8 - PLANT AND EQUIPMENT, NET

Plant and equipment consist of the following:

	June 30, 2009			December 31, 2008
	(Unaudited)
Building and improvements	$	4,970,868		$	4,977,654
Machinery and equipment		3,029,797			3,035,376
Office equipment and furniture		187,888			186,702
Vehicles		328,882			329,331
Total		8,517,435			8,529,063
Less: accumulated depreciation		(1,339,699	)		(1,115,374	)
Plant and equipment, net	$	7,177,736		$	7,413,689

Depreciation expense amounted to $113,031 and $110,496 for the three months ended June 30, 2009 and 2008, respectively. For the six months ended June 30, 2009 and 2008, depreciation expense amounted to $225,953 and $217,378, respectively.

Note 9 - CONSTURCTION-IN-PROGRESS

Construction-in-progress is related to a plant being built in accordance with the PRC’s Good Manufacturing Practices (“GMP”) Standard. Construction on this plant commenced in 2005. The veterinary medicine facility and the building that houses quality control, research and development and administration were completed during 2007, and the remaining plant facilities are expected to be completed by the end of 2009, at an estimated cost of $1,251,000. No depreciation is provided for construction-in-progress until such time the assets are completed and placed into service.

For the three months and six months ended June 30, 2009, $20,972 and $40,050 had been capitalized for construction-in- progress for the three months and six months ended June 30, 2009, respectively. For the three months and six months ended June 30, 2008, the Company did not capitalize interest expense as construction-in-progress as the amounts were de minimis.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Note 10 - LONG-TERM PREPAYMENTS

Long-term prepayments consist of the following as of June 30, 2009 and December 31, 2008:

	June 30, 2009		December 31, 2008
	(Unaudited)
Construction deposit	$	1,465,000	$	2,493,167
Deposit for potential acquisitions		—		2,713,950
Total	$	1,465,000	$	5,207,117

As of June 30, 2009 and December 31, 2008, the Company has determined that these prepayments are noncurrent because: (1) these amounts relate to noncurrent assets, and (2) the Company’s ability to complete the projects underlying the construction deposit and any potential acquisitions is contingent upon the Company identifying target companies.

Deposits for potential acquisitions represent deposits made to four separate potential acquisition targets: one that produces veterinary medicines, one that produces micro-organisms and feed additives, one that produces veterinary medicines for domestic pets, and one with buildings for the Company’s own future expansion. In April 2009, all deposits made by the Company for potential acquisitions in the amount of $2,711,545 (RMB 18,500,000) were returned to the Company.

Note 11 – INTANGIBLE ASSETS

	June 30, 2009			December 31, 2008
	(Unaudited)
Land use rights	$	378,337		$	378,853
Technological know-how		879,000			880,200
Total		1,257,337			1,259,053
Less: accumulated amortization		(436,067	)		(359,524	)
Intangible assets, net	$	821,270		$	899,529

During 2007, the Company paid $658,350 for the exclusive rights to the use of a strain of micro-bio organisms for a five-year term from November 1, 2007 through October 31, 2012. The Company began using the strain in its veterinary medicines in 2008.

For the three months ended June 30, 2009 and 2008, the amortization expense amounted to $38,551 and $37,836, respectively. The amortization expense for intangibles was $77,070 and $74,583 for the six months ended June 30, 2009 and 2008, respectively.

Amortization expense for the future five years and thereafter is as follows:

Years ending December 31,	Amount
2009	$	77,039
2010		154,076
2011		154,076
2012		123,974
2013		1,891
2014 and thereafter		310,214
Total	$	821,270

Note 12 – SHORT-TERM LOANS

On September 3, 2008, the Company signed a one year short-term agreement with the Bank of East Asia to borrow up to $1.9 million (RMB 13 million) for operating purposes secured by the Company’s land use rights and buildings. On September 17, 2008, the Company received proceeds of $733,500 (RMB 5 million) from the bank. This amount will become due on September 16, 2009. The balance of $1.1 million (RMB 8 million) can be borrowed once the Company has a deposit balance in the amount of $4 million with the bank and uses the bank as the Company’s primary transaction bank. As of June 30, 2009, the net values of the land use rights and properties pledged for the loan were $334,828 and $3,287,019, respectively. The applicable interest rate of the loan is the Bank of China’s standard short-term rate, 6.93% at inception of the loan, which is subject to change with the government policy, plus an additional 20% interest rate float. Pursuant to these terms, the interest rates were approximately 8.42% and 8.32% as of June 30, 2009 and December 31, 2008, respectively. Interest payments to the Bank of East Asia are due every six months.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Pursuant to the short-term loan agreement, the Company is required to comply with certain covenants, such as maintaining sufficient environmental controls with respect to the Company’s manufacturing processes, providing written notification to the bank for any changes in the organizational structure or executive officers, among others. As of June 30, 2009, the Company determined that it was in compliance with these covenants.

On January 14, 2009, the Company signed a one year short-term loan contract with Shaanxi Agricultural Yanta Credit Union for $219,750 (RMB 1.5 million) at an annual interest rate of 8.66% for operating purposes secured by the personal property of Weibing Lu, the Company’s Chief Executive Officer. This amount will become due on January 13, 2010.

Interest expense incurred and associated with the short-term loans amounted to $20,972 and $40,050 for the three months and six months ended June 30, 2009, respectively, which has been capitalized as part of construction-in-progress.

Note 13 - DEFERRED GOVERNMENT GRANT

Deferred government grant represents subsidies for GMP projects granted by the PRC government. A subsidy in the amount of $641,000 was approved by the PRC government for the Company to construct a new factory in which operations will meet the GMP Standard. In 2003, $516,500 was received by the Company and the remaining $124,500 was received in the first quarter of 2006. In 2006, the Company expended $186,644 for the construction of its new factory (Note 10).

Also in 2003, the Company received a second subsidy in the amount of $256,400 to finance the Company’s research and development activities. In 2005, the Company received a third subsidy of $64,100 for the Company’s research and development activities, which was expended during that year.

According to PRC government regulations, the funds granted may be treated as capital contributed by a company appointed by the PRC government or as a loan from such company, which the Company will be required to repay. As of June 30, 2009, the Company has not reached a final agreement with the PRC government regarding the treatment of these three subsidies as either a loan or capital contribution, and the Company does not expect that the final agreement will be completed within the next year. Therefore, these amounts are reflected as non-current liabilities in the accompanying consolidated financial statements.

Note 14 - CAPITAL TRANSACTIONS

On May 12, 2009, the Company effectuated a 10-for-1 reverse stock split of its issued and outstanding shares of common stock and a proportional reduction of its authorized shares of common stock. Number of common stock, warrants, options disclosed in the footnotes has been retroactively restated to reflect the 10-for-1 reverse stock split.

Stock-based compensation

On February 12, 2008, the Company issued 9,000 shares of common stock as salary to a non-executive director. The trading value of the Company's common stock on February 12, 2008, was $11.10 per share and a corresponding amount of $99,900 was charged to general and administrative expenses. The Company also had a $148,226 and $95,204 balance under shares to be issued as of June 30, 2009 and December 31, 2008, which represented 17,500 and 11,000 common shares to be issued to the non-executive director for his service provided for the period from May 2008 to June 2009, and for the period from May 2008 to December 2008, respectively. The amounts were included in general and administrative expenses based on the weighted-average trading price of the Company’s common stock for the said period.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

On February 29, 2008, the Company issued 21,040 shares of common stock to its legal counsel as partial payment for services rendered. The trading value of the Company's common stock on February 29, 2008, was $10.50 per share and additional inducement cost of $42,081 between the fair value of the shares at $220,920 and the partial payment of $178,839 was charged to general and administrative expenses.

On April 21, 2008, two of the Company’s convertible debenture holders converted $982,003 of debentures into 122,750 shares of common stock.

On May 5, 2008, the Company agreed to issue 5,217 shares of common stock to its chief financial officer (“CFO”) during the term of the one-year agreement. The shares vest in four equal installments of 1,304 shares each quarter. The trading value of the common stock on May 5, 2008 was $11.70 per share for a total value of $61,042. On May 5, 2009, the Company renewed the one-year service agreement with the CFO and agreed to issue 7,220 restricted shares of the Company’s common stock, which will vest in four equal installments of 1,805 shares every quarter starting August 5, 2009. Compensation expense is recognized on a straight-line basis over the vesting period. Compensation expense of $15,469 and $30,521 was charged to general and administrative expenses for the three months and six months ended June 30, 2009, respectively. No such expense was incurred during the same periods in 2008.

On May 26, 2009, the Company agreed to issue 2,778 shares of common stock to its director at the beginning of each term of his directorship. The trading value of the common stock on May 26, 2009 was $9.00 per share for the total value of $25,002, and was charged to general and administrative expenses for the three months and six months ended June 30, 2009.

Warrants

On February 28, 2007, the Company issued 97,500 warrants to four investors with an exercisable price of $12.00 per share for a term of three years. On the same date, the Company also issued warrants to the private placement agent, exercisable for 57,050 shares of the Company’s common stock at a price of $10.00 per share for a five-year term. As of June 30, 2009, there was no warrant exercised. Following is a summary of the status of warrants outstanding at June 30, 2009:

Number of		Average Remaining	Average
Warrants		Contractual Life	Exercise Price
	97,500	0.66 years	$	12.00
	57,050	2.66 years	$	10.00
	154,550		$	11.26

Following is an activity summary of the Company’s outstanding warrants:

Outstanding as of December 31, 2007			154,500
Granted			—
Forfeited			—
Exercised			—
Outstanding as of June 30, 2008 (unaudited)			154,550
Granted			—
Forfeited			—
Exercised			—
Outstanding as of December 31, 2008			154,550
Granted			—
Forfeited			—
Exercised			—
Outstanding as of June 30, 2009 (unaudited)			154,550

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

On June 30, 2009, the Company and Rodman & Renshaw, LLC, as representative of underwriters (the "Underwriters") entered into an Underwriting Agreement. Pursuant to the Underwriting Agreement, Skystar agreed to issue and sell an aggregate of 1,610,000 shares (including 210,000 over-allotment shares) of the Company’s common stock, at a price of $12.98 per share in a public offering. The closing date of this offering was on the third business day following the effective date of the registration statement registering the shares offered, or July 3, 2009.

Equity offering

In connection with this offering, the Company agreed to grant 70,000 common stock purchase options to five individuals from the Underwriters. The options are exercisable from June 30, 2010 to June 30, 2014, and each option is exercisable for one share of common stock of the Company, with exercise price at $16.225 per share. The Company used the Black-Scholes Model to value the options granted, which amounted to $1,065,842. The value of options granted to these individuals was included as part of the offering costs, and had no net effect on the Company’s equity.

The following are the assumptions used by the Company in the Black-Scholes Model:

Number of options				Stock price				Exercise price			Expected term		Dividend yield				Volatility				Risk-free interest rate
	70,000			$	17.94			$	16.225		3.0 years			—				161	%			1.67	%

The following is a summary of the status of options outstanding at June 30, 2009:

Outstanding Options

Exercisable Options

Number

Average Remaining

Average

Number

Average Remaining

Average

of Options

Contractual Life

Exercise Price

of Options

Contractual Life

Exercise Price

70,000

5.00

16.225

—

Following is an activity summary of the Company’s outstanding options:

	Number of Options Outstanding		Weighted-Average Exercise Price		Aggregate Intrinsic Value
Outstanding as of December 31, 2008		—		—		—
Granted		70,000	$	16.225		—
Forfeited		—		—		—
Exercised		—		—		—
Outstanding as of June 30, 2009		70,000	$	16.225	$	120,050

Incremental costs incurred of this offering, including underwriting commission, legal fees, and printing costs were $1,730,477, and directly deducted from the proceeds. The gross proceeds of this offering were $20,897,800. The Company received cash proceeds of $19,167,323 on July 6, 2009.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Note 15 - CONVERTIBLE DEBENTURES

In February 2007, the Company sold an aggregate of $4.075 million of its 8% convertible debentures (the “Debentures”) and issued warrants to purchase 407,500 shares of common stock to several institutional and accredited investors. On April 21, 2008, the Company entered into an Amendment and Waiver Agreement (the “Amendment”) with two institutional and accredited investors who acquired two remaining unconverted Debentures in a private transaction from the original holders of these Debentures. A summary of the Amendment is as follows:

•

The Amendment amends the terms of these Debentures by: (a) changing the conversion price from $10.00 per share to $8.00 per share; (b) deleting the trading conditions for mandatory conversion; (c) granting the Company the right to mandatory conversion at any time, and (d) allowing the Company to designate the date for the mandatory conversion.

•	The Amendment is deemed to be the Company’s notice to require conversion of the entire outstanding principal of these Debentures and all accrued but unpaid interest thereon.

The difference between the value of the conversion option at the previous prices and their value at the modified prices are deemed costs for the Company and are charged to operations. The inducement cost for the two Debentures converted was $257,775 for six months ended June 30, 2008. The inducement cost for the converted Debentures was based on the market value of the additional 24,550 shares obtained by these two investors at $10.50 per share on April 21, 2008.

122,750 shares of common stock were issued upon conversion of the two Debentures with a carrying value of $982,003 (including $490,713 of default premium) at a reduced conversion price of $8.00.

In accordance with EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” all unamortized discount amounting to $291,548 at the time of the conversion was recognized as interest expense for the three months and six months ended June 30, 2008. The unamortized deferred financing costs of $79,998 on conversion of the Debentures were also recorded as interest expense for the three months and six months ended June 30, 2008.

Note 16 - STATUTORY RESERVES

Statutory reserves represent restricted retained earnings. Based on the legal formation of the entities, all PRC entities are required to set aside 10% of its net income as reported in its statutory accounts on an annual basis to the statutory surplus reserve fund. Once the total statutory surplus reserve reaches 50% of the registered capital of the respective subsidiaries, further appropriations are discretionary. The statutory surplus reserve can be used to increase the registered capital and eliminate future losses of the respective companies under PRC GAAP. The Company’s statutory surplus reserve is not distributable to shareholders except in the event of liquidation. As of June 30, 2009, Xian Tianxing has not met the statutory surplus reserve requirement, and approximately $2,405,000 still needs to be transferred to the statutory surplus reserve from Shanghai Siqiang and Sida.

The reserve fund can be used to increase the registered capital upon approval by relevant government authorities and eliminate future losses of the respective companies upon a resolution by the board of directors.

Appropriations to the above statutory reserves are accounted for as a transfer from unrestricted earnings to statutory reserves. There are no legal requirements in the PRC to fund these statutory reserves by the transfer of cash to any restricted accounts, and as such, the Company has not transferred any cash to these accounts. These reserves are not distributable as cash dividends.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Skystar is registered in the State of Nevada whereas its subsidiary, Skystar Cayman, is a tax-exempt company incorporated in the Cayman Islands and conducts all of its business through its subsidiaries, Fortunate Time, Sida, and Sida’s PRC VIEs, Xian Tianxing and Shanghai Siqiang.

Note 17 - TAXES

Sida, Xian Tianxing, and Shanghai Siqiang are subject to PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25% beginning on January 1, 2008. Xian Tianxing has been approved as a new technology enterprise, and under PRC Income Tax Laws is entitled to a preferential tax rate of 15%.

The following table reconciles the U.S. statutory rates to the Company's effective tax rate as of June 30:

	2009			2008
	(Unaudited)
U.S. Statutory rate		34.0	%		34.0	%
Foreign income not recognized in the U.S.		(34.0	)		(34.0	)
China income tax rate		25.0			25.0
China income tax exemption		(10.0	)		(10.0	)
Other item (1)		21.9			30.8
Total provision for income taxes		36.9	%		45.8	%

(1)	The other item is operating expenses incurred by Skystar that are not deductible in the PRC which resulted in an increase in effective tax rate of 21.9% and 30.8% for the six months ended June 30, 2009 and 2008, respectively.

The estimated tax savings due to the reduced tax rate for the three months ended June 30, 2009 and 2008 amounted to $193,525 and $178,122, respectively. If the statutory income tax had been applied, the Company would have basic and diluted losses per share of $0.17 for the three months ended June 30, 2009, and the Company would have basic and diluted earnings per share of $0.01 for the three months ended June 30, 2008.

The estimated tax savings due to the reduced tax rate for the six months ended June 30, 2009 and 2008 amounted to $344,672 and $283,126, respectively. The net effect on earnings per share if the statutory income tax had been applied would decrease basic earnings per share for the six months ended June 30, 2009 and 2008 to $0.32 and $0.10, respectively, and would decrease diluted earnings per share to $0.32 and $0.10, respectively.

Skystar is incorporated in the U.S. and has incurred a net operating loss for income tax purposes for 2009. As of June 30, 2009, the estimated net operating loss carryforwards for U.S. income tax purposes amounted to $3,482,585 which may be available to reduce future years’ taxable income. These carryforwards will expire, if not utilized, beginning in 2026 and continue through 2029. Management believes that the realization of the benefits arising from this loss appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at June 30, 2009 and December 31, 2008. The valuation allowance at June 30, 2009 and December 31, 2008 was $1,184,079 and $967,424, respectively. The Company’s management reviews this valuation allowance periodically and makes adjustments as necessary.

The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $ 17,093,000 as of June 30, 2009, which are included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Note 18 - EARNINGS PER SHARE

The following is the calculation of earnings per share:

	For the three months ended June 30,						For the six months ended June 30,
	2009			2008			2009		2008
Net income (loss)	$	(116,797	)	$	(126,065	)	$	947,847	$	490,286

Weighted average shares used in basic computation		1,869,512			1,836,932			1,868,854		1,780,149
Diluted effect of stock warrants		—			—			43,362		6,883
Weighted average shares used in diluted computation		1,869,512			1,836,932			1,912,216		1,787,032

Earnings (Loss) per share:

Basic		$	(0.06	)		$	(0.07	)		$	0.51			$	0.28
Diluted		$	(0.06	)		$	(0.07	)		$	0.50			$	0.27

At June 30, 2009 and 2008, the Company had 154,550 warrants outstanding. For the six months ended June 30, 2009 and 2008, the average stock price was greater than the exercise prices of warrants which resulted in additional weighted-average common stock equivalents of 43,362 and 6,883, respectively. For the three months ended June 30, 2009 and 2008, these warrants were considered anti-dilutive due to the net loss incurred.

70,000 outstanding options were excluded from the diluted earnings per share calculation as they are anti-dilutive.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

Amounts receivable from and payable to related parties are summarized as follows:

	June 30, 2009		December 31, 2008
	(Unaudited)
Short-term loans from shareholders
Mr. Weibing Lu – officer and shareholder (1) (2)	$	36,625	$	220,050
Mr. Wei Wen – officer and shareholder (2)		36,625		44,010
Ms. Aixia Wang – shareholder (2)		36,625		44,010
Total	$	109,875	$	308,070

Shares to be issued to related party
Scott Cramer – non-executive director (3)	$	148,226	$	95,204
Mark D Chen – non-executive director(3)		25,002		—
Total	$	173,228	$	95,204

Amounts due to related parties
Bennet P. Tchaikovsky – CFO (4)		13,168		13,168
Scott Cramer – non-executive director and shareholder (4)		447,171		224,684
Shaanxi Xingji Electronics Co. - owned by a director's wife (4)		34,399		4,373
Mr. Weibing Lu – officer and shareholder (4)		56,157		—
Total	$	550,895	$	242,225

(1) In 2008, Weibing Lu obtained an unsecured personal loan in the amount of $176,040 (RMB 1,500,000) from Huaxia Bank with annual interest rate of 7.47% and advanced to Xian Tianxing to facilitate operations. Xian Tianxing guaranteed the loan. The loan principal and related interest was due on December 30, 2008. On January 4, 2009, Xian Tianxing paid the full principal amount to the bank, with related interest of $15,741.

(2) On May 29, 2008, Weibing Lu, Wei Wen and Aixia Wang obtained personal loans from Yanta Credit Union and advanced cash to Xian Tianxing in the total amount of $132,030 to facilitate operations. These loans, which were due on May 29, 2009 with 8.436% interest per annum and guaranteed by Xian Tianxing, were paid in full on May 29, 2009. On June 2, 2009, Mr. Lu, Mr. Wen and Ms. Wang again obtained loans from the same bank and advanced cash to Xian Tianxing in the total amount of $109,875. These loans are due on June 1, 2010, with 10.11% interest per annum and are also guaranteed by Xian Tianxing. For the three months and six months ended June 30, 2009, Xian Tianxing paid interest of $2,748 and $5,630, respectively, for these loans.

(3) As of June 30, 2009 and December 31, 2008, the Company had $148,226 (representing 17,500 common shares) and $95,204 balances (representing 11,000 common shares), respectively, under agreement to issue shares to Scott Cramer, respectively, as compensation for being a representative of the Company in the United States for the periods from May 2008 to June 30, 2009, and December 31, 2008, respectively. In addition, as of June 30, 2009, the Company had $25,002 balance (representing 2,778 common shares) under agreement to issue shares to Mr. Mark D Chen as compensation at the beginning of each term of his directorship.

(4) Shaanxi Xinji Electronics Co., Ltd. is owned by the wife of Weibing Lu. The amounts due to Shaanxi Xinji Electronics as of June 30, 2009 and December 31, 2008 were short-term cash transfers for business operations, non-interest bearing, unsecured, and payable upon demand. As of June 30, 2009, the Company also had $56,157 payable to Mr. Lu for advance from Mr. Lu for short-term financing purposes. As of June 30, 2009 and December 31, 2008, the Company also had amounts due to Scott Cramer and Bennet P. Tchaikovsky for the expenses paid by them on behalf of the Company.

Note 20 - COMMITMENTS AND CONTINGENCIES

(a) Lease commitments

The Company recognizes lease expense on a straight-line basis over the term of the lease in accordance to SFAS 13, “Accounting for Leases.” The Company entered into a tenancy agreement for the lease of factory premises for a period of ten years from October 1, 2004 to December 31, 2014, with annual rent of $13,563 (or RMB 94,600), which is subject to a 10% increase every four subsequent years.

The Company leases office space from Weibing Lu, the Company’s chief executive officer, for a period of five years from January 1, 2007 to December 31, 2011, with annual rent of approximately $24,000 (or RMB 165,600). The Company also entered into a tenancy agreement with Weibing Lu for the lease of Shanghai Siqiang’s office for a period of ten years from August 1, 2007 to August 1, 2017, with annual rent of approximately $21,000 (or RMB 144,000).

The minimum future lease payments for the next five years and thereafter are as follows:

Period	Amount
Six months ending December 31, 2009	$	29,608
Year ending December 31, 2010		59,215
Year ending December 31, 2011		59,215
Year ending December 31, 2012		34,955
Year ending December 31, 2013		34,955
Year ending December 31, 2014 and thereafter		89,453
Total	$	307,401

Rental expense for the three months ended June 30, 2009 and 2008 amounted to $14,811 and $4,778, respectively. Rental expense for the six months ended June 30, 2009 and 2008 amounted to $29,622 and $9,555, respectively.

(b) Legal proceedings

From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation, which would have a significant effect on the Company’s consolidated financial statements as of June 30, 2009.

In May 2007, Andrew Chien filed suit against the Company, Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in United States District Court for the District of Connecticut, alleging causes of action for violation of Sections 10(b) and 20(a) of the Exchange Act. On July 17, 2008, in a decision that is now published, the Court granted defendants' motion to dismiss and subsequently dismissed the lawsuit, entering judgment on behalf of the defendants. Mr. Chien filed a notice of appeal of the Court's dismissal of his lawsuit, opposed by the defendants, which remains pending. Additionally, on February 5, 2009, the Court issued a ruling on defendants' motion for sanctions, finding the action filed by Mr. Chien to have been entirely frivolous, and to have constituted a "substantial" violation of Federal Rule of Civil Procedure Rule 11, and imposed significant monetary sanctions on both Mr. Chien and his former attorney. As part of the basis for imposing sanctions on Mr. Chien personally, the Court specifically found that Mr. Chien had knowledge of facts directly contradicting the allegations of his complaint, as evident in internet postings he made on online message boards. Mr. Chien subsequently filed motions seeking to "re-open" this case, and to recuse the judge, but both motions were denied.

Subsequently, Mr. Chien, proceeding pro se, filed another lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court, alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action. The case was removed to the U.S. District Court, District of Connecticut, and assigned to the same Judge who dismissed Mr. Chien’s related federal action. On June 8, 2009, the Court granted defendants’ motion to dismiss this action in its entirety, and denied Mr. Chien’s motion to further amend his complaint.

Other than the above described legal proceedings, the Company is not aware of any other legal matters in which purchasers, any director, officer, or any owner of record or beneficial owner of more than five percent of any class of voting securities of the Company, or any affiliate of purchaser, or of any such director, officer, affiliate of the Company, or security holder, is a party adverse to the Company or has a material adverse interest to the Company. No provision has been made in the consolidated financial statements for the above contingencies.

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES