Skystar Bio-pharmaceutical (SKBI) 10-Q 2011 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2011

or

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______ to ______.

Commission File Number 001-34394

SKYSTAR BIO-PHARMACEUTICAL COMPANY

(Exact name of small business issuer as specified in its charter)

Nevada	33-0901534
(State or other jurisdiction of	(I.R.S. employer
incorporation or organization)	identification number)

4/F Building B, Chuangye Square, No. 48 Keji Road,

Gaoxin District, Xi’an Province, P.R. China

(Address of principal executive offices and zip code)

(8629) 8819-3188

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  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 ¨	Smaller Reporting Company x

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

7,161,919 shares of the issuer’s common stock are issued and outstanding as of November 14, 2011.

SKYSTAR BIO-PHARMACEUTICAL COMPANY

FORM 10-Q

INDEX

		Page No.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS		3
PART I.  FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements	4
	Condensed Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010	F-1
	Condensed Consolidated Statements of Income and Other Comprehensive Income for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)	F-2
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (unaudited)	F-3
	Condensed Consolidated Statements of Shareholders’ Equity (unaudited)	F-4
	Notes to the Condensed Consolidated Financial Statements (unaudited)	F-5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	5
Item 4.	Controls and Procedures	13
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	14
Item 6.	Exhibits	15
SIGNATURES		16

2

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words “estimate,” “anticipate,” “believe,” “expect,” or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this report and in our other SEC filings. These risks and uncertainties could cause our actual results to differ materially from those indicated in the forward-looking statements. We undertake no obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments.

Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

3

PART I.  FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Our financial statements begin on the following page, beginning with page F-1.

4

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30,		December 31,
	2011 (Unaudited)		2010
ASSETS
CURRENT ASSETS:
Cash	$	3,783,152	$	5,887,831
Accounts receivable, net of allowance for doubtful accounts of $349,759 and $339,031 as of September 30, 2011 and December 31, 2010, respectively		9,772,146		4,977,850
Inventories		14,425,659		7,202,223
Deposits and prepaid expenses		26,590,556		17,074,000
Loans receivable		-		8,040,100
Other receivables		1,458,518		1,558,775
Total current assets		56,030,031		44,740,779
PLANT AND EQUIPMENT, NET		27,467,207		22,613,113
CONSTRUCTION-IN-PROGRESS		10,165,654		1,590,720
OTHER ASSETS:
Long-term prepayments		766,850		1,454,226
Long-term prepayments for acquisitions		222,230		4,806,352
Intangible assets, net		5,780,132		6,043,941
Total other assets		6,769,212		12,304,519
Total assets	$	100,432,104	$	81,249,131
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	1,383,984	$	201,850
Other payable and accrued expenses		2,613,682		1,845,051
Short-term loans		3,358,881		3,025,884
Deposits from customers		1,425,373		1,260,030
Taxes payable		5,072,803		749,836
Shares to be issued to related parties		126,015		53,050
Due to related parties		130,218		217,912
Total current liabilities		14,110,956		7,353,613
OTHER LIABILITIES:
Deferred government grant		1,017,250		986,050
Warrant/purchase option liability		152,227		1,419,639
Total other liabilities		1,169,477		2,405,689
Total liabilities		15,280,433		9,759,302
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
Preferred stock, $0.001 par value, 50,000,000 shares authorized, No Series “A” shares authorized, 48,000,000 Series “B” shares authorized, No Series “B” shares issued and outstanding
Common stock, $0.001 par value, 40,000,000 shares authorized, 7,161,919 shares issued and outstanding as of September 30, 2011 and December 31, 2010		7,162		7,162
Paid-in capital		35,784,378		35,784,378
Statutory reserves		5,695,236		5,695,236
Retained earnings		36,014,173		24,847,290
Accumulated other comprehensive income		7,650,722		5,155,763
Total shareholders’ equity		85,151,671		71,489,829
Total liabilities and shareholders’ equity	$	100,432,104	$	81,249,131

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

F-1

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

	For Three Months Ended September 30,					For Nine Months Ended September 30,
	2011		2010			2011			2010
REVENUE, NET	$	20,903,063	$	18,569,747		$	37,086,158		$	31,703,531
COST OF REVENUE		10,057,212		8,506,137			18,185,565			14,702,419
GROSS PROFIT		10,845,851		10,063,610			18,900,593			17,001,112
OPERATING EXPENSES:
Research and development		91,124		208,197			2,180,147			444,280
Selling expenses		1,174,928		709,188			2,154,158			1,312,132
General and administrative		602,248		1,281,731			2,412,339			2,899,315
Total operating expenses		1,868,300		2,199,116			6,746,644			4,655,727
INCOME FROM OPERATIONS		8,977,551		7,864,494			12,153,949			12,345,385
OTHER INCOME (EXPENSE):
Other income (expense), net		9,421		(28,265	)		5,054			8,409
Interest income (expense), net		15,036		5,356			(54,265	)		(12,436	)
Change in fair value of warrant/purchase option liability		171,765		141,057			1,267,412			(18,269	)
Total other income (expense), net		196,222		118,148			1,218,201			(22,296	)
INCOME BEFORE PROVISION FOR INCOME TAXES		9,173,773		7,982,642			13,372,150			12,323,089
PROVISION FOR INCOME TAXES		1,446,112		1,334,843			2,205,267			2,200,648
NET INCOME		7,727,661		6,647,799			11,166,883			10,122,441
OTHER COMPREHENSIVE INCOME
Foreign currency translation adjustment		898,786		1,015,911			2,494,959			1,256,093
COMPREHENSIVE INCOME	$	8,626,447	$	7,663,710		$	13,661,842		$	11,378,534
EARNINGS PER SHARE:
Basic	$	1.08	$	0.93		$	1.56		$	1.43
Diluted	$	1.08	$	0.93		$	1.56		$	1.42
WEIGHTED AVERAGE NUMBER OF COMMON SHARES:
Basic		7,172,354		7,119,585			7,171,530			7,103,365
Diluted		7,172,354		7,147,124			7,174,668			7,116,520

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

F-2

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

(Unaudited)

	Nine months ended September 30,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	11,166,883		$	10,122,441
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation		709,749			515,178
Amortization		432,098			125,591
Allowance for slow moving inventories		-			63,177
Common stock issued for services		-			16,245
Common stock to be issued to related parties for compensation		72,965			96,892
Change in fair value of warrant/purchase option liability		(1,267,412	)		18,269
Change in operating assets and liabilities
Accounts receivable		(4,566,868	)		(1,445,225	)
Inventories		(6,890,055	)		(10,699,989	)
Deposits and prepaid expenses		(8,746,398	)		(3,674,364	)
Other receivables		147,323			(583,082	)
Accounts payable		1,073,204			69,181
Other payables and accrued expenses		710,264			726,855
Deposits from customers		123,582			(370,290	)
Taxes payable		4,234,408			2,458,008
Net cash used in operating activities		(2,800,257	)		(2,561,113	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Long-term prepayments		(357,226	)		-
Prepayment for acquisitions		-			(4,673,367	)
Loans to third parties		(2,885,501	)		(441,300	)
Collection of loans to third parties		11,054,921			-
Purchases of plant and equipment		(58,560	)		(2,527,188	)
Purchases of intangible assets		(46,496	)		(1,883	)
Payments on construction-in-progress		(7,316,494	)		(788,797	)
Net cash provided by (used in) investing activities		390,644			(8,432,535	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term loans		3,277,016			1,799,621
Repayment of short-term loans		(3,043,340	)		(330,975	)
Repayment of shareholder and directors’ loans		-			(110,325	)
Due (from) to related parties		4,960			(34,859	)
Net cash provided by financing activities		238,636			1,323,462
EFFECT OF EXCHANGE RATE CHANGES ON CASH		66,298			3,272
DECREASE IN CASH		(2,104,679	)		(9,666,914	)
CASH, beginning  of period		5,887,831			11,699,398
CASH, end of period	$	3,783,152		$	2,032,484
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$	266,797		$	11,368
Cash paid for income taxes	$	1,271,193		$	579,670
Non-cash investing and financing activities
Long-term prepayment transferred to construction-in-progress	$	5,497,461		$	-
Long-term prepayment transferred to intangible assets	$			$	1,518,660
Long-term prepayment transferred to plant and equipment	$	4,727,364		$	1,931,720
Construction-in-progress transferred to plant and equipment	$	-		$	1,347,489
Cashless exercise of warrants	$	-		$	1,511,603
Issuance of common stock accrued in previous year	$	-		$	25,002
Expense paid through long-term prepayment	$	-		$	294,200

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

F-3

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

											Accumulated
							Retained earnings				other
	Common stock				Paid-in		Statutory				comprehensive
	Shares		Amount		capital		reserves		Unrestricted		income		Total
BALANCE, January 1, 2011		7,161,919	$	7,162	$	35,784,378	$	5,695,236	$	24,847,290	$	5,155,763	$	71,489,829
Foreign currency translation		-		-		-		-		-		2,494,959		2,494,959
Net income		-		-		-		-		11,166,883		-		11,166,883
BALANCE, September 30, 2011		7,161,919	$	7,162	$	35,784,378	$	5,695,236	$	36,014,173	$	7,650,722	$	85,151,671

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

F-4

SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

(Unaudited)

Note 1 - ORGANIZATION

Organization and description of business

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 the 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 Xi’an Tianxing Bio-Pharmaceutical Co., Limited (“Xi’an Tianxing”), a PRC joint stock company that the Company controls through contractual arrangements originally between Skystar Cayman and Xi’an 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 (Xi’an) 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. Xi’an 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 obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi’an Tianxing as a variable interest entity (“VIE”) under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities.  Accordingly, the Company consolidates Xi’an Tianxing’s results, assets, and liabilities.

On September 18, 2009, Skystar Bio-Pharmaceutical Inc. (“Skystar California”) was incorporated in California and became a wholly owned subsidiary of Skystar.  On December 20, 2010, we dissolved Skystar California.

On April 21, 2010, Kunshan Sikeda Biotechnology Co., Ltd. (“Kunshan Sikeda”) was incorporated in Kunshan, Jiangsu province, China with registered capital of RMB 500,000, of which Xi’an Tianxing and Sida each contributed RMB 250,000. Kunshan Sikeda is jointly owned by Xi’an Tianxing and Sida.

On May 7, 2010, Fortunate Time formed Skystar Biotechnology (Kunshan) Co., Limited (“Skystar Kunshan”) in Kunshan, Jiangsu province, China with registered capital of $15,000,000, of which $2,250,000 was paid by Fortunate Time in cash, and of which the remaining $12,750,000 is due by May 7, 2012. Kunshan was formed in connection with an acquisition of assets to meet part of the registered capital requirements, and was intended to be a micro-organism manufacturing facility for the Company once the acquisition was complete. As of September 30, 2011, the asset acquisition was completed, and the Company is in the process of transferring the assets acquired to meet part of the registered capital requirements. 

On August 11, 2010, Sida became the parent company of Skystar Biotechnology (Jingzhou) Co., Limited (“Skystar Jingzhou”), a company established in Jingzhou, Hubei Province, China on February 5, 2010, with registered capital of approximately $3.8 million, of which $3.5 million has been paid.  The remaining $0.3 million is required to be invested by April 6, 2012.  Skystar Jingzhou started production in the third quarter of 2010.

On March 15, 2011, Xi’an Tianxing formed Xi’an Sikaida Bio-products Co., Ltd. (“Xi’an Sikaida”) with registered capital of RMB 10,000,000, of which RMB 3,000,000 has been paid by Xi’an Tianxing.

Hereinafter, Skystar, Skystar Cayman, Fortunate Time, Sida, Xi’an Tianxing, Skystar Kunshan, Kunshan Sikeda, Skystar Jingzhou, Shanghai Siqiang, and Xi’an Sikaida are sometimes collectively referred to as the “Company.”

F-5

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation

The accompanying condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The condensed consolidated financial statements include the financial statements of the Company, its wholly owned subsidiaries, and its VIEs. All significant inter-company transactions and balances between the Company, its subsidiaries, and VIEs have been eliminated in consolidation.

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 three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year ending December 31, 2011.

Use of estimates

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.

Foreign currency translation

The Company uses the United States dollar (“U.S. dollar”) for financial reporting purposes and the Chinese Renminbi (“RMB”) as its functional 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. 

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.

Fair values of financial instruments

The accounting standards regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires fair value disclosures of those financial instruments.  This accounting standard defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement, and enhances disclosures requirements for fair value measures.  Certain current assets and current liabilities qualify as financial instruments.  Management believes their carrying amounts 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 current interest rates are equivalent to interest rates currently available.  The three levels of valuation hierarchy are defined as follows:

F-6

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

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

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

The Company has stock purchase warrants that are treated as derivative liabilities.  These warrants do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants and purchase options using the Black-Scholes Option Pricing Model (“Black-Scholes Model”) using the following assumptions:

	Warrants – (1)						Purchase Options – (2)
	September 30, 2011 (Unaudited)			December 31, 2010			September 30, 2011 (Unaudited)			December 31, 2010
Stock price	$	1.95		$	9.73		$	1.95		$	9.73
Exercise price	$	5.00		$	5.00		$	8.11		$	8.11
Annual dividend yield		-			-				-		-
Expected term (years)		0.41			1.16			2.75			3.50
Risk-free interest rate		0.06	%		0.30	%		0.42	%		1.50	%
Expected volatility		83	%		51	%		141	%		180	%

(1) As of December 31, 2010, 34,230 warrants with an exercise price of $5.00 were outstanding. As of September 30, 2011, 34,230 of these warrants were outstanding.

(2) As of December 31, 2010, 140,000 purchase options with an exercise price of $8.11 were outstanding. As of September 30, 2011, 140,000 of these options were outstanding.

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 the FASB’s accounting standards, 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 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 174,230 warrants and options outstanding as of September 30, 2011 was determined using the Black-Scholes Model, defined in the FASB’s accounting standard of fair value measurement 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 Company recognized a gain of $171,765 and $141,057 from the change in fair value of derivative liability for the three months ended September 30, 2011 and 2010, respectively, and a gain of $1,267,412 and a loss of $18,269 for the nine months ended September 30, 2011 and 2010, respectively.

F-7

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 September 30, 2011:

	Carrying Value at		Fair Value Measurement at
	September		September 30, 2011
	30, 2011		Level 1		Level 2		Level 3
Warrant/purchase option liability (unaudited)	$	152,227	$	—	$	152,227	$	—

In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company is required to record assets and liabilities at fair value on a non-recurring basis.  Generally, assets are recorded at fair value on a non-recurring basis as a result of impairment charges.  For the nine months ended September 30, 2011, there were no impairment charges.     

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 estimated allowance for sales returns is reflected on these consolidated financial statements as sales returns are de minimis based on historical experience.

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 goods sold are included in selling expenses, which totaled $837,006 and $393,344 for the three months ended September 30, 2011 and 2010, respectively, and $1,381,276 and $678,224 for the nine months ended September 30, 2011 and 2010, respectively.

The Company’s revenues and cost of revenues by product line were as follows:

	Three months ended September 30,				Nine months ended September 30,
	2011		2010		2011		2010
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Revenue
Micro-organism	$	5,997,055	$	4,700,623	$	9,574,277	$	7,892,296
Veterinary Medications		12,979,162		12,366,426		24,186,068		21,095,705
Feed Additives		1,055,001		737,077		1,772,280		1,341,654
Vaccines		871,845		765,621		1,553,533		1,373,876
Total Revenue		20,903,063		18,569,747		37,086,158		31,703,531
Cost of Revenue
Micro-organism		1,608,861		1,186,977		2,683,849		2,050,907
Veterinary Medications		7,696,914		6,950,838		14,361,371		11,970,865
Feed Additives		663,002		289,262		968,250		536,292
Vaccines		88,435		79,060		172,095		144,355
Total Cost of Revenue		10,057,212		8,506,137		18,185,565		14,702,419
Gross Profit	$	10,845,851	$	10,063,610	$	18,900,593	$	17,001,112

F-8

Cash

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

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 that 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 September 30, 2011 and December 31, 2010, 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 that the assets are completed and put into service.

F-9

Intangible assets

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.

Technological Know-How — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over the weighted average useful life of nine 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 may exist. 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 September 30, 2011, there was no impairment of its intangible assets.

Comprehensive income

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. 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 for the three months ended September 30, 2011 and 2010 were $655 and $8,383, respectively, and for the nine months ended September 30, 2011 and 2010 were $1,160 and $14,852, respectively.

Income taxes

The Company accounts for income taxes in accordance with the FASB’s accounting standard for income taxes.  Under the asset and liability method as required by this accounting standard,  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. 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.

Further, in accordance with this accounting standard, 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. The standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. 

F-10

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.

According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent.  The statute of limitations extends to five years under special circumstances. In the case of transfer pricing issues, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. Accordingly, the income tax returns of the Company’s PRC operating subsidiaries for the years ended December 31, 2008 through 2010 are open to examination by the PRC state and local tax authorities.

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

Stock-based compensation

The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Earnings per share

The Company reports earnings per share and presents both basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such 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, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period or  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 during 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. 

Related parties

Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of such principal owners and management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.

Recently issued accounting pronouncements

In December 2010, the FASB issued Accounting Standards Update 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force). ASU No. 2010-28 addresses questions about entities that have reporting units with zero or negative carrying amounts. The amendments modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In addition, current GAAP will be improved by eliminating an entity’s ability to assert that a reporting unit is not required to perform Step 2 because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired. As a result, goodwill impairments may be reported sooner than under current practice. The provisions of ASC No. 2010-28 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted.

F-11

In December 2010, the FASB issued Accounting Standards Update 2010-29, Business Combinations (Topic 805) — Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU No. 2010-29 clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The amendments expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted.

In April 2011, the FASB issued Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU No. 2011-04 amends current U.S. GAAP fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. ASU No. 2011-04 will be effective for interim and annual periods beginning on or after December 15, 2011. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU No. 2011-05 is new guidance on the presentation of comprehensive income that eliminates the option to report the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, comprehensive income must be reported in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. This guidance will be effective during the interim and annual periods beginning after December 15, 2011 with early adoption permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU No. 2011-08 amends existing guidance by allowing companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. ASU No. 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011with early adoption permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

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 that subject the Company to concentration of credit risk consist of cash and accounts receivable. Balances at financial institutions or state-owned banks within the PRC are not covered by insurance. The Company has not experienced any losses in such accounts. The Company provides credit terms for sales to certain customers.  As a result, there are credit risks with the accounts receivable balances.  The Company constantly re-evaluates the credit worthiness of customers buying on credit and maintains an allowance for doubtful accounts.

F-12

For the three months and nine months ended September 30, 2011 and 2010, all of the Company’s sales occurred in the PRC. In those periods, no individual customer accounted for more than 10% of the Company’s total revenues. In addition, all accounts receivable at September 30, 2011 and December 31, 2010 arose in the PRC.

The Company’s three largest vendors (vendors with more than 10% of total purchases) accounted for approximately 52% and 41% of the Company’s total purchases for the three months and nine months ended September 30, 2011, respectively, while the Company’s four largest vendors accounted for approximately 46% and 44% of the Company’s total purchases for the three months and nine months ended September 30, 2010, respectively.

The Company had one product that accounted for 26% and 23% of the Company’s total revenues for the three months and nine months ended September 30, 2011, respectively, while the Company had one product that accounted for 27% and 25% of the Company’s total revenues for the three months and nine months ended September 30, 2010, respectively. 

Note 4 - ACCOUNTS RECEIVABLE, NET

Accounts receivable consisted of the following:

	September  30, 2011			December 31, 2010
Account receivable	$	10,121,905		$	5,316,881
Allowance for bad debts		(349,759	)		(339,031	)
Account receivable, net	$	9,772,146		$	4,977,850

The following table presents the movement of allowance for doubtful accounts:

Allowance for bad debt, January 1, 2011		339,031
Addition		—
Recovery		—
Translation adjustment		10,728
Allowance for bad debt, September 30, 2011 (unaudited)	$	349,759

Note 5 – INVENTORIES

Inventories consisted of the following:

	September  30, 2011			December 31, 2010
Raw materials	$	12,151,851		$	5,466,902
Packing materials		771,503			170,843
Work-in-process		70,551			23,071
Finished goods		1,615,255			1,721,943
Other		29,284			25,723
Total		14,638,444			7,408,482
Less: Allowance for slow moving raw materials		(212,785	)		(206,259	)
Total	$	14,425,659		$	7,202,223

The Company periodically reviews its reserves for slow-moving and obsolete inventories.

F-13

Note 6 - DEPOSITS AND PREPAID EXPENSES

Deposits and prepaid expenses were comprised of the following:

	September  30, 2011		December 31, 2010
Prepayment for raw materials purchasing	$	25,588,724	$	15,967,236
Prepayment for packaging materials purchasing		560,237		767,623
Other		441,595		339,141
Total	$	26,590,556	$	17,074,000

Note 7 - PLANT AND EQUIPMENT, NET

Plant and equipment consisted of the following:

	September  30, 2011			December 31, 2010
Building and improvements	$	25,384,100		$	20,757,554
Machinery and equipment		4,591,007			3,640,635
Office equipment and furniture		318,665			256,690
Vehicles		585,071			566,718
Total		30,878,843			25,221,597
Less: Accumulated depreciation		(3,411,636	)		(2,608,484	)
Plant and equipment, net	$	27,467,207		$	22,613,113

The Company’s one year loan with Shaanxi Agricultural Yanta Credit Union is secured by the Company’s office buildings located in Xi’an City.

The Company’s line of credit with Bank of East-Asia is secured by the Company’s manufacturing plant in Huxian County.

The Company’s one year loan with Chang’an Bank is secured by the Company’s office buildings located in Xi’an City.

Depreciation expense was $210,989 and $215,330 for the three months ended September 30, 2011 and 2010, respectively. For the nine months ended September 30, 2011 and 2010, depreciation expense was $709,749 and $515,178, respectively.

Note 8 - CONSTRUCTION-IN-PROGRESS

Xi’an facility

We started constructing our Huxian vaccine facility in 2005, and it was completed in 2010.  During the nine months ended September 30, 2011, the Company started two projects at the vaccine facility to modify air filtration, water treatment, and other facility changes based on recommendations by outside experts hired by the Company to advise on the GMP (PRC’s Good Manufacturing Practices Standard) qualification process for the vaccine facility. The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification process to be complete by June 2012.

F-14

During the nine months ended September 30, 2011, the Company started a facility improvement project in the amount of $313,000 (RMB 2,000,000) for the Huxian Animal Laboratory. The Company expects the project will be completed by December 2011.

During the third quarter ended September 30, 2011, the Company started a facility improvement project in the amount of $1,114,280 (RMB 7,120,000) at the Huxian veterinary medicine facility to prepare its GMP re-examination. The project includes a renovation project to clean ​​3,160 square feet in area and to replace or implement an exhaust ventilation system, color steel enclosure, process water piping, purification equipment, fire alarm, and combined air supply unit. The Company expects that the project will be completed by the end of November 2011.

The Company also started an office building decoration project at its headquarter in Xi’an in the amount of $334,426 (RMB 2,136,905). The Company expects the project will be completed by December 2011.

Jingzhou facility

During the third quarter ended September 30, 2011, the Company started a facility improvement project in the amount of $1,643,250 (RMB 10,500,000) to expand production capacity at the Jingzhou facility. The project includes plant construction and water supply and drainage. The Company expects the project will be completed by March 2012.

Kunshan facility

The construction and supporting projects at the Kunshan facility include plumbing, sewer, electrical, HVAC, fire protection and alarm system, drainage, office, lab, road construction, parking, and landscaping with a total estimated cost in the amount of $4,894,847 (RMB 31,276,980). The Company expects the project will be completed by December 2011.

During the three months and nine months ended September 30, 2011, no amount was transferred from CIP to property, plant, and equipment.  During the three months and nine months ended September 30, 2010, the micro-organism facility and some general facility improvements were completed and placed in service resulting in a transfer from CIP to property, plant, and equipment of $1,347,489. No depreciation is provided for in construction-in-progress until such time that the assets are completed and placed into service.

The Company is in the process of completing the following construction projects:

Project	Total in CIP  as of September 30,  2011		Estimate cost to Complete		Estimated Total Cost		Estimated  Completion Date
Xi'an Huxian vaccine facility	$	2,723,201		-	$	2,723,201	June 2012
Xi'an headquarter office		239,445		94,981		334,426	December 2011
Xi'an Huxian animal laboratory		313,000		-		313,000	December 2011
Xi'an Huxian veterinary medicine facility		899,875		214,405		1,114,280	November 2011
Jingzhou facility		1,244,175		399,075		1,643,250	March 2012
Kunshan facility		4,745,958		148,890		4,894,847	December 2011
Total	$	10,165,654		857,350	$	11,023,004	December 2011

As of September 30, 2011 and December 31, 2010, the Company had construction-in-progress amounting to $10,165,654 and $1,590,720, respectively. No interest expense was capitalized for construction-in-progress for the three months and nine months ended September 30, 2011 and 2010 as management determined the amount of capitalized interest would be  insignificant.

F-15

Note 9 - LONG-TERM PREPAYMENTS

Long-term prepayments consisted of the following:

	September  30, 2011		December 31, 2010
R&D project	$	313,000	$	303,400
Construction deposit		-		455,100
Deposit for building and equipment purchase		453,850		695,726
Deposit for potential acquisitions		222,230		4,806,352
Total	$	989,080	$	6,260,578

As of September 30, 2011, deposits for building and equipment purchase of $453,850 (RMB 2,900,000) represented deposits made for the purchase of equipment.

As of September 30, 2011 and December 31, 2010, deposits for potential acquisitions totaled $222,230 and $4,806,352, respectively, all of which was held by an unrelated third party engaged to facilitate the purchase of a Kunshan-based micro-organism manufacturing facility and other future potential acquisition for the Company. As of September 30, 2011, we completed the purchase of the Kunshan facility, and $4,664,780 of long-term prepayments was transferred to building and improvements, property, plant, and equipment, and intangible assets.

Note 10 – INTANGIBLE ASSETS

Intangible assets consisted of the following:

	September  30, 2011			December 31, 2010
Land use rights	$	4,773,252		$	4,650,521
Technological know-how		2,191,000			2,123,800
Patent		313,000			303,400
Total		7,277,252			7,077,721
Less: accumulated amortization		(1,497,120	)		(1,033,780	)
Intangible assets, net	$	5,780,132		$	6,043,941

In 2009, the Company paid $1,252,000 (RMB 8,000,000) for a fish disease vaccine technology transfer for an 11 year term from September 2009 through September 2020.

The Company’s line of credit with Bank of East-Asia is secured by the Company’s land use rights in Huxian County, Shaanxi Province.

The Company’s one year loan with Industrial and Commercial Bank of China Songzi Branch is secured by the Company’s land use rights in Jingzhou, Hubei Province.

For the three months ended September 30, 2011 and 2010, the amortization expense for intangibles amounted to $46,376 and $48,458, respectively. For the nine months ended September 30, 2011 and 2010, the amortization expense for intangibles amounted to $432,098 and $125,591, respectively.

F-16

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

Years ending December 31,	Amount
2011 (three months)	$	99,246
2012		396,983
2013		240,483
2014		240,483
2015		240,483
Thereafter		4,562,456
Total	$	5,780,132

Note 11 – LOAN RECEIVABLE

In December 2010, the Company provided two of its largest suppliers with a short term loan totaling $7,825,000 (RMB 50,000,000) at the prevailing interest rate of 5%.  The two suppliers, Fandike and Chenyue, are among the largest suppliers to the Company.  On March 15, 2011, the suppliers repaid the entire $7,825,000 (RMB 50,000,000) loan plus interest of $85,340 (RMB 553,650).

In August 2010, the Company issued an unsecured loan to an unrelated third party in the amount of $469,500 (RMB 3,000,000) for one year from August 10, 2010 through August 9, 2011, with an annual interest rate of 0.6%. During the nine months ended September 30, 2011, this unrelated party repaid the entire loan of $469,500 (RMB 3,000,000) plus interest of $2,775 (RMB 18,000).

On January 4, 2011, the Company entered a loan agreement with Shaanxi Feilong Logistics Co., Ltd., one of its largest logistics providers, to lend up to $3,130,000 (RMB 20,000,000) to Feilong. This loan agreement expires within one year with an annual interest rate of 6%. During the nine months ended September 30, 2011, Feilong borrowed a total amount of $2,929,680 (RMB 18,720,000) from the Company. During the nine months ended September 30, 2011, Feilong repaid the entire $2,929,680 (RMB 18,720,000) loan plus interest of $161,847 (RMB 1,050,000).

Note 12 – SHORT-TERM LOANS

On August 24, 2010, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $782,500 (RMB 5,000,000) at an annual interest rate of 8.66%. This loan is secured by the Company’s office buildings located in Xi’an City. During the nine months ended September 30, 2011, the Company repaid the entire loan of $782,500 (RMB 5,000,000) plus interest.

The Company entered into a line of credit agreement with Bank of East-Asia that allows the Company to borrow up to $3,000,000 (RMB 20,000,000). This line of credit agreement expires within two years starting with the first withdrawal. The Company withdrew $483,585 (RMB 3,090,000), $531,161 (RMB 3,394,000), and $1,324,382 (RMB 8,462,500) on September 7, 2010, September 9, 2010, and October 12, 2010, respectively, at an annual interest rate of 6.372% with interest due every three months starting on the date of the first withdrawal. This line of credit is secured by the Company’s land use right and manufacturing plant located in Huxian County. During the nine months ended September 30, 2011, the Company repaid $483,585 (RMB 3,090,000) and $531,161 (RMB 3,394,000) plus interest, respectively. On October 12, 2011, the Company repaid the remaining balance of $1,324,382 (RMB 8,462,500) plus interest on this line of credit. On October 20, 2011, the Company borrowed $2,347,500 (RMB 15,000,000) from this line of credit.

On March 24, 2011, the Company obtained a six month unsecured loan with Kunshan Agricultural Credit Union Rural Microfinance Limited for $782,500 (RMB 5,000,000) at an annual interest rate of 16%. During the nine months ended September 30, 2011, the Company repaid the entire loan of $782,500 (RMB 5,000,000) plus interest.

On May 5, 2011, the Company obtained a one year loan with Industrial and Commercial Bank of China Songzi Branch for $469,500 (RMB 3,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate, which was 8.528% at September 30, 2011. During the nine months ended September 30, 2011, the Company repaid $156,500 (RMB 1,000,000) and subsequently borrowed back $156,500 (RMB 1,000,000). This loan is secured by the Company’s land use rights in Jingzhou, Hubei Province.

F-17

During the nine months ended September 30, 2011, the Company obtained one month and two month short-term loans with three third-party individuals for a total amount of $510,190 (RMB 3,260,000). These loans are non-interest bearing and are unsecured. During the nine months ended September 30, 2011, the Company repaid all three loans totaling $510,190 (RMB 3,260,000).

On July 8, 2011, the Company obtained a one year loan with Chang’an Bank for $782,500 (RMB 5,000,000) at an annual interest rate of 8.658%. This loan is secured by the Company’s office buildings and its Chairman and CEO’s personal property located in Xi’an City.

On August 25, 2011, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $782,500 (RMB 5,000,000) at an annual interest rate of 9.411%. This loan is secured by the Company’s office buildings located in Xi’an City.

Interest expense incurred and associated with the short-term loans amounted to $117,046 and $266,797 for the three months and nine months ended September 30, 2011, respectively, none of which has been capitalized as part of construction-in-progress in 2011. Interest expense incurred and associated with the short-term loans amounted to $9,806 and $11,171 for the three months and nine months ended September 30, 2010, respectively, none of which has been capitalized as part of construction-in-progress in 2010.

Note 13 - DEFERRED GOVERNMENT GRANT

Deferred government grant represents subsidies for Good Manufacturing Practice projects granted by various levels of the PRC government. To date, the Company received government subsidies totaling $1,173,750 (RMB 7,500,000), of which RMB 5,000,000 was granted by the PRC government, of which RMB 1,000,000 was re-paid on December 7, 2010, with the remaining amount to be repaid in 2012. RMB 2,000,000 was granted by Shaanxi provincial government, and RMB 500,000 was granted by Xi’an municipal government. The Shaanxi provincial government grant and Xi’an municipal government grant are not required to be repaid.

Note 14 - CAPITAL TRANSACTIONS

Stock-based compensation

On March 30, 2010, the Company agreed to issue 2,500 shares of common stock to a non-executive director in exchange for services unrelated to his services as a director at the fair market value of $11.74 per share based on the closing price on March 30, 2010. On April 16, 2010, the Company entered into another agreement to grant 10,000 shares of common stock to that director for his one year service from April 1, 2010. The closing price per share on the grant date was $10.61. The common stock compensation vests in four equal quarterly installments of 2,500 shares. Shares owed were accrued at the end of each quarter at the fair market value on the grant date of $10.61 per share. On August 31, 2011, the Company entered into another agreement to grant 36,000 shares of common stock to that director for his one year service from April 1, 2011. The closing price per share on the grant date was $2.58. The common stock compensation vests in four equal quarterly installments of 9,000 shares. Shares owed were accrued at the end of each quarter at the fair market value of the grant date at $2.58 per share. A total of $46,440 and $26,525 was charged to general and administrative expense for the three months ended on September 30, 2011 and 2010, respectively. A total of $72,965 and $80,075 was charged to general and administrative expense for the nine months ended on September 30, 2011 and 2010, respectively. On October 25, 2010, 5,000 shares were issued to the director for the shares vested in the first two quarters of 2010. As of September 30, 2011, 25,500 shares were accrued for the shares vested and pending to be issued.

On May 26, 2009, the Company renewed a one year service agreement with its former CFO and agreed to issue 14,440 shares of common stock, which would vest in four equal installments of 3,610 shares every quarter starting August 5, 2009. Compensation expense is recognized on the straight-line method over the vesting period. On February 26, 2010, 10,830 shares were issued at the fair market value of $8.57. Effective April 16, 2010, the former CFO resigned, and the last installment of 3,610 shares was prorated to 2,880 shares. The Company issued the 2,880 common shares to the former CFO on October 25, 2010 at the fair market value of $7.81 per share. Total compensation expense of $0 and $29,205 were charged to general and administrative expenses for the nine months ended September 30, 2011 and 2010, respectively.

F-18

On May 26, 2009, the Company agreed to issue 5,556 shares of common stock to a director at the beginning of each term of his directorship. The trading value of the common stock on May 26, 2009 was $4.50 per share. Total compensation expense of $0 and $3,857 were charged to general and administrative expenses for the nine months ended September 30, 2011 and 2010, respectively. The Company issued 5,556 shares on February 26, 2010. In accordance with the agreement between the Company and this director, this director must continue to serve as a member of the Board until his successor is duly elected and qualified in order to receive the shares. This director has continued in his position, and the Company is in the process of finalizing its agreement with this director and expects to complete this process shortly.

Warrants and Purchase Options

On February 28, 2007, the Company issued 195,000 warrants to four investors with an exercise price of $6.00 per share for a term of three years.  On the same date, the Company also issued warrants to the private placement agent, exercisable for 114,100 shares of the Company’s common stock at a price of $5.00 per share for a 5 year term. For the three and nine months ended September 30, 2011, no warrants were exercised. For the three and nine months ended September 30, 2010, 0 and 218,024 shares of warrants were exercised.

In connection with a 2009 equity offering, the Company granted 140,000 common stock purchase options to five designees of the Underwriters with a vesting date of September 30, 2010. The options are exercisable from September 30, 2010 to September 30, 2014, and each option is exercisable for one share of the Company’s common stock at an exercise price at $8.11 per share. All options were provided for services performed. On September 30, 2010, the purchase options were reclassified from equity to warrant liabilities, and the Company reclassified $779,674 from additional paid in capital to derivative liability.

The fair value of each warrant and purchase option is estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Company’s stock, and reflect the assumption that the historical volatilities are indicative of future trends, which may not necessarily be the actual outcome. Expected term of each warrant and purchase option award represents the period of time that options granted are expected to be outstanding and is estimated based on the historical exercise behavior of separate groups of employees or officers. The risk-free rate reflects the interest rate for United States Treasury Notes with similar time-to-maturity to that of the options.

	September 30, 2011			September 30, 2010
Expected term (year)		0.41 – 2.75			1.42- 3.75
Expected volatility		83% - 141	%		80% - 143	%
Weighted average volatility		83% - 141	%		80% - 143	%
Expected dividend yield		0	%		0	%
Risk-free rate		0.06% - 0.42	%		0.35% - 0.96	%

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

	Number of warrants/purchase options			Weighted – average exercise price		Weighted- average remaining contractual term (Year)
Outstanding at January 1, 2010		392,254		$	5.57
Granted		-		$
Forfeited		-
Exercised		(218,024	)		5.72
Outstanding at December 31, 2010		174,230		$	7.50
Granted		-			-
Forfeited		-			-
Exercised		-		$	-
Outstanding at September 30, 2011		174,230		$	7.50		2.29
Vested and expected to vest at September 30, 2011		174,230		$	7.50		2.29
Exercisable at September 30, 2011		174,230		$	7.50		2.29

F-19

Equity Compensation Plan

On December 8, 2009, the Company’s board of directors approved a stock incentive plan for officers, directors, employees and consultants entitled the “Skystar Bio-Pharmaceutical Company 2010 Stock Incentive Plan” (the “2010 Plan”). The maximum number of shares that may be issued under the 2010 Plan is 700,000 shares of common stock. The 2010 Plan was approved by the Company’s stockholders on December 31, 2009, and awards may be granted thereunder until December 7, 2019. As of September 30, 2011, there are 690,000 shares of the Company’s common stock remaining available for future issuance under the Plan.

Note 15 - 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  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 entity’s registered capital, further appropriations are discretionary. The statutory surplus reserve can be used to increase the entity’s registered capital (upon approval by relevant government authorities) and eliminate its future losses under PRC regulatory requirements (upon a resolution by the board of directors). The statutory surplus reserve is not distributable to shareholders except in the event of liquidation. As of September 30, 2011, apart from Xi’an Tianxing meeting the statutory surplus reserve requirement, we must transfer approximately $10,418,518 to the respective statutory surplus reserve of our other PRC subsidiaries.

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.

Note 16 – TAXES

Skystar is subject to United States federal income tax provisions. Skystar Cayman is a tax-exempt company incorporated in the Cayman Islands and conducts all of its business through its subsidiaries, Fortune Time, Sida, Fortune Time’s subsidiary Skystar Kunshan, Sida’s subsidiary Skystar Jingzhou, Sida’s PRC VIEs, Xi’an Tianxing, Xi’an Tianxing’s subsidiary Shanghai Siqiang, Sida and Xi’an Tianxing’s joint venture Kunshan Sikeda, and Xi’an Tianxing’s subsidiary Xi’an Sikaida.

Sida, Skystar Jingzhou, Skystar Kunshan, Xi’an Tianxing, Shanghai Siqiang, Kunshan Sikeda and Xi’an Sikaida are subject to the PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25%. Xi’an 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 for the three and nine months ended September 30, 2011 and 2010:

	For the three months ended September 30,						For the nine months ended September 30,
	2011			2010			2011			2010
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
U.S. Statutory rate		34.0	%		34.0	%		34.0	%		34.0	%
Foreign income not recognized in the U.S.		(34.0	)		(34.0	)		(34.0	)		(34.0	)
China income tax rate		25.0			25.0			25.0			25.0
China income tax exemption		(10.0	)		(10.0	)		(10.0	)		(10.0	)
Other item (1)		0.8			1.7			1.5			2.9
Total provision for income taxes		15.8	%		16.7	%		16.5	%		17.9	%

(1) The other item is operating expenses incurred by Skystar that are not deductible in the PRC that resulted in an increase of 0. 8% and 1.7% for the three months ended September 30, 2011 and 2010, respectively, and an increase of 1.5% and 2.9% for the nine months ended September 30, 2011 and 2010, respectively.

F-20

Taxes payable consisted of the following:

	September  30, 2011		December 31, 2010
Income taxes payable	$	1,120,211	$	432,722
Value added tax		3,549,634		203,684
Other taxes		402,958		113,430
Total	$	5,072,803	$	749,836

The estimated tax savings due to the reduced tax rate for the nine months ended September 30, 2011 and 2010 amounted to $1,119,467 and $1,459,668, respectively. 

Skystar is incorporated in the U.S. and has incurred a net operating loss for income tax purposes for the three and nine months ended September 30, 2011. As of September 30, 2011, the estimated net operating loss carryforwards for U.S. income tax purposes amounted to $5,679,978, which may be available to reduce future years’ taxable income. These carryforwards will expire, if not utilized, beginning in 2026 and continue through 2030. 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 September 30, 2011 and December 31, 2010. The valuation allowance at September 30, 2011 and December 31, 2010 was $1,931,193 and $1,781,954, 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 $52 million as of September 30, 2011, 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.

Note 17 - EARNINGS PER SHARE

The following is the calculation of earnings per share:

	For the three months ended September 30,				For the nine months ended September 30,
	2011		2010		2011		2010
Net income	$	7,727,661	$	6,647,799	$	11,166,883	$	10,122,441
Weighted average shares used in basic computation		7,172,354		7,119,585		7,171,530		7,103,365
Diluted effect of stock warrants		-		27,539		3,138		13,155
Weighted average shares used in diluted computation		7,172,354		7,147,124		7,174,668		7,116,520
Earnings per share:
Basic	$	1.08	$	0.93	$	1.56	$	1.43
Diluted	$	1.08	$	0.93	$	1.56	$	1.42

F-21

For the three months ended September 30, 2011, a total of 34,230 warrants were excluded from the diluted earnings per share calculation as they were anti-dilutive as the average stock price was less than the exercise prices of warrants. For the nine months ended September 30, 2011, the average stock price was greater than the exercise prices of warrants, which resulted in additional weighted-average common stock equivalents of 3,138. For the three and nine months ended September 30, 2011, a total of 140,000 options were excluded from the diluted earnings per share calculation as they are anti-dilutive because the average stock price was less than the exercise prices of the options.

For the three months ended September 30, 2010, the average stock price was greater than the exercise prices of warrants, which resulted in additional weighted-average common stock equivalents of 27,539. For the nine months ended September 30, 2010, the average stock price was greater than the exercise prices of warrants, which resulted in additional weighted-average common stock equivalents of 13,155. 140,000 outstanding purchase options were excluded from the diluted earnings per share calculation as they are anti-dilutive.

Note 18 - RELATED PARTY TRANSACTIONS AND ARRANGEMENTS

Amounts payable (receivable) to related parties are summarized as follows:

	September 30, 2011			December 31, 2010
Shares to be issued to related party
Scott Cramer – non-executive director (1)	$	126,015		$	53,050
Amounts due to (from) related parties
Scott Cramer – non-executive director and shareholder		159,189			170,937
Officers and shareholders (2)		(28,971	)		46,975
Total	$	130,218		$	217,912

(1) The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. As of  September 30, 2011 and December 31, 2010, the Company had $126,015 (representing 25,500 common shares) and $53,050 (representing 5,000 common shares), respectively, under agreement to issue shares to Scott Cramer, as compensation for being a representative of the Company in the United States for the period April 1, 2010 to March 31, 2012. 

(2) As of September 30, 2011, the amount due to (from) officers and shareholders includes accrued expense to Weibing Lu. 

Note 19 - COMMITMENTS AND CONTINGENCIES

(a) Lease commitments

The Company recognizes lease expense on the straight-line basis over the term of the lease in accordance with the FASB’s accounting standard of 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. The annual rent for the factory premises was adjusted to approximately $18,154 (RMB 116,000) and subject to a 10% increase every two years starting October 1, 2009.

F-22

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 $25,916 (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 $22,536 (or RMB 144,000).

The Company entered into a one year tenancy agreement for leasing Tianxing’s sales office space in Tianjin from April 21, 2010 to April 20, 2011 with annual rent of approximately $3,756 (RMB 24,000).

The Company entered into a one year tenancy agreement for an office lease in Kunshan, Jiangsu Province from April 15, 2011 to April 14, 2012 with annual rent of approximately $3.005 (RMB 19,200).

The Company entered into a tenancy agreement for the lease of warehouse premises in Xi’an for a period of three years from July 20, 2011 to July 19, 2014 with annual rent of approximately $36,778 (RMB 235,000) subject to a 10% increase every two years starting July 20, 2013.

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

Period	Amount
Three months ending December 31, 2011	$	26,597
Year ending December 31, 2012		78,219
Year ending December 31, 2013		79,306
Year ending December 31, 2014		56,379
Year ending December 31, 2015		22,536
Year ending December 31, 2016 and thereafter		35,682
Total	$	298,719

Rental expense for the three months ended September 30, 2011 and 2010 amounted to $26,435 and $19,553, respectively. Rental expense for the nine months ended September 30, 2011 and 2010 amounted to $61,895 and $55,964, respectively.

(b) Legal proceedings

From time to time, the Companyis involved in legal matters arising in the ordinary course of business. Management currentlyis not aware of any legal matters or pending litigation that would have a significant effect on the Company’s consolidated financial statements as of September 30, 2011.

In May 2007, Andrew Chien filed suit against the Company, R. 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 Securities Exchange Act of 1934.  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.  Chien appealed the dismissal.  Defendants filed a post-judgment motion for sanctions against Chien.  On February 5, 2009, the court found the action filed by Chien to have been frivolous, and to have constituted a “substantial” violation of Rule 11, and imposed monetary sanctions on both Chien and his former attorney.  Chien appealed the award of sanctions.  All appeals, including the one referenced below concerning Chien’s second lawsuit, were subsequently consolidated.  The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing sanctions against Chien in light of the circumstances and facts on record.  This Mandate was entered on or about November 8, 2010.

Andrew Chien, proceeding pro se (i.e., he represented himself without an attorney), filed another lawsuit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court (which was removed to U.S. District Court) alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action.  The court held that all claims asserted against the defendants were barred and failed to state a claim on a multiplicity of grounds, including on the basis of res judicata.  Defendants filed a second Motion for Sanctions under Rule 11 and the PSLRA, which was granted.  Chien appealed the dismissal.  The Court of Appeals for the Second Circuit consolidated all of Chien’s appeals from both of his lawsuits.   On November 8, 2010, the Court of Appeals affirmed the dismissals and the awards of sanctions.  On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. The Supreme Court denied review of the petition.

F-23

Andrew Chien, again proceeding pro se, commenced another lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung, Weibing Lu, Weinberg & Company, P.A., Moore Stephens Wirth Frazer & Torbet, LLP, Frazer Frost, LLP, Crowe Horwath LLP, Richardson & Patel LLP, Kevin K. Leung, Harvey Kesner, and Jody M. Borrelli alleging the same facts and circumstances as set forth in the above two matters, although adding the aforementioned accountants and lawyers as defendants to the claims.  The matter commenced on August 8, 2011, and shortly thereafter was removed to U.S. District Court.  On October 5, 2011, the court dismissed the entire action as to all defendants. 

Other than the above described legal proceedings, the Company is not aware of any other legal matters in which 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 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.

(c) Ownership of leasehold property

In 2005, a shareholder contributed a leasehold office building as additional capital of Xi’an Tianxing. However, the title of the leasehold property has not passed to the Company. The Company does not believe there are any legal barriers for the shareholder to transfer ownership to the Company. However, in the event that the Company fails to obtain the ownership certificate for the leasehold property, there is a risk that the building will need to be vacated due to unofficial ownership. Management believes that this possibility is remote, and, as such, no provision has been made in the consolidated financial statements for this potential occurrence.

(d) R&D Project

During the first quarter of 2008, Xi’an Tianxing contracted with Northwestern Agricultural Technology University to work jointly on an R&D project concerning the application of nano-technology in the prevention of major milk cow disease. The total projected budget for this project is approximately $626,000 (RMB 4,000,000), which is to be paid according to completed stages of the project. For the nine months ended September 30, 2011 and 2010, the Company incurred $0 and $369,750 (RMB 2,500,000), respectively, relating to this project. The project reached trial stage in September 2009.

During the year ended December 31, 2009, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on a R&D project with a contracted amount of approximated $939,000 (RMB 6,000,000).  The Company paid $411,880 (RMB 2,800,000) in the fourth quarter of 2009. For the nine months ended September 30, 2011 and 2010, the Company incurred approximately $46,242 (RMB 300,000) and $0, respectively, of expenses relating to this project.

During the first quarter of 2011, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project to develop new treatment and diagnosis method for Mycoplasmal pneumonia of swine.  The project term is from January 2011 through September 2013.  The cost to the Company for the initial phase is approximately $313,000 (RMB 2,000,000), of which $77,070 (RMB 500,000) has been paid for the nine months ended September 30, 2011.

During the second quarter of 2011, Xi’an Tianxing launched four new R&D projects to develop ceftiofur sodium for injection (powder for injection), a sulfuric acid injection neostigmine, dexamethasone sodium phosphate injection, and houttuynia preparation of compound application in weaning piglets. The projected budget for the R&D project of ceftiofur sodium for injection (powder for injection) is approximately $547,750 (RMB 3,500,000), of which $425,426 (RMB 2,760,000) has been paid for the nine months ended September 30, 2011. The projected budget for the R&D project of a sulfuric acid injection neostigmine is approximately $469,500 (RMB 3,000,000), of which $262,049 (RMB 1,700,071) has been paid for the nine months ended September 30, 2011. The projected budget for the R&D project of dexamethasone sodium phosphate injection is approximately $547,750 (RMB 3,500,000), of which $451,047 (RMB 2,926,215) has been paid for the nine months ended September 30, 2011. The projected budget for the R&D project of houttuynia preparation of compound application in weaning piglets is approximately $704,250 (RMB 4,500,000), of which $661,820 (RMB 4,293,630) has been paid for the nine months ended September 30, 2011. 

F-24

(e) Capital commitment

From July 2010 to September 2011, the Company contracted with nineteen different business entities to construct or implement plumbing, sewage, electricity, HVAC, fire protection and alarm system, drainage, an office, a lab, road construction, parking, and landscaping at a micro-organism manufacturing facility located in Kunshan, Jiangsu Province. The total projected budget for this project is approximately $4,894,847 (RMB 31,276,980), which is to be paid according to completed stages of the project. For the nine months ended September 30, 2011 and 2010, the Company incurred $4,745,958 (RMB 30,325,608) and $0, respectively, relating to this project. The Company expects this project to be completed by the end of 2011.

F-25

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

We were incorporated in Nevada on September 24, 1998.  We are a holding company that, through our wholly owned subsidiaries in China, including Skystar Bio Technology (Jingzhou) Co. (“Skystar Jingzhou”), and a variable interest entity (“VIE”), Xi’an Tianxing Bio-Pharmaceutical Co., Ltd. (“Xi’an Tianxing”), researches, develops, manufactures, and distributes veterinary health care and medical care products in the People’s Republic of China (“PRC”).

All of our operations are carried out by our subsidiaries in China and Xi’an Tianxing, which the Company controls through contractual arrangements between Xi’an Tianxing and Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), the wholly owned subsidiary of Fortunate Time International Limited, the wholly owned subsidiary of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), which became our wholly owned subsidiary in 2005. Such contractual arrangements are necessary to comply with PRC laws limiting foreign ownership of certain companies. Through these contractual arrangements, we have the ability to substantially influence Xi’an Tianxing’s daily operations and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control Xi’an Tianxing, we are considered the primary beneficiary of Xi’an Tianxing.

In addition to Xi’an Tianxing, Skystar Jingzhou also manufactures and distributes veterinary medicines, including aquaculture medicines in China. Skystar Jingzhou is a wholly owned subsidiary of the Company’s Sida entity. It was formed with the August 2010 acquisition of a veterinary medicine manufacturing facility in Hubei Province, China.

On August 21, 2007, Xi’an Tianxing invested $68,550 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Company Limited (‘Shanghai Siqiang’). Xi’an Tianxing is the 100% shareholder. Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipments.

Our financial statements are prepared in U.S. dollars and in accordance with accounting principles generally accepted in the United States of America. See “Exchange Rates” below for information concerning the exchanges rates at which Renminbi were translated into U.S. dollars at various pertinent dates and for pertinent periods.

Critical Accounting Policies and Estimates

In preparing the consolidated financial statements in accordance with U.S. GAAP, we make estimates and assumptions about the effect of matters that are inherently uncertain and may change in subsequent periods. The resulting accounting estimates will, by definition, vary from the related actual results. We consider the following to be the most critical accounting policies:

Principles of consolidation

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of the Company, its wholly owned subsidiaries, and its VIEs.  All significant inter-company transactions and balances between the Company, its subsidiaries, and its VIEs have been eliminated in consolidation.

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 estimated allowance for sales returns is reflected on these consolidated financial statements as sales returns are de minimal based on historical experience.

5

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 the customers.

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 and 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.

Intangible assets

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 the straight-line basis over the term granted by the government.

Technological Know-How — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over the weighted average useful life of nine 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, 2011, there was no impairment of its intangible assets.

Earnings per share

The Company reports earnings per share and presents both basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such 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, warrants and stock options were converted or exercised. Further, the method 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 during 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. 

6

Recent Issued Accounting Pronouncements

In December 2010, the FASB issued Accounting Standards Update 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force). ASU No. 2010-28 addresses questions about entities that have reporting units with zero or negative carrying amounts. The amendments modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In addition, current GAAP will be improved by eliminating an entity’s ability to assert that a reporting unit is not required to perform Step 2 because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired. As a result, goodwill impairments may be reported sooner than under current practice. The provisions of ASC No. 2010-28 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of this ASU did not have a material impact on our consolidated financial statements.

In December 2010, the FASB issued Accounting Standards Update 2010-29, Business Combinations (Topic 805) — Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU No. 2010-29 clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The amendments expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted.

In April 2011, the FASB issued Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU No. 2011-04 amends current U.S. GAAP fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. ASU No. 2011-04 will be effective for interim and annual periods beginning on or after December 15, 2011. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU No. 2011-05 is new guidance on the presentation of comprehensive income that eliminates the option to report the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, comprehensive income must be reported in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. This guidance will be effective during the interim and annual periods beginning after December 15, 2011 with early adoption permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU No. 2011-08 amends existing guidance by allowing companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. ASU No. 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011with early adoption permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

7

Results of Operations – Three Months Ended September 30, 2011 and 2010

The following table summarizes our results of operations for the three months ended September 30, 2011 and 2010.

	Three Months Ended September 30,
	2011					2010
	Amount		% of total revenue			Amount		% of total revenue
Revenue	$	20,903,063		100.0	%	$	18,569,747		100.0	%
Gross Profit	$	10,845,851		51.9	%	$	10,063,610		54.2	%
Operating Expenses	$	1,868,300		8.9	%	$	2,199,116		11.8	%
Income from Operations	$	8,977,551		42.9	%	$	7,864,494		42.4	%
Other Income	$	196,222		0.9	%	$	118,148		0.6	%
Income Tax Expenses	$	1,446,112		6.9	%	$	1,334,843		7.2	%
Net Income	$	7,727,661		37.0	%	$	6,647,799		35.8	%

Revenue.   All of our revenue is derived from the sale of veterinary healthcare and medical care products in the PRC. For the three months ended September 30, 2011, we had revenue of $20,903,063 as compared to revenue of $18,569,747 for the three months ended September 30, 2010, an increase of $2,333,316 or 12.6%. We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  Selling prices have not changed from the same period last year for most of our past customers.

Revenue — Veterinary Medications.   Revenue from sales of our veterinary medications increased by $612,736 or 5.0% from $12,366,426 for the three months ended September 30, 2010 to $12,979,162 for the three months ended September 30, 2011.  The moderate increase was mainly because the existing production capacity at our Huxian plant is close to saturation and our Jingzhou plant is currently under GMP re-certification. According to Chinese government regulations, we cannot launch manufacturing production until GMP re-certification is completed and a new production permit is granted. Of the total revenues from veterinary medications during three months ended September 30, 2011, approximately 26% of total revenue resulted from the sale of Praziquantel tablets, which treats schistosomiasis.

Revenue — Micro-Organism.   Revenue from sales of our micro-organism products increased by $1,296,432 or 27.6% from $4,700,623 for the three months ended September 30, 2010 to $5,997,055 during the three months ended September 30, 2011.  The increase was primarily due to increased sales efforts and improved technology resulting in strong market demand. The increase in micro-organism sales contributed the majority or 55.6% of revenue growth for the entire company during the three months ended September 30, 2011.

Revenue — Feed Additives.   Revenue from sales of our feed additives product line increased by $317,924 or 43.1% from $737,077 for the three months ended September 30, 2010 to $1,055,001 for the three months ended September 30, 2011.  The increase was primarily the result of increased orders from some of our long-term customers as they expanded their animal farming.

Revenue — Vaccines.   Revenue from sales of our vaccines increased by $106,224 or 13.9% from $765,621 for the three months ended September 30, 2010 to $871,845 for the three months ended September 30, 2011. We are currently only capable of small-scale production of our vaccine products and therefore cannot significantly increase sales until we expand our production capability. We completed the construction of a new vaccine facility at our Huxian plant in 2010. The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification will be completed by June 2012, and we expect to commence production shortly thereafter for large-scale production.

Cost of Sales. Cost of revenue, which consists of raw materials, direct labor, and manufacturing overhead for our four product lines, was $10,057,212 for the three months ended September 30, 2011, as compared to $8,506,137 for the three months ended September 30, 2010, an increase of $1,551,075 or 18.2%, as a result of increased sales and higher raw material costs because of elevated inflation in China. For the three months ended September 30, 2011, raw material costs contributed the majority or approximately 81.6% of total cost of sales, packing material costs contributed approximately 16.4% of total cost of sales, and labor costs contributed approximately 2.0% of total cost of sales. The impact to our gross margins mainly came from higher raw materials costs.

8

Cost of Sales — Veterinary Medications.  Cost of revenue for our veterinary medications increased by $746,076 or 10.7% from $6,950,838 for the three months ended September 30, 2010 to $7,696,914 for the three months ended September 30, 2011. This increase was mainly due to the corresponding increase in sales and higher raw material costs. The increase of costs in veterinary medications sales contributed to 48.1% of the increase in cost of sales for the entire company during three months ended September 30, 2011.

Cost of Sales — Micro-Organism.   Cost of revenue for our micro-organism products increased by $421,884 or 35.5%, from $1,186,977 for the three months ended September 30, 2010 to $1,608,861 for the three months ended September 30, 2011.  This increase was mainly due to increased sales and higher raw material costs.

Cost of Sales — Feed Additives.   Cost of revenue for our feed additives increased by $373,740 or 129.2% from $289,262 for the three months ended September 30, 2010 to $663,002 for the three months ended September 30, 2011.  The increase was primarily due to the increase in sales and significantly increased raw material costs of yeast extract, the main raw material to manufacture feed additives products.

Cost of Sales — Vaccines.   Cost of revenue for our vaccines products increased by $9,375 or 11.9% from $79,060 for the three months ended September 30, 2010 to $88,435 for the three months ended September 30, 2011.  This increase was mainly a result of the corresponding increase in sales.

The following table summarizes our operating expenses for the three months ended September 30, 2011 and 2010.

	Three Months Ended September 30,
	2011					2010
	Amount		% of total revenue			Amount		% of total revenue
Operating Expenses
Research and Development Costs	$	91,124		0.4	%	$	208,197		1.1	%
Selling Expenses	$	1,174,928		5.6	%	$	709,188		3.8	%
General and Administrative Expenses	$	602,248		2.9	%	$	1,281,731		6.9	%
Total Operating Expenses	$	1,868,300		8.9	%	$	2,199,116		11.8	%

Research and Development Costs.  Research and development costs, which consist of salaries, professional fees, and technical support fees, totaled $91,124 for the three months ended September 30, 2011, as compared to $208,197 for the three months ended September 30, 2010, a decrease of $117,073 or 56.2%.   The decrease was mainly due to R&D expenses incurred for newly launched in-house R&D projects during the first half year of 2011, with substantially less spending on new projects in the third quarter of 2011.

Selling Expenses.  Selling expenses, which consist of commissions, advertising and promotion expenses, freight charges, and salaries, totaled $1,174,928 for the three months ended September 30, 2011 as compared to $709,188 for the three months ended September 30, 2010, an increase of $465,740 or 65.7%.  This increase was primarily due to the increase in our shipping and handling costs related to delivering our products to customers as we continued to expand our market to remote areas, and to inflation pressure in China, which resulted in higher unit costs for transportation and delivery services.  Shipping and handling costs totaled $837,006 and $393,344 during the three months ended September 30, 2011 and 2010, respectively.

General and Administrative Expenses.  General and administrative expenses totaled $602,248 for the three months ended September 30, 2011, as compared to $1,281,731 for the three months ended September 30, 2010, a decrease of $679,483 or 53.0%.  The decrease was mainly due to no acquisition costs being incurred during the quarter ended September 30, 2011 while we incurred approximately $635,000 of asset acquisition costs during the same quarter last year related to the purchase of Jingzhou facility, which was completed in August 2010.

9

Results of Operations – Nine Months Ended September 30, 2011 and 2010

The following table summarizes our results of operations for the nine months ended September 30, 2011 and 2010.

	Nine Months Ended September 30,
	2011					2010
	Amount		% of total revenue			Amount			% of total revenue
Revenue	$	37,086,158		100.0	%	$	31,703,531			100.0	%
Gross Profit	$	18,900,593		51.0	%	$	17,001,112			53.6	%
Operating Expenses	$	6,746,644		18.2	%	$	4,655,727			14.7	%
Income from Operations	$	12,153,949		32.8	%	$	12,345,385			38.9	%
Other Income (Expenses)	$	1,218,201		3.3	%	$	(22,296	)		(0.1	)%
Income Tax Expenses	$	2,205,267		5.9	%	$	2,200,648			6.9	%
Net Income	$	11,166,883		30.1	%	$	10,122,441			31.9	%

Revenue.   All of our revenue is derived from the sale of veterinary healthcare and medical care products in the PRC. For the nine months ended September 30, 2011, we had revenue of $37,086,158 as compared to revenue of $31,703,531 for the nine months ended September 30, 2010, an increase of $5,382,627 or 17.0%. We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  Selling prices have not changed from the same period last year for most of our past customers.

Revenue — Veterinary Medications. Revenue from sales of our veterinary medications increased by $3,090,363 or 14.6% from $21,095,705 for the nine months ended September 30, 2010 to $24,186,068 for the nine months ended September 30, 2011. The increase was primarily due to improved utilization of manufacturing capacity at our Huxian plant, a better product mix to meet customer demands, increased sales efforts, and the contribution of our Jingzhou plant to our revenue growth in the first half of 2011. The increase in veterinary medications sales contributed the majority or approximately 57.4% of revenue growth for the entire company during the nine months ended September 30, 2011. Of total revenues from veterinary medications during the nine months ended September 30, 2011, approximately 23% of total revenue resulted from the sale of Praziquantel tablets, which treats schistosomiasis.

Revenue — Micro-Organism.   Revenue from sales of our micro-organism products increased by $1,681,981 or 21.3% from $7,892,296 for the nine months ended September 30, 2010 to $9,574,277 during the nine months ended September 30, 2011.  The increase was primarily the result of improved utilization of the micro-organism production capacity at our Huxian plant, improved products, which generated increased sales, and increased sales efforts.

Revenue — Feed Additives.   Revenue from sales of our feed additives product line increased by $430,626 or 32.1% from $1,341,654 for the nine months ended September 30, 2010 to $1,772,280 for the nine months ended September 30, 2011.  The increase was the result of increased demand of our multi-enzyme feed additive products as we continued to develop new products to meet customers’ needs.

Revenue — Vaccines. Revenue from sales of our vaccines increased by $179,657 or 13.1% from $1,373,876 for the nine months ended September 30, 2010 to $1,553,533 for the nine months ended September 30, 2011. We are currently only capable of small-scale production of vaccine products and therefore cannot significantly increase sales until we expand our production capability. We completed the construction of a new vaccine facility at our Huxian plant in 2010. The facility is currently waiting for GMP certification from the Ministry of Agriculture. The Company expects the GMP certification will be completed by June 2012, and we expect to commence production shortly thereafter for large-scale production.

Cost of Sales.  Cost of revenue, which consists of raw materials, direct labor, and manufacturing overhead for our four product lines, was $18,185,565 for the nine months ended September 30, 2011, as compared to $14,702,419 for the nine months ended September 30, 2010, an increase of $3,483,146 or 23.7%, as a result of increased sales and higher raw material costs. For the nine months ended September 30, 2011, raw material costs contributed the majority or approximately 79.7% of total cost of sales, packing material costs contributed approximately 16.8% of total cost of sales, and labor costs contributed approximately 3.5% of total cost of sales. The impact to our gross margins mainly came from higher raw materials costs.

10

Cost of Sales — Veterinary Medications.   Cost of revenue for our veterinary medications increased by $2,390,506 or 20.0% from $11,970,865 for the nine months ended September 30, 2010 to $14,361,371 for the nine months ended September 30, 2011.  This increase was mainly due to the corresponding increase in sales and higher raw material costs. The increase of costs in veterinary medications sales contributed to the majority or 68.6% of the increase in cost of sales for the entire company during nine months ended September 30, 2011.

Cost of Sales — Micro-Organism.   Cost of revenue for our micro-organism products increased by $632,942 or 30.9%, from $2,050,907 for the nine months ended September 30, 2010 to $2,683,849 for the nine months ended September 30, 2011.  This increase was mainly due to the corresponding increase in sales and higher raw material costs.

Cost of Sales — Feed Additives.   Cost of revenue for our feed additives increased by $431,958 or 80.5% from $536,292 for the nine months ended September 30, 2010 to $968,250 for the nine months ended September 30, 2011.  The increase was primarily due to the corresponding increase in sales and significantly increased raw material costs.

Cost of Sales — Vaccines.   Cost of revenue for our vaccines products increased by $27,740 or 19.2% from $144,355 for the nine months ended September 30, 2010 to $172,095 for the nine months ended September 30, 2011.  This increase was mainly a result of the corresponding increase in sales.

The following table summarizes our operating expense for the nine months ended September 30, 2011 and 2010.

	Nine Months Ended September 30,
	2011					2010
	Amount		% of total revenue			Amount		% of total revenue
Operating Expenses
Research and Development Costs	$	2,180,147		5.9	%	$	444,280		1.4	%
Selling Expenses	$	2,154,158		5.8	%	$	1,312,132		4.1	%
General and Administrative Expenses	$	2,412,339		6.5	%	$	2,899,315		9.2	%
Total Operating Expenses	$	6,746,644		18.2	%	$	4,655,727		14.7	%

Research and Development Costs.  Research and development costs, which consist of salaries, professional fees, and technical support fees, totaled $2,180,147 for the nine months ended September 30, 2011, as compared to $444,280 for the nine months ended September 30, 2010, an increase of $1,735,867 or 390.7%.  The increase was due to a significant increase in R&D efforts during the nine months ended September 30, 2011. In addition to continuing to fund existing joint R&D projects with various research institutions, we launched several new in-house R&D projects to develop new veterinary medications during the nine months ended September 30, 2011.

Selling Expenses.  Selling expenses, which consist of commissions, advertising and promotion expenses, freight charges, and salaries, totaled $2,154,158 for the nine months ended September 30, 2011 as compared to $1,312,132 for the nine months ended September 30, 2010, an increase of $842,026 or 64.2%.  This increase is primarily a result of significantly increased shipping and handling costs related to delivering our products to customers. Shipping and handling costs totaled $1,381,276 and $678,224 during the nine months ended September 30, 2011 and 2010, respectively.  Increased labor costs for sales staff and higher travel costs also contributed to the increase in selling costs.

General and Administrative Expenses.  General and administrative expenses totaled $2,412,339 for the nine months ended September 30, 2011, as compared to $2,899,315 for the nine months ended September 30, 2010, a decrease of $486,976 or 16.8%.  The higher G&A expense in 2010 was mainly due to the asset acquisition costs related to the purchase of our Jingzhou facility, which was completed in August 2010.

11

Liquidity

For the nine months ended September 30, 2011, cash used in operating activities was $2,800,257 compared to $2,561,113 for the same period in 2010. The major operating activities that provided cash during the nine months ended September 30, 2011 were net income of $11,166,883, an increase in tax payable of $4,234,408, and an increase in accounts payable of $1,073,204. The major operating activities that used cash during the nine months ended September 30, 2011 were an increase in deposits and prepaid expenses of $8,746,398, a build-up in inventory that used $6,890,055, an increase in accounts receivable of $4,566,868, and a change in fair value of warrant/purchase option liability of $1,267,412.

Based on our research and feedback from the market, we believe the current inflationary pressure will continue to build in 2011, and cost of raw materials will continue to escalate.  We accumulated more inventory than in the past to ensure the supply of raw materials at lower cost levels and to protect our profit margins from being eroded by escalated inflation. As a result, the negative impact to the gross margins from the cost increases of raw materials has been relatively moderate for the nine months ended September 30, 2011.  However, if the government is unsuccessful in reining in inflation, there may be greater negative impact to our gross margins from cost increases of raw materials in the future. As of September 30, 2011, we had approximately 51 suppliers that we made advances to in order to secure our raw material needs and to obtain favorable pricing.  We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.

Cash provided by investing activities for the nine months ended September 30, 2011 was $390,644, as compared to cash used in investing activities of $8,432,535 for the nine months ended September 30, 2010. Cash provided by investing activities for the nine months ended September 30, 2011 was primarily the result of collection of loans made to third parties of $11,054,921.  Cash used in investing activities for the nine months ended September 30, 2011 was primarily the result of payment on construction-in-progress of $7,316,494and loans made to third parties of $2,885,501.

Cash provided by financing activities for the nine months ended September 30, 2011was $238,636, as compared to cash provided by financing activities of $1,323,462 for the nine months ended September 30, 2010. Cash provided by financing activities for the nine months ended September 30, 2011 was primarily the result of short-term loans of $3,277,016. Cash used in financing activities for the nine months ended September 30, 2011 was primarily the result of repayment of short-term loans of $3,043,340.

As of September 30, 2011, we had cash of $3,783,152. Our total current assets were $56,030,031, and our total current liabilities were $14,110,956, which resulted in a net working capital of $41,919,075.

Capital Resources

We borrowed $3,277,016 in short-term loans and repaid $3,043,340 during the nine months ended September 30, 2011. Considering our existing working capital position and our ability to access debt funding sources, we believe we have sufficient capital to support our ongoing operations. 

	Payments Due by Period
Contractual Obligations	Total		Less than 1 year		1 – 3 years		3 – 5 years		More than 5 years
R&D Project Obligation	$	1,286,443	$	1,286,443	$	-	$	-	$	-
Operating Lease Obligations		298,719		26,597		157,525		78,915		35,682
Government Grant Obligation		618,800		-		618,800		-		-
Total	$	2,203,962	$	1,313,040		776,325		78,915		35,682

In addition to the contractual obligations listed above, we have a future registered capital commitment related to our newly created subsidiary Skystar Kunshan, located in Kunshan, Jiangsu province, China. Skystar Kunshan has a registered capital of $15,000,000, of which we invested $2,250,000 in cash. The remaining $12,750,000 of capital must be invested prior to May 7, 2012. We also made prepayments in an effort to acquire assets in a micro-organism manufacturing facility in Kunshan. As of September 30, 2011, the asset acquisition of Kunshan facility was completed. We are in the process of getting the government’s approval to transfer the asset purchased to satisfy some of our registered capital commitment. As of the date of this report, we have not received the approval.

12

Off-Balance Sheet Arrangements

We do not have any outstanding financial guarantees or commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity, or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.

Exchange Rate

The Company’s operating subsidiaries in China maintain their books and records in Renminbi (��RMB”), the currency of China. In general, for consolidation purposes, we translate the subsidiaries’ assets and liabilities into US Dollars using the applicable exchange rates prevailing at the balance sheet date, and the statement of income is translated at average exchange rates during the reporting period. Adjustments resulting from the translation of the financial statements of the Company’s Chinese subsidiaries are recorded as accumulated other comprehensive income.

The exchange rates used to translate amounts in RMB into US Dollar for the purposes of preparing the consolidated financial statements or otherwise stated in this MD&A were as follows:

	September 30, 2010	December 31, 2010	September 30, 2011
Assets and liabilities	1 RMB = 0.14970 USD	1 RMB = 0.15170 USD	1 RMB = 0.15650 USD
Statements of operations and cash flows for the period/year ended	1 RMB = 0.14710 USD	1 RMB = 0.14794 USD	1 RMB = 0.15414 USD

Inflation

Although China's consumer inflation dipped to 6.1% in September, inflation is still close to the three year peak of 6.5% hit in July and we continue to see inflation pressures building in China. For the nine months ended September 30, 2011, we were able to secure favorable pricing by prepaying for major components to certain suppliers to lock in prices ahead of time. As a result, we did not experience as much cost pressure as evidenced in the spot market prices of the raw materials. However, we are seeing the rising costs of raw materials gradually starting to impact our margins, as evidenced by the moderate decrease in gross margins from 53.6% for the nine months ended September 30, 2010 to 51.0% for the nine months ended September 30, 2011. We anticipate the inflationary pressures will continue for the rest of 2011. We are taking actions to minimize the negative impact of cost increases that erode our profit margin and monitor the situation closely. We are continuing the practice of prepayments to suppliers. We are also taking steps to improve the production process to reduce raw material waste, optimize product mix to meet market demand and improve profitability, increase R&D efforts to develop new and profitable products, and identify new suppliers with better terms on the supply of raw materials.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer (Chief Executive Officer) and principal financial officer (Chief Financial Officer), as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

13

As of September 30, 2011, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).

Based on the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2011, our disclosure controls and procedures were ineffective due to an ongoing material weakness related to the lack of accounting and internal audit personnel with an appropriate level of knowledge, experience, and training in the application of U.S. GAAP. We have initiated a plan and are taking steps to implement the following measures to remediate this material weakness:

1. Recruit sufficient qualified accounting and internal audit personnel and continue to engage outside contractor with technical accounting expertise, as needed.

2. Reorganize the accounting and finance department to ensure that accounting personnel with adequate experience, skills and knowledge are directly involved in the review and accounting evaluation of our complex, non-routine transactions.

3. Continue to evaluate our existing staffs and make adjustments as necessary, in addition to providing additional training on accounting principles and internal control procedures for our existing staffs.

4. Improve the interaction among our management, audit committee, independent auditors and other external advisors.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Andrew Chien v. Skystar Bio-Pharmaceutical Company, et. al. (U.S. District Court, District of Connecticut, Case No. 3:2007cv00781). In or around May 2007, Andrew Chien filed suit against the Company, R. 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 Securities Exchange Act of 1934.  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.  Chien appealed the dismissal.  Defendants filed a post-judgment motion for sanctions against Chien.  On February 5, 2009, the court found the action filed by Chien to have been frivolous, and to have constituted a “substantial” violation of Rule 11, and imposed monetary sanctions on both Chien and his former attorney.  Chien appealed the award of sanctions.  All appeals, including the one referenced below concerning Chien’s second lawsuit, were subsequently consolidated.  The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing sanctions against Chien in light of the circumstances and facts on record.  This Mandate was entered on or about November 8, 2010.

14

Andrew Chien v. Skystar Bio-Pharmaceutical Company, et. al. (formerly Superior Court, State of Connecticut, Case No. NNH-CV-09-5025938-S, now U.S. District Court, District of Connecticut, Case No. 3:09-CV-00149 (MRK)). Andrew Chien, proceeding pro se (i.e., he represented himself without an attorney), filed another lawsuit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court (which was removed to U.S. District Court), alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action.  The court held that all claims asserted against the defendants were barred and failed to state a claim on a multiplicity of grounds, including on the basis of res judicata.  Defendants filed a second Motion for Sanctions under Rule 11 and the PSLRA, which was granted.  Chien appealed the dismissal.  The Court of Appeals for the Second Circuit consolidated all of Chien’s appeals from both of his lawsuits.   On November 8, 2010, the Court of Appeals affirmed the dismissals and the awards of sanctions.  On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. The Supreme Court denied review of the petition.

Andrew Chien v. Skystar Bio-Pharmaceutical Company, et. al. (formerly Superior Court, State of Connecticut, now U.S. District Court, District of Connecticut, Case No. 3:11-CV-1387 (MRK)).  Andrew Chien, again proceeding pro se, commenced another lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung, Weibing Lu, Weinberg & Company, P.A., Moore Stephens Wirth Frazer & Torbet, LLP, Frazer Frost, LLP, Crowe Horwath LLP, Richardson & Patel LLP, Kevin K. Leung, Harvey Kesner, and Jody M. Borrelli alleging the same facts and circumstances as set forth in the above two matters, although adding the aforementioned accountants and lawyers as defendants to the claims.  The matter was commenced on August 8, 2011, and shortly thereafter removed to U.S. District Court.  Thereafter, on October 5, 2011, the court dismissed the entire action as to all defendants. 

ITEM 6. EXHIBITS

Exh. No.	Description
3.1	Articles of Incorporation, as amended  (2)
3.2	Bylaws, as amended (1)
31.1	Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
31.2	Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
32.1	Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
32.2	Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *

101.INS**	XBRL Instance Document
101.SCH**	XBRL Taxonomy Extension Schema
101.CAL**	XBRL Taxonomy Extension Calculation Linkbase
101.DEF**	XBRL Taxonomy Extension Definition Linkbase
101.LAB**	XBRL Taxonomy Extension Label Linkbase
101.PRE**	XBRL Taxonomy Extension Presentation Linkbase

*  Filed herewith.

** In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q/A shall be deemed “furnished” and not “filed.”

(1)  Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 15, 2008.

(2) Incorporated by reference from Registrant’s Quarter Report on Form 10-Q filed on November 15, 2010.

15

SIGNATURES

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

	SKYSTAR BIO-PHARMACEUTICAL COMPANY
November 14, 2011	By:	/s/ Weibing Lu
		Weibing Lu
		Chief Executive Officer
		(Principal Executive Officer)

November 14, 2011	By:	/s/ Bing Mei
		Bing Mei
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

16