China Shenghuo Pharmaceutical (KUN) 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission file number001-33537

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	20-2903562
(State or Other Jurisdiction of Incorporation or Organization)	(IR.S. Employer Identification No.)
No. 2, Jing You Road,
Kunming National Economy &
Technology Developing District
People’s Republic of China 650217	N/A
(Address of Principal Executive Offices)	(Zip Code)
0086-871-728-2628
(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.

YesxNoo

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.

Large accelerated filero Accelerated filero Non-accelerated filero Smaller Reporting Companyx

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Nox

There were 19,679,400 shares outstanding of the issuer’s common stock, par value $.0001 per share, as of August 14, 2009.

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

			Page
PART I - FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS		1
	Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008 (Unaudited)		1
	Consolidated Statements of Operations and Comprehensive Income for the Three and Nine Months Ended September 30, 2009 and 2008 (Unaudited)		3
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (Unaudited)		4
	Notes to Consolidated Financial Statements (Unaudited)		5
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		19
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		38
ITEM 4T.	CONTROLS AND PROCEDURES		38
PART II - OTHER INFORMATION
ITEM 1.		LEGAL PROCEEDINGS	40
ITEM 1A.		RISK FACTORS	41
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	42
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES	42
ITEM 4.		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	42
ITEM 5.		OTHER INFORMATION	42
ITEM 6.		EXHIBITS	42
SIGNATURES

PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS

	September 30, 2009		December 31, 2008
	Unaudited		Audited
Assets:
Current Assets:
Cash and cash equivalents	$	2,723,716	$	1,612,054
Accounts and notes receivable, less allowance for doubtful accounts of $1,650,774 and $4,834,745, for 2009 and 2008, respectively		13,721,541		9,108,703
Other receivables, less allowance for doubtful accounts of $2,495,914 and $2,955,516, respectively		7,212,920		8,637,653
Advances to suppliers		271,132		446,168
Inventories, net of allowance for obsolescence of $148,335 and $147,978, respectively		3,485,225		4,287,462
Receivables from related parties		164,044		—
Other current assets		10,543		41,177
Total Current Assets		27,589,121		24,133,217
Property, plant and equipment, net of accumulated depreciation of $5,761,407 and $5,341,933, respectively		7,345,163		7,581,664
Intangible assets, net of accumulated amortization of $186,951 and $71,456, respectively		1,134,697		665,959
Deferred tax assets		401,300		—
Long-term other receivables, less allowance for doubtful accounts of nil and $664,532, respectively		—		663,433
	$	36,470,281	$	33,044,273

See notes to consolidated financial statements.

- 1 -

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUTED)

	September 30, 2009			December 31, 2008
	Unaudited			Audited
LIABILITIES AND STOCKHOLDERS’ EQUITY:
Current Liabilities:
Accounts payable	$	3,228,171		$	1,293,460
Other payables and accrued expenses		8,143,224			2,721,082
Deposits		6,379,811			5,550,502
Payables to related parties		—			148,575
Short-term notes payable		5,337,043			9,850,211
Advances from customers		1,304,861			222,609
Taxes and related payables		1,440,571			1,236,574
Current portion of long-term notes payable		3,802,504			3,245,685
Total Current Liabilities		29,636,185			24,268,698
Long-term notes payable		6,435,006			1,131,193
Total Liabilities		36,071,191			25,399,891
Equity:
Common stock, par value $0.0001; 100,000,000 shares authorized; 19,679,400 shares outstanding, both periods		1,968			1,968
Additional paid-in capital		6,193,927			6,193,927
Statutory reserves		147,023			147,023
Accumulated deficit		(7,372,543	)		(603,572	)
Accumulated other comprehensive income		1,587,438			1,656,812
Total shareholder’s equity		557,813			7,396,158
Noncontrolling interest		(158,723	)		248,224
Total equity		399,090			7,644,382
	$	36,470,281		$	33,044,273

See notes to consolidated financial statements.

- 2 -

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME/(LOSS)

	Three months ended September 30,						Nine months ended September 30,
	2009			2008			2009			2008
	Unaudited			Unaudited			Unaudited			Unaudited
Sales	$	10,558,218		$	7,281,384		$	25,459,077		$	21,359,149
Cost of Sales		2,947,511			1,973,865			7,643,566			7,061,446
Gross Margin		7,610,707			5,307,519			17,815,511			14,297,703
Operating Expenses:
Selling expenses		6,988,017			2,989,486			19,604,857			8,666,561
General and administrative expenses		1,063,981			1,819,573			5,230,722			7,001,410
Research and development expenses		10,534			66,052			24,455			255,241
		8,062,532			4,875,111			24,860,034			15,923,212
(Loss) / Income from Operations		(451,825	)		432,408			(7,044,523	)		(1,625,509	)
Other Income / (Expense):
Interest income		1,349			588			2,661			5,701
Income from research and development activities		49,723			5,745			194,902			344,370
Interest expense		(184,228	)		(272,002	)		(704,242	)		(963,198	)
Non-operating expenses		(2,847	)		(330	)		(22,038	)		(138,812	)
		(136,003	)		(265,999	)		(528,717	)		(751,939	)
(Loss) / Income Before Income Tax (Expense) Benefit and Non-controlling Interest		(587,828	)		166,409			(7,573,240	)		(2,377,448	)
Income tax benefit / (expense)		401,012			(4,471	)		401,012			(4,484	)
Net (Loss) / Income		(186,816	)		161,938			(7,172,228	)		(2,381,932	)
Net loss / (income) attributable to noncontrolling interest		154,892			(7,652	)		403,257			146,089
Net (Loss) / Income Attributable to Shareholders	$	(31,924	)	$	154,286		$	(6,768,971	)	$	(2,235,843	)
Basic and Diluted Earnings / (Loss) per Share	$	(0.00	)	$	0.01		$	(0.34	)	$	(0.11	)
Weighted-average Number of Shares Outstanding - Basic and Diluted		19,679,400			19,679,400			19,679,400			19,679,400
Comprehensive (Loss) / Income:
Net (Loss) / Income		(186,816	)		161,938			(7,172,228	)		(2,381,932	)
Foreign currency translation adjustment		(76,185	)		54,116			(73,064	)		744,189
Comprehensive (Loss) / Income	$	(263,001	)	$	216,054		$	(7,245,292	)	$	(1,637,743	)
Comprehensive (Loss) / Income attributable to noncontrolling interest	$	158,739		$	(10,385	)	$	406,947		$	108,507
Comprehensive (Loss) Income Attributable to Shareholders	$	(104,262	)	$	205,669		$	(6,838,345	)	$	(1,529,236	)

See notes to consolidated financial statements.

- 3 -

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

	Nine months ended September 30,
	2009			2008
	Unaudited			Unaudited
Cash Flows from Operating Activities:
Net loss	$	(6,768,971	)	$	(2,235,843	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		542,040			619,402
Deferred income taxes		(401,012	)		—
Non-controlling interest in loss of subsidiaries		(403,257	)		(146,089	)
Allowance for doubtful accounts		1,454,131			3,596,319
Change in current assets and liabilities:
Accounts and notes receivable		(5,749,846	)		(919,991	)
Other receivables		1,783,691			(1,465,805	)
Advances to suppliers		175,993			(60,460	)
Inventories		812,063			333,486
Other current assets		30,709			143,282
Accounts payable		1,930,185			655,989
Accrued expenses and deposits		6,191,182			(538,712	)
Advances from customers		1,080,935			119,991
Taxes and related payables		200,851			(334,217	)
Net Cash Provided by (Used in) Operating Activities		878,694			(232,648	)
Cash Flows from Investing Activities:
Capital expenditures		(738,350	)		(218,780	)
Receivables from related parties		(163,926	)		(3,957	)
Net Cash Used in Investing Activities		(902,276	)		(222,737	)
Cash Flows from Financing Activities:
Payables to related parties		(181,445	)		87,385
Proceeds from short and long-term notes payable		21,227,417			5,715,216
Payments on short and long-term notes payable		(19,915,434	)		(7,215,461	)
Net Cash Provided by (Used in) Financing Activities		1,130,538			(1,412,860	)
Effect of foreign currency exchange rate fluctuation on Cash and Cash Equivalents		4,706			148,328
Net Change in Cash and Cash Equivalents		1,111,662			(1,719,917	)
Cash and Cash Equivalents at Beginning of Period		1,612,054			2,800,641
Cash and Cash Equivalents at End of Period	$	2,723,716		$	1,080,724
Supplemental Information
Cash paid for interest	$	704,242		$	963,198
Cash paid for income taxes	$	—		$	—

See notes to consolidated financial statements.

- 4 -

NOTE 1 – BASIS OF PRESENTATION

The accompanying consolidated financial statements of China Shenghuo Pharmaceutical Holdings, Inc., (the “Company” or the “Parent” or the “Group”) were prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission without audit. Certain information and footnote disclosures normally included in financial statements prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) in the United States of America have been condensed or omitted pursuant to such rules and regulations. Management of the Company (“Management”) believes that the following disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Form 10-K for the year ended December 31, 2008, as amended. Amounts as of December 31, 2008 are derived from those audited consolidated financial statements.

These consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of Management, are necessary to present fairly the consolidated financial position and results of operations of the Company for the periods presented. Operating results for the nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2009.

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The functional currency of the operating subsidiaries in the People’s Republic of China (“PRC”) is the Chinese Yuan Renminbi (“RMB”) and the functional currency of the Parent is USD; however, the condensed consolidated financial statements have been expressed in United States Dollars (“USD”). The accompanying consolidated balance sheets have been translated into USD at the exchange rates prevailing at each balance sheet date. The consolidated statements of operations have been translated using the weighted average exchange rates prevailing during the operating periods of each statement.

NOTE 2 – ORGANIZATION AND NATURE OF OPERATIONS

Nature of Business – The Company, incorporated in Delaware, United States of America, through its subsidiaries, designs, develops, markets, sells and exports pharmaceutical, nutritional supplements and cosmetic products throughout PRC and abroad. The Company also conducts research and development for third parties as well as for itself using the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi, or Tienchi and sells pharmaceutical, nutritional supplements and cosmetic products that contain this herb, which is grown in two provinces in the PRC. Sales from the cosmetic products represent less than 10% of total Company sales and revenue. The Company does not maintain accounting records by line of business as the Company’s subsidiaries sell products from multiple lines of business and Management evaluates each subsidiary as a separate entity.

Organization – The Company owns a 94.95% equity interest in Kunming Shenghuo Pharmaceuticals Co., Ltd. (“Shenghuo”). Shenghuo owns a 99% equity interest in Kunming Shenghuo Medicine Co., Ltd. (“Medicine”), a 99% equity interest in Kunming Pharmaceutical Importation and Exportation Co., Ltd. (“Import/Export”), a 98.18% interest in Kunming Shenghuo Cosmetics Co., Ltd. (“Cosmetic”), and a 70% interest in Kunming Beisheng Science and Technology Development Co., Ltd (“Beisheng”). On April 30, 2009 the Company formed Shi Ling Shenghuo Co., Ltd. (“Shi Ling”) as a wholly owned subsidiary. Shi Ling was formed for the purpose of purchasing or leasing land suitable for cultivating the medicinal herb Panax notoginseng for use in the production of the Company’s medicinal products. All of these entities are formed in and operate within the PRC.

- 5 -

NOTE 3 – SELECTED SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation – The accompanying consolidated financial statements present the operations of the Company and its majority owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Accounting Estimates – The preparation of 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 and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Fair Value of Financial Instruments – The carrying amounts reported in the consolidated balance sheets for accounts and notes receivable, employee advances, advances to suppliers, accounts payable, accrued liabilities, and advances from customers approximate fair value because of the immediate or short-term maturity of these financial instruments. Management believes the interest rates on short-term notes payable and long-term debt reflect rates currently available in the PRC. Thus, the carrying value of these loans approximates fair value.

Cash and Cash Equivalents – The Company’s cash and cash equivalents are maintained in bank deposit accounts. The Company has not experienced any losses with respect to these deposits. Cash and cash equivalents include interest bearing and non-interest bearing bank deposits, money market accounts, and short-term certificates of deposit with original maturities of three months or less. The Company did not enter into any hedge contracts during any of the periods presented.

Accounts and Notes Receivable and Allowance for Doubtful Accounts – Trade receivables are carried at original invoiced amounts less an allowance for doubtful accounts. An allowance for doubtful accounts receivable is established by charges to operations for amounts required to maintain an adequate allowance, based on the Management’s review of credit risk of customers and aging of the ending balance, to cover anticipated losses from customer accounts and sales returns. Such accounts are charged to the allowance when collection appears doubtful. Any subsequent recoveries are credited to the allowance account. The Company believes that the allowance for doubtful accounts is adequate and consistent with industry standards in the PRC based on the products that are being sold.. Deductions from the allowance are recorded when specific accounts receivable are written off as uncollectible. For the three and nine months ended September 30, 2009, accounts receivable amounting to $4,235,109, which had aging of more than 2 years and for which full allowance had been provided, were written off since thay were deemed uncollectible after Management had implemented every possible collection procedure.

Notes receivable included with accounts receivable were $414,678 and $750,877 as of September 30, 2009 and December 31, 2008, respectively. The notes represent bank drafts that have been arranged with third-party financial institutions by certain customers to settle their purchases from us. These bank drafts are non-interest bearing and are collectible within six months. Such sales and purchasing arrangements are consistent with industry practices in the PRC.

Other Receivables – Other receivables are presented net of an estimated allowance for doubtful accounts. Other receivables include sales representative advances for market development, employee advances and sales office advances for facilities of sales activities. As time passes from when advances are made to sales representatives for travel and related expenses, the Company will provide allowance for these older receivables based on review of collectability risk from each particular sales representative and aging of the ending balance. For the three and nine months ended September 30, 2009, other receivables amounting to $1,458,698, which had aging of more than 2 years and for which full allowance had been provided for, were written off since they were deemed uncollectible after Management had implemented every possible collection procedure.

- 6 -

Inventories – Inventories consist principally of pharmaceutical products and are stated at the lower of cost or net realizable value. Cost is determined on a weighted-average cost method. When market value of the inventory products is lower than the weighted average cost, inventory is reduced to its net realizable value. The Company also holds inventory on consignment.

Property and Equipment – Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Maintenance and depreciation are charged to expense as incurred and major improvements are capitalized. Gains or losses on sales or retirements are included in the statements of operations in the period of disposition, determined by reference to their carrying amounts. The Company reviews its property and equipment periodically for changes in circumstances that would indicate its recoverable carrying value is less than its net book value. If such circumstances occur, impairment is charged to such items.

Intangible Assets – Acquisition costs of land use rights are capitalized at their acquisition cost and amortized using the straight-line method over their estimated useful lives. For those intangible assets with legal protection over a specific period, their useful life is the protected period. Assets that do not have legal protection periods are amortized over their estimated useful life. Research and development costs are expensed during the period incurred.

Impairment of Long-Lived Assets –The Company reviews its long-lived assets, including intangibles, for impairment at least annually or when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The Company evaluates, at each balance sheet date, whether events and circumstances have occurred that indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows from the related asset or group of assets over their remaining life in measuring whether the assets are recoverable.

Accrued Expenses and Other Payables – Accrued expenses and other payables primarily consist of accrued commission expense, accrued legal expense and accrued payroll expense, etc.

Deposits –Deposits consist of funds paid in advance by the sales representatives to obtain the Company’s products to sell. The Company retains these deposits during the time the sales representatives provide services to the Company. When the Company receives full payment from the customer or sales representatives terminate sales services, the deposits are returned to the sales representatives. The Company records deposits from sales representatives when payments are received.

Advances to Suppliers and Advances from Customers – The Company will often make advanced payments to suppliers for materials, or receive advance payments from customers in the normal course of business. Advances to suppliers were $271,132 and $446,168 as of September 30, 2009 and December 31, 2008, respectively. Advances to suppliers are recorded when payment is made by the Company and relieved against inventory when goods are received. The advance payments to suppliers may include provisions that set the purchase price and delivery date of raw materials. Advances from customers were $1,304,861 and $222,609 as of September 30, 2009 and December 31, 2008, respectively and are recognized in revenue when delivery has occurred.

Revenue Recognition – The products of the Company are mainly sold to wholesale companies. The Company recognizes revenue when it is realized and earned. The Company considers revenue realized or realizable and earned when (1) it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured. Delivery does not occur until products have been shipped to the wholesale companies, risk of loss has transferred to the wholesale companies and wholesale companies’ acceptance has been obtained, or the Company has objective evidence that the criteria specified in wholesale companies’ acceptance provisions have been satisfied. The sales price is not considered to be fixed or determinable until all contingencies related to the sale have been resolved.

In general, the Company does not allow wholesale companies to return products unless there are defects in manufacturing or workmanship. Sales returns need to go through a strict process and have

- 7 -

to be authorized by Management. Sales returns are netted against sales when incurred. Historically, the amounts of sales return were immaterial.

Cost of Sales – The cost of sales are the direct expenses incurred in producing the pharmaceuticals and cosmetics, which include materials, direct labor, handling charges, and a portion of overhead expenses associated with the manufacture of products.

Selling Expense– Selling expense mainly consists of sales commission, salesmen’s salaries, travelling expense, advertising and shipping and handling cost, etc. All advertising costs are changed to selling expenses when incurred or when advertising first takes place.

Research and Development – The Company charges research and development costs to operations in the period incurred. The Company recognizes revenue from research and development activities in accordance with the revenue recognition policy as stated above. Because in many cases the Company cannot be assured that the terms of specific contracts can be fulfilled, the Company recognizes revenue only after all terms of a contract are complete.

Basic and Diluted Earnings per Share – The computation of basic and diluted earnings per share is based on the weighted-average number of shares outstanding during the periods presented. Potentially dilutive securities for the three and nine months ended September 30, 2009 and 2008 include 246,000 warrants that were anti-dilutive due to losses of the Company.

Retirement Benefit Plans – The Company makes monthly contributions to various employee retirement benefit plans organized by provincial governments in the PRC in accordance with rates prescribed by them. The provincial governments undertake to assume the retirement benefit obligations of all existing and future retired employees of the Company. Contributions to these plans are charged to expense as incurred.

Comprehensive Income – Other comprehensive income presented in the consolidated financial statements consists of cumulative foreign currency translation adjustments.

Credit Risk – The carrying amounts of accounts receivable and sales representative advances included in the balance sheets represent the Company’s major exposure to credit risk in relation to its financial assets. No other financial assets carry a significant exposure to credit risk. The Company performs ongoing credit evaluations of each customer’s financial condition. It maintains an allowance for doubtful accounts. Management believes the Company’s current allowance is adequate.

The Company has its cash in bank deposits and money market funds primarily in the PRC. Historically, deposits in Chinese banks have been secure due to the state policy on protecting depositors’ interests. China promulgated a new Bankruptcy Law in August 2006, which came into effect on June 1, 2007, which, together with more specific, complementary regulations to be issued in the future, shall provide the implementation for the bankruptcy of Chinese banks. In the event that bankruptcy laws are enacted for banks in the PRC, the Company’s deposits may be at a higher risk of loss. The Company has maintained its funds in quality financial institutions to mitigate the risk.

Concentration – For the nine months ended September 30, 2009, the Company had concentrations of purchases from one vendor accounting for 29.86% of total purchases.

Business Condition and Liquidity – Although the Company had a history prior to 2008 of positive net income, working capital and retained earnings, the Company has incurred a net loss for the nine months ended September 30, 2009 of $6,768,971 and had net cash provided by operating activities of $878,694 and proceeds from financing activities of $1,130,538. In addition, the Company had an accumulated deficit of $7,372,543 as of September 30, 2009, primarily due to the losses in the nine months ended September 30, 2009 and the loss of $4.6 million for fiscal 2008. As discussed in Note 8, the Company has $9,139,547in short term loans that mature in the next twelve months.

On August 6, 2009, the Company entered into a one-year term loan facility with the Yunnan Shuang Long Branch of Agricultural Bank of China (“Agricultural Bank”) amounting to RMB 110 million (approximately $16 million) based on the Agricultural Bank’s assessment of the Company’s operations and unencumbered assets. As of September 30, 2009, the Company has drawn RMB 50 million (approximately $7 million) under the term loan. Additionally, and the remaining unused loan facility was RMB 60 million (approximately $9 million). In addition, in July, 2009, the Company signed a factoring agreement with Heping Branch of China Construction Bank (the “Heping Bank”). Heping Bank has agreed to act as an

- 8 -

additional source of capital for the Company based on the Company’s accounts receivable balance from time to time. Under this factoring agreement the Company has drawn bank loans amounting to approximately RMB 9 million.

The Company has expended significant efforts to expand its revenues by assisting its sales representatives and increasing its marketing efforts during the nine months ended September 30, 2009 and during fiscal 2008. The net loss for the nine months ended September 30, 2009 was caused primarily by increased selling expenses, legal, auditing, sales representative assistance and marketing expenses. The increase in the selling expense in 2009 was mainly due to the fact that beginning in March 2009, in order to develop a better channel for selling our products and to increase our revenue in the fierce industry competition, we began to build relationships with high quality agents and terminated our relationships with agents with poor historical performance. Moreover, we believe it is in our -long-term best interest to grow our operations through the over-the-counter (“OTC”) market, which will produce higher profit margins. Accordingly, we began developing the OTC market in 2009.We believes that after expending funds to develop new agents in 2009, we will be able to decrease selling and sales representative assistance expenses in the near future as the daily operations between new agents and the Company becomes more efficient. In addition, the Company may be forced to give significant attention to the class action lawsuits discussed in Note 11.

Since all of the Company’s operations are conducted in the PRC, the Company is subject to special considerations and significant risks not typically associated with companies operating in the United States of America. These risks include, among others, the political, economic and legal environments and foreign currency exchange rate fluctuations. The Company’s operational results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to medical reforms and other laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. In addition, all of the Company’s revenue is denominated in the PRC’s currency RMB, which must be converted into other currencies before remittance out of the PRC. Both the conversion of RMB into foreign currencies and the remittance of foreign currencies abroad require approval of the PRC government.

Due to changes in current worldwide economic conditions, the Company’s ability to raise capital or borrow funds may be limited and may also adversely affect the Company’s operations.

Recently Enacted Accounting Standards – In June 2009, the FASB issued Accounting Standards Update No. 2009-01, “Generally Accepted Accounting Principles” (ASC Topic 105) which establishes the FASB Accounting Standards Codification (“the Codification” or “ASC”) as the official single source of authoritative U.S. GAAP. All existing accounting standards are superseded. All other accounting guidance not included in the Codification will be considered non-authoritative. The Codification also includes all relevant Securities and Exchange Commission (“SEC”) guidance organized using the same topical structure in separate sections within the Codification.

Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASU”) which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification.

The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented. The Codification is effective for our third-quarter 2009 financial statements and the principal impact on our financial statements is limited to disclosures as all future references to authoritative accounting literature will be referenced in accordance with the Codification. In order to ease the transition to the Codification, we are providing the Codification cross-reference alongside the references to the standards issued and adopted prior to the adoption of the Codification.

Fair Value Accounting

In 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (ASC Topic 820) which defines fair value, establishes a market-based framework or hierarchy for measuring fair value and expands disclosures about fair value measurements. This guidance is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. It does not expand or require any new fair value measures; however the application of this statement may change current practice. We adopted this guidance for financial assets and liabilities effective January 1, 2008 and for non financial assets and liabilities effective January 1, 2009. The adoption did not have a material effect on our financial condition or results of operations.

- 9 -

• In April 2009, the FASB issued FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASC Topic 320-10-65). This update requires fair value disclosures for financial instruments that are not currently reflected on the balance sheet at fair value on a quarterly basis. We adopted these updates effective June 30, 2009 and the adoption did not have a material effect on our financial condition or results of operations.

Business Combinations and Noncontrolling Interests

In 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (ASC Topic 805). This guidance requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose the information necessary to evaluate and understand the nature and financial effect of the business combination. We adopted this guidance effective January 1, 2009 and will apply it to all business combinations prospectively from that date. The impact of ASC 805 on our consolidated financial statements will depend upon the nature, terms and size of the acquisitions we consummate in the future.

In April 2009, the FASB issued Staff Position No. 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (ASC Topic 805-20). This updated guidance amended the accounting treatment for assets and liabilities arising from contingencies in a business combination and requires that pre-acquisition contingencies be recognized at fair value, if fair value can be reasonably determined. If fair value cannot be reasonably determined, measurement should be based on the best estimate in accordance with SFAS No. 5, “Accounting for Contingencies” (ASC Topic 405). This updated guidance was effective January 1, 2009 and the adoption did not have a material effect on our financial condition or results of operations.

- 10 -

In 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51”, (ASC Topic 810-10-65). This guidance requires companies to present noncontrolling (minority) interests as equity (as opposed to a liability) and provided guidance on the accounting for transactions between an entity and noncontrolling interests. In addition, it requires companies to report a consolidated net income (loss) measure that includes the amount attributable to such noncontrolling interests. We adopted this guidance effective January 1, 2009, and have applied it to noncontrolling interests prospectively from that date. The presentation and disclosure requirements we applied retrospectively for all periods presented. As a result of this adoption, we reclassified noncontrolling interests in the amount of $248,224 from Minority Interest in Net Assets of Subsidiaries to Equity in the December 31, 2008 balance sheet.

Other Accounting Changes

In June 2009, the FASB issued the following standards:

• SFAS No. 167, “Amendments to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities” (ASC Topic 810-10). This updated guidance requires an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. It also requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. This update is effective for our fiscal year beginning January 1, 2010 and we are currently evaluating the impact of adopting this update on our consolidated financial statements.

• SFAS No. 166, “Accounting for Transfers of Financial Assets”, (ASC Topic 810). This updated guidance removed the concept of a qualifying special-purpose entity and removed the exception from applying consolidation guidance to these entities. This update also clarified the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. ASC Topic 810 is effective for our fiscal year beginning on January 1, 2010. We are currently evaluating the impact of adopting this update on our consolidated financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (ASC Topic 855). This guidance is intended to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. It requires disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting this date, that is, whether this date represents the date the financial statements were issued or were available to be issued. This guidance was effective for our second quarter ended June 30, 2009.

- 11 -

NOTE 4 – INVENTORIES

Inventories consisted of the following:

	September 30, 2009		December 31, 2008
Raw materials	$	1,428,959	$	1,061,465
Work-in-process		1,660,370		2,003,825
Finished goods		544,231		1,370,150
Total Inventories		3,633,560		4,435,440
Less: Provision for obsolescence		148,335		147,978
Net Inventories	$	3,485,225	$	4,287,462

NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET

Property and equipment consisted of the following:

	September 30, 2009		December 31, 2008
Buildings	$	5,798,558	$	6,130,852
Machinery		5,766,820		5,724,217
Other equipment		276,149		477,315
Vehicles		540,968		445,166
		12,382,495		12,777,550
Less accumulated depreciation		5,761,407		5,341,933
		6,621,088		7,435,617
Construction in progress		724,075		146,047
	$	7,345,163	$	7,581,664

- 12 -

Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, which are as follows:

Asset	Life (years)
Buildings	30 - 50
Machinery	3 - 20
Other equipment	3 - 10
Vehicles	3 - 10

Depreciation and amortization expense was $542,040 and $619,402 for the nine months ended September 30, 2009 and 2008, respectively.

NOTE 6 – INTANGIBLE ASSETS

At September 30, 2009 the Company’s intangible assets mainly consist of land use rights and are amortized using the straight-line method over the remainder of their 50-year life.

	September 30, 2009		December 31, 2008
Land use right used for CIP	$	739,205	$	737,415
land use right used for property		582,443		—
		1,321,648		737,415
Less accumulated amortization		186,951		71,456
	$	1,134,697	$	665,959

NOTE 7 – RELATED PARTY TRANSACTIONS

Receivables from related parties as of September 30 2009 mainly consist of receivables from Kun Ming Dianjiao Nutritional Supplements Co., Ltd, which is under common control with the Company and accounts due from officers for daily purchases, amounting to $126,953 and $37,091, respectively. These amounts are due on demand and do not accrue interest.

During 2007, the Company entered into a loan agreement with a bank which is secured by shares of the Company owned by the Company’s principal shareholder. See Note 8.

- 13 -

NOTE 8 – NOTES PAYABLE

The Company’s notes payable consist of short-term debt that is payable to banks, governmental financial bureaus, municipalities and a company. The following schedule summarizes the Company’s debt obligations and respective balances at September 30, 2009 and December 31, 2008:

	September 30, 2009		December 31, 2008
Short-term note payable to a municipality, interest at 1.8%, due on demand, unsecured	$	73,124	$	72,948
Short-term note payable to a finance bureau, interest at 4.5%, due on demand, unsecured		75,365		75,182
Short-term note payable to a bank, interest at 5.31%, matures April 2010, secured by property (note a)		3,656,254		—
Short-term note payable to a bank, interest at 7.47%, matured April 2009, secured by property (note a)		—		3,647,399
Short-term note payable to a bank secured by insurance company, interest at approximately 5.31%, matures within four months		1,321,329		—
Short-term note payable to a government development zone interest at 2.43%, due on demand, secured by property		—		218,844
Short-term note payable to a bank, interest at 7.72%, matures August 2009, secured by shareholder		—		5,835,838
Discount bills with recourse, matures within six months		210,971		—
Total short-term notes payable	$	5,337,043	$	9,850,211

- 14 -

	September 30, 2009		December 31, 2008
Long-term note payable to a bank, interest at 5.4%, matures March 2010, secured by property, equipment and land use right		1,462,501		1,458,959
Long-term note payable to a bank, interest at 5.84%, matures before March 2010, secured by property and land use right		1,462,501		2,917,919
Long-term note payable to a bank, interest at 5.4%, matures before June 2010, secured by the Company’s shares in Shenghuo (note b)		877,502		—
Long-term note payable to a bank, interest at 5.4%, matures before August 2011, secured by the Company’s shares in Shenghuo (note b)		6,435,006		—
Total long-term notes payable		10,237,510		4,376,878
Less current maturities of long- term notes payable		3,802,504		3,245,685
Long-term notes payable, net of current portion	$	6,435,006	$	1,131,193
Past due notes payable (note c)	$	292,500	$	294,026

(a) In April 2009, a note payable with an interest rate of 7.47% and a balance of $3,647,399 as of December 31, 2008 was refinanced. The new note payable is due in one year and has an interest rate of 5.31%.

(b) On August 24, 2009, the Company drew down $7,312,508(approximately 50 million RMB) from the bank facility with Shuang Long Branch of Agricultural Bank of China executed on August 6 2009, This proportion of the loan has a term of two years, with repayment of $438,751 before December 2009, repayment of $438,751 before June 2010, repayment of $585,001 before December 2010, repayment of $731,251 before April 2011 and repayment of the remainder before August 2011. This drawdown of the loan bears interest at a rate of 5.40% which is due quarterly. The loan was for working capital and is secured by the Company’s 94.95% shares in Shenghuo.

(c) Of the aggregate amount $1,462,501 borrowed from Agricultural Bank of China, $292,500 matured in May 2009, which was past due as of September 30. 2009, However, based on the Company’s good historical credit record, the Company reached an oral agreement with the lender to extend the maturity date for this portion of the loan to March 2010. Therefore the Company did not repay the amount of the loan originally due in May 2009.

(d) All long term notes payable mature during the years ended September 30, 2011 and December 31, 2010, respectively.

- 15 -

NOTE 9 – STOCKHOLDERS’ EQUITY

Statutory Reserves- According to the Articles of Association, the Company is required to transfer a certain portion of its net profits to Statutory Reserves, as determined under PRC accounting regulations, from net income to both the surplus reserve fund. Accordingly, the Company has recorded an aggregate of $147,023 in the Statutory Reserves account in the equity section of the accompanying balance sheet as of September 30, 2009 and December 31, 2008.

Warrants- The following summarizes the outstanding warrants as of September 30, 2009:

Exercisable Date	Exercise Price		Warrants Outstanding		Weighted-Average Remaining Contractual Life (Years)	Number Exercisable
June 2007	$	3.5		6,000	3		6,000
June 2007	$	4.2		40,000	2.8		40,000
June 2007	$	3.5		200,000	1.5		200,000
				246,000			246,000

Exercise prices are significantly higher than the Company’s current stock price which is approximately $1. Management believes that it is unlikely that these warrants will be exercised.

NOTE 10 – INCOME AND OTHER TAXES

The Company accounts for its income taxes in accordance with SFAS No. 109, which requires recognition of deferred tax assets and liabilities and their respective tax bases and any tax credit carry forwards available. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has established a valuation allowance for all deferred income tax assets due to the uncertainty of their realization. Income taxes payable are included in taxes and related payables on the accompanying balance sheets. Income taxes are not required to be paid to the PRC until after the end of the Company’s fiscal year.

The principle of group consolidation for tax purposes does not exist in China. Each legal entity files its own individual tax return in the PRC. This means that the Company pays tax on all profits realized by each subsidiary, and that losses can only be carried forward and utilized in the same legal entity.

The Company is not subject to any income taxes in the United States, but was subject to corporate income tax in the PRC at a combined rate of 25% for 2008. However, because Shenghuo is located in a special region, it has a 15% corporate income tax rate and has been granted a “tax holiday” of two years tax-exemption beginning from the year of 2007 and followed by 50% reduction on the applicable income tax rate for three years.

On March 16, 2007, the National People’s Congress of China passed the new Enterprise Income Tax Law, (“EIT Law”), and on December 6, 2007, the State Council of China issued the Implementation Regulations for the EIT Law which took effect on January 1, 2008. The EIT Law and Implementation Regulations Rules impose a unified EIT of 25% on all domestic-invested enterprises and Foreign Invested Entities, or FIEs, unless they qualify under certain limited exceptions.

As a result of the above change in the income tax laws, the phase-in income tax rate for Shenghuo is 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011, 25% for 2012 and after, and it will continue to enjoy the tax holiday mentioned above.

- 16 -

Medicine, Import/Export, Cosmetics, Beisheng and Shilin are taxed at the new 25% rate effective January 1, 2008 for the year of 2009.

The Company recognizes deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases and any tax credit carry forwards available. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has established a valuation allowance for all deferred income tax assets due to the uncertainty of their realization. Income taxes payable are included in taxes and related payables on the accompanying balance sheets. Income taxes are not required to be paid to the PRC until after the end of the Company’s fiscal year.

As of September 30, 2009, a deferred tax asset amount to $0.4 million was recognized by the Company, mainly due to a temporary difference in accrued expenes amounting to approximately $4 million, which Management believes will be deductible in future years.

Three of the Company’s subsidiaries in PRC, including Medicine, Import/Export and Cosmetic, have an aggregate of approximate $4.6 million of tax loss carry forwards available. These tax loss carry forwards, if unused by the offset of future income of the individual subsidiary, begin to expire in 2011. The table below summarizes the expiration dates of the tax loss carry forwards.

Tax loss carry forwards in million	Expiration Year
$   0.7	2011
0.5	2012
0.3	2013
1.8	2014
1.3	2015
$   4.6

Management believes that it is unlikely that the Company will be able to deduct these amounts in future years, therefore no deferred tax assets were recognized with respect to the tax loss of these subsidiaries.

The Company had no undistributed earnings of the Company’s foreign subsidiaries since acquisition at June 30, 2009. The investment in subsidiaries of approximately $8.73 million is considered to be indefinitely reinvested and, accordingly, no U.S. federal and state income taxes have been provided thereon. The Company has U.S. net operating loss carry forwards of approximately $2.86 million that, if unused begin to expire in 2026. Determination of the amount of unrecognized deferred U.S. income tax liability is not practical because of the complexities associated with its hypothetical calculation; however, unrecognized foreign tax credits may be available to reduce a portion of the U.S. tax liability.

The Company is also subject to Value Added Tax (“VAT”) and other miscellaneous taxes including city construction tax, turnover tax and consumption tax. All enterprises that sell commodities, engage in repair and maintenance or import and export business in the PRC are subject to VAT tax. The standard rate for VAT tax is 17%. Once declared, VAT taxes are due on a monthly basis.

NOTE 11 – COMMITMENTS AND CONTINGENCIES

Operating Lease Commitment– Future minimum lease payments under non-cancellable operating leases as of September 30, 2009 are as follows:

	September 30, 2009
Within 1 year	$	263,250
Within 2 years		308,880
Within 3 years		429,975
Within 4 years		623,026
Within 5 years and thereafter		14,040,014
	$	15,665,145

Capital Commitment–Capital commitments under a construction contract entered into to construct a new building as of September 30, 2009 were $6,213,810, which will be settled within one year.

Class Action Lawsuits–In 2008, putative class action lawsuits were asserted against the Company and certain other parties in the United States District Court for the Southern District of New York (the “Court”) by several public shareholders. On February 12, 2009, an amended complaint was served on the Company by new lead counsel for the class, consolidating the

- 17 -

putative class actions and bearing the caption Beni Varghese, Individually and on Behalf of All Other Similarly Situated v. China Shenghuo Pharmaceutical Holdings, Inc., et al., Index No. 1:08 CIV. 7422. The defendants include the Company, the Company’s controlling shareholders, Lan’s International Medicine Investment Co., Limited, the Company’s chief executive officer, Gui Hua Lan, the Company’s former chief financial officer, Qiong Hua Gao, and the Company’s former independent registered public accounting firm, Hansen, Barnett & Maxwell, P.C. During the second quarter of 2009, the Company and the accounting firm filed motions to dismiss the complaint and the plaintiffs filed a memorandum in opposition to those motions. On August 31, 2009, the Company filed a reply brief in further support of its motion, and no further information regarding the progress of the lawsuit is available as of at the latest practical date of the report.

The amended consolidated complaint alleges that the Company failed to take adequate steps to ensure its financial reporting comported with U.S. Generally Accepted Accounting Principles (“GAAP”) and, as a result, the Company was required to restate what are alleged to be materially false and misleading financials for accounting periods during the alleged class period from August 2007 through August 20, 2008. The amended consolidated complaint further alleges, among other things, that certain of the Company’s SEC filings and other public statements contained false and misleading statements that resulted in damages to the plaintiffs and the members of the purported class when they purchased the Company’s securities. On the basis of those allegations, plaintiffs in each of the actions seek an unspecified amount of damages under Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated thereunder.

The Company believes the allegations in the amended consolidated complaint are without merit, and intends to vigorously defend the class action lawsuits. The Company does not believe the outcome of this suit will have a material adverse effect on the Company. However, the Company is unable at this time to predict the outcome of this litigation or whether the Company will incur any liability associated with the litigation, or to estimate the effect such outcome would have on the financial condition, results of operations, or cash flows of the Company based on the opinion of the counsel.

Other litigation has arisen in the normal course of the Company’s business, none of which is deemed to be material.

Dependence on a single raw material – The primary ingredient in all of the Company’s products is Sanchi, an herb grown in two provinces of the PRC. The Company relies on its in-house purchasing department to acquire sufficient Sanchi at reasonable prices and may on occasion make advance payments to suppliers that include provisions for setting the purchase price and delivery date. However, the Company is not reliant on a single source or supplier for Sanchi. With the development of its new investment in Shilin, the Company can reduce its reliance on suppliers and self-provide Sanchi with lower cost.

NOTE 12 – SUBSEQUENT EVENTS

As of November 16 2009, no significant subsequent events have occurred.

- 18 -

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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

The information contained in this quarterly report, including in the documents incorporated by reference into this quarterly report, includes some statements that are not purely historical and that are “forward-looking statements.” Such forward-looking statements include, but are not limited to, statements regarding our company’s and our management’s expectations, hopes, beliefs, intentions or strategies regarding the future, including our financial condition, and results of operations. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,” “should,” “will,” “would” and similar expressions, or the negatives of such terms, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.

The forward-looking statements contained in this quarterly report are based on current expectations and beliefs concerning future developments and the potential effects on the Company. There can be no assurance that future developments actually affecting us will be those anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements, including the following:

• our reliance on one product for over 93% of our revenues;

• our reliance on limited suppliers for Sanchi, a scarce plant that is the primary ingredient in almost all of our products;

• replacement of our primary product by other medicines or the removal of our primary product from China’s Insurance Catalogue;

• our ability to raise additional capital needed for working capital, future operations and research and development;

• our ability to collect on advances to sales representatives;

• our reliance on our three largest customers for a significant percentage of our sales;

• our ability to effectively grow management;

• our dependence on key personnel;

• our ability to establish and maintain a strong brand;

• the ability of our products to effectively compete with those of our competitors;

• continued receipt and maintenance of regulatory approvals, certificates, permits and licenses required to conduct business in China;

• our ability to collect on trade receivables;

• our ability to develop and market new products, including those with high profit margins;

• subjection of additional products to price controls by the Chinese government;

• our ability to obtain all necessary government certifications and/or licenses to conduct our business;

• protection of our intellectual property rights;

• loss of certain tax concessions;

- 19 -

• our lack of insurance to cover losses due to fire, casualty or theft;

• changes in the laws of the PRC that affect our operations;

• changes in the foreign currency exchange rate between U.S. dollars and RMB;

• cost of complying with current and future governmental regulations and the impact of any changes in the regulations on our operations;

• the effect on our operations of costs associated with the Restatement, including litigation costs;

• a downturn in the economy of the PRC or inflation in the PRC;

• our ability to establish and maintain adequate management, legal and financial controls, including effective internal controls over financial reporting;

• volatility of the market for our common stock;

• the possibility of substantial sales of our common stock;

• influence of our principal stockholder;

• cooperation of the minority shareholder of our principal operating subsidiary;

• The pledge of the stock of our operating subsidiaries to secure the bank loan entered into in August 2009; and

• other factors listed from time to time in our filings with the Securities and Exchange Commission, including without limitation, our Annual Report on Form 10-K for the year ended December 31, 2008 and subsequent reports on Form 8-K.

The risks included above are not exhaustive. Other sections of this quarterly report may include additional factors that could adversely impact our business and operating results. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and we cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward looking statements.

You should not rely upon forward-looking statements as predictions of future events. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assume responsibility for the accuracy and completeness of the forward-looking statements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.

You should read this quarterly report, and the documents that we reference in this quarterly report and have filed as exhibits to this quarterly report with the Securities and Exchange Commission, completely and with the understanding that our actual future results, levels of activity, performance and achievements may materially differ from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

- 20 -

Overview

We are primarily engaged in the research, development, manufacture, and marketing of pharmaceutical, nutritional supplement and cosmetic products. Almost all of our products are derived from the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi or Tienchi. Panax notoginseng is the root of a greyish-brown or greyish-yellow plant that only grows in a few geographic locations, including Yunnan Province in southwest China where we are located. Yunnan Province accounts for 90% of the global production of Panax notoginseng. The main root of Panax notoginseng is cylindrically shaped and is most commonly one-to-six centimeters long and one-to-four centimeters in diameter. Panax notoginseng saponins (PNS), the active ingredients in Panax notoginseng, are extracted from the plant using high-tech equipment and in accord with Good Manufacturing Practice (GMP) standards. Our main product, Xuesaitong Soft Capsules, accounted for more than 93% of our sales for the nine months ended September 30, 2009.

We earn revenues mainly from the production and sale of our products and external processing. We hope to increase profits as a result of making new products and increasing sales, since the sale of products is our main source for generating cash. Our business involves a significant degree of risk as a result of the opportunities and challenges we face in selling our products. We have traditionally focused on research and development of products serving cardiovascular and cerebrovascular disease, peptic ulcer disease and health products markets, but we intend to devote additional resources to research and development and to continue to evaluate and develop additional product candidates to expand our pipeline where we perceive an unmet need and commercial potential, as well as to improve existing products to enhance their efficacy.

With intense price competition among many similar or identical products in the industry, we believe that building brand equity is the primary means to generate and sustain profitable growth in the future. Our brand strategy is centered on “Lixuwang” – the brand under which most of our products are sold. We believe that our relationships within the Chinese pharmaceutical industry are key to building brand equity, and we believe we can benefit from developing and maintaining relationships with professionals within the industry, especially physicians and hospitals.

Xuesaitong Soft Capsules, which have been listed in the National Insurance Catalogue and are subject to wholesale and retail price controls by the Chinese government, are primarily sold in China, but the product is also sold in various developing countries, including Malaysia, Indonesia and Kyrgyzstan. Sales of the product in China are regulated by the State Food and Drug Administration (“SFDA”) as a prescription drug and therefore must be sold to consumers through hospital pharmacies and cannot be advertised, thus limiting the ability of the Company to market the brand. We sell Xuesaitong Soft Capsules to wholesale companies who resell them to hospital pharmacies. Our three main customers are Yunnan Medicine Co., Ltd, Guangzhou Medicine Co., Ltd and Beijing Ai Xin Wei Ye Medicine Co., Ltd. The three wholesale companies’ sales account for 6.83%, 6.82% and 5.39% of our sales respectively for the nine months ended September 30, 2009.

As of September 30, 2009, our medicine marketing team maintains sales offices or agents in approximately 31 provinces throughout China. The sales network covers approximately 210 cities and is staffed by approximately 600 sales representatives. We intend to grow our internal marketing and sales function and increase our relationships with other national wholesale companies to expand the distribution and presence of our non-prescription brands and cosmetics.

We hope to further expand sales beyond China into other countries where our products could be affordable treatment options. We intend to focus on the expansion of our cosmetics product line and devote additional marketing and sales resources to that end with the aim that our cosmetics products will account for a larger percentage of our revenue in the future.

Our business is capital intensive, and these research and development, marketing, sales network expansion and cosmetic product expansion initiatives will require us to expend significant cash resources, which could adversely affect our profitability and liquidity. We do face certain challenges and risks, including our relatively high debt ratio, which is one of our main risks. We also regularly incur significant expenses in our efforts to maintain the continued listing status of the Company on an exchange. We have encountered a shortage of working capital and are exploring possible ways to address our short and long term cash needs.

We believe that among the most important economic or industry-wide factors relevant to our growth in the short term are the reform of the medical system in China and the adjustment of medicine prices, which will affect the sale of our main product, Xuesaitong Soft Capsules, in hospitals. In order to increase long-term growth, we previously applied for the designation of Xuesaitong Soft Capsules as a medicine with “good quality worthy of high price,” which designation we received in February 2007. Currently, the Chinese government supports the medical system in urban and rural communities, which we believe will lead to a sustained increase in the sales of prescription medicines in the future.

- 21 -

According to data from the Southern Medicine Economy Research Institute, the pharmaceutical industry in China grew about 27% on a year-over-year basis in 2008. This growth was driven by a number of favorable factors including improving standards of living from an increase in disposable income, an aging population, the improving access and higher participation in the State Basic Medical Insurance System, and the increase in government spending on public health care.

On January 21, 2009, the Chinese government announced a healthcare reform plan pursuant to which the government would spend upward of RMB 850 billion over the next three years to make medical services and products more affordable and accessible to the entire population. We believe the successful implementation of the policies outlined in the plan will have a significant impact on the domestic pharmaceutical sector. There are five key tasks the healthcare reforms are aiming to address: 1) expanding medical insurance coverage and increasing participation rates, 2) initiating a national basic drug system, 3) establishing an extensive public health system, 4) increasing the efficiency and improving the quality of basic medical services, especially in the rural areas, and 5) reforming state-owned hospitals.

Traditional Chinese Medicine (“TCM”), including prescription and over-the-counter pharmaceuticals, has been widely used in China for many years and is an important part of the overall Chinese culture. The recently announced healthcare reform plan contains measures and policies that we believe will help support and promote the growth and development of the domestic TCM market. TCM drug manufacturers are likely to benefit from this reform as we believe the government will add more TCM-related drugs to the national medicine catalogue. In addition, we expect the government will focus on disease prevention as it rolls out the nationwide medical insurance coverage. The TCM market is a vibrant and growing industry despite the challenging economic environment and it will remain a part of mainstream medicine in China.

We hope to stabilize the sales channel into hospitals and widen the reach of sales in urban and rural communities at the same time. Large increases in medicine sales at an average lower price will ensure the growth of general medicinal sales over the next few years. Also, we are focusing our efforts on developing better channels for selling our products to expand our revenue and to counter in fierce market competition,. To that extend, we began to build relationships with new high-quality sales agents and terminate our relationships with sales agent with poor historical performances during 2009. We believe that this shift will provide a sound foundation for our operation going forward.

Our 12 Ways^TM Chinese Traditional Medicine Beauty Salon Series (“12 Ways”) cosmetic products are sold in a number of cities and provinces outside our local region. We have opened a number of retail specialty counters to offer our cosmetic products at pharmacies throughout Eastern China, eventually expanding our retail presence across China. As of September 30, 2009, we have opened approximately 618 retail specialty counters in more than 30 cities throughout China. In addition, we opened a 12 Ways Chinese Herbal Beauty Salon in Kunming that will feature approximately ten traditional Chinese medicine practitioners and beauticians that provide a variety of services, including acupuncture, body massage, foot massage and other services. All products used in the salon will be supplied by us. Management hopes that the opening of this salon and the opening of retail counters will allow us to increase our brand recognition and strengthen marketing. Our ability to effectively open and operate new retail locations depends on several factors, including, among others, our ability to identify suitable counter locations, the availability of which is outside our control; our ability to prepare counters for opening within budget; our ability to hire, train and retain personnel; our ability to secure required governmental permits and approvals; our ability to contain payroll costs; and our ability to generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund short term cash needs and our expansion plans.

There is potential for growth in production and sales due to the growth of new products and expansion of new channels into urban and rural communities. However, it will be uncertain which of our new products will pass the applicable tests and receive clinical approval without difficulty because of the uncertainty of test results and clinical approvals. Over the last three years, the price of the main raw material we use - Sanchi - has risen. We expect this trend to continue and will likely increase our cost of product sold. In addition, our expected increased expenses for research and development, marketing and sales may have a short-term adverse affect on future profit levels and available cash resources.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America, or U.S. GAAP. We believe the following are the critical accounting policies that impact the financial statements, some of which are based on Management’s best estimates available at the time of preparation. Actual experience may differ from these estimates.

- 22 -

Basis of Preparation– The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The functional currency of the operating subsidiaries in the People’s Republic of China (“PRC”) is the Chinese Yuan Renminbi (“RMB”) and the functional currency of the Parent is USD; however, the condensed consolidated financial statements have been expressed in United States Dollars (“USD”). The accompanying consolidated balance sheets have been translated into USD at the exchange rates prevailing at each balance sheet date. The consolidated statements of operations have been translated using the weighted average exchange rates prevailing during the operating periods of each statement.

Principles of Consolidation– The accompanying consolidated financial statements present the operations of the Company and its majority owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Accounting Estimates – The preparation of 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 and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Fair Value of Financial Instruments– The carrying amounts reported in the consolidated balance sheets for accounts and notes receivable, employee advances, advances to suppliers, accounts payable, accrued liabilities, and advances from customers approximate fair value because of the immediate or short-term maturity of these financial instruments. Management believes the interest rates on short-term notes payable and long-term debt reflect rates currently available in the PRC. Thus, the carrying value of these loans approximates fair value.

Cash and Cash Equivalents– The Company’s cash and cash equivalents are maintained in bank deposit accounts. The Company has not experienced any losses with respect to these deposits. Cash and cash equivalents include interest bearing and non-interest bearing bank deposits, money market accounts, and short-term certificates of deposit with original maturities of three months or less. The Company did not enter into any hedge contracts during any of the periods presented.

Accounts and Notes Receivable and Allowance for Doubtful Accounts– Trade receivables are carried at original invoiced amounts less an allowance for doubtful accounts. An allowance for doubtful accounts receivable is established by charges to operations for amounts required to maintain an adequate allowance, based on the Management’s review of credit risk of customers and aging of the ending balance, to cover anticipated losses from customer accounts and sales returns. Such accounts are charged to the allowance when collection appears doubtful. Any subsequent recoveries are credited to the allowance account. The Company believes that the allowance for doubtful accounts is adequate and consistent with industry standards in the PRC based on the products that are being sold. Deductions from the allowance are recorded when specific accounts receivable are written off as uncollectible. For the three and nine months ended September 30, 2009, accounts receivable amounting to $4,235,109, which had aging of more than 2 years and for which full allowance had been provided, were written off since they were deemed uncollectable after Management had implemented every possible collection procedure.

Notes receivable included with accounts receivable were $414,678 and $750,877 as of September 30, 2009 and December 31, 2008, respectively. The notes represent bank drafts that have been arranged with third-party financial institutions by certain customers to settle their purchases from us. These bank drafts are non-interest bearing and are collectible within six months. Such sales and purchasing arrangements are consistent with industry practices in the PRC.

Other Receivables – Other receivables are presented net of an estimated allowance for doubtful accounts. Other receivables include sales representative advances for market development, employee advances and sales office advances for facilities of sales activities. As time passes from when advances are made to sales representatives for travel and related expenses, the Company will provide allowance for these older receivables based on review of collectability risk from each particular sales representative and aging of the ending balance. For the three and nine months ended September 30, 2009, other receivables amounting to $1,458,698, which had aging of more than 2 years and for which full allowance had been provided, were written off since they were deemed uncollectible after Management had implemented every possible collection procedure.

- 23 -

Inventories – Inventories consist principally of pharmaceutical products and are stated at the lower of cost or net realizable value. Cost is determined on a weighted-average cost method. When market value of the inventory products is lower than the weighted average cost, inventory is reduced to its net realizable value. The Company also holds inventory on consignment.

Property and Equipment– Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Maintenance and depreciation are charged to expense as incurred and major improvements are capitalized. Gains or losses on sales or retirements are included in the statements of operations in the period of disposition, determined by reference to their carrying amounts. The Company reviews its property and equipment periodically for changes in circumstances that would indicate its recoverable carrying value is less than its net book value. If such circumstances occur, impairment is charged to such items.

Intangible Assets – Acquisition costs of land use rights are capitalized at their acquisition cost and amortized using the straight-line method over their estimated useful lives. For those intangible assets with legal protection over a specific period, their useful life is the protected period. Assets that do not have legal protection periods are amortized over their estimated useful life. Research and development costs are expensed during the period incurred.

Impairment of Long-Lived Assets–The Company reviews its long-lived assets, including intangibles, for impairment at least annually or when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The Company evaluates, at each balance sheet date, whether events and circumstances have occurred that indicate possible impairment. The Company uses an estimate of future undiscounted net cash flows from the related asset or group of assets over their remaining life in measuring whether the assets are recoverable.

Accrued Expenses and Other Payables– Accrued expenses and other payables primarily consist of accrued commission expense, accrued legal expense and accrued payroll expense, etc.

Deposits –Deposits consist of funds paid in advance by the sales representatives to obtain the Company’s products to sell. The Company retains these deposits during the time the sales representatives provide services to the Company. When the Company receives full payment from the customer or sales representatives terminate sales services, the deposits are returned to the sales representatives. The Company records deposits from sales representatives when payments are received.

Advances to Suppliers and Advances from Customers– The Company will often make advanced payments to suppliers for materials, or receive advance payments from customers in the normal course of business. Advances to suppliers were $271,132 and $446,168 as of September 30, 2009 and December 31, 2008, respectively. Advances to suppliers are recorded when payment is made by the Company and relieved against inventory when goods are received. The advance payments to suppliers may include provisions that set the purchase price and delivery date of raw materials. Advances from customers were $1,304,861 and $222,609 as of September 30, 2009 and December 31, 2008, respectively and are recognized in revenue when delivery has occurred.

Revenue Recognition – The products of the Company are mainly sold to wholesale companies. The Company recognizes revenue when it is realized and earned. The Company considers revenue realized or realizable and earned when (1) it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured. Delivery does not occur until products have been shipped to the wholesale companies, risk of loss has transferred to the wholesale comapnies and wholesale companies’ acceptance has been obtained, or the Company has objective evidence that the criteria specified in wholesale companies’ acceptance provisions have been satisfied. The sales price is not considered to be fixed or determinable until all contingencies related to the sale have been resolved.

In general, the Company does not allow wholesale companies to return products unless there are defects in manufacturing or workmanship. Sales returns need to go through a strict process and have

- 24 -

to be authorized by Management. Sales returns are netted against sales when incurred. Historically, the amounts of actual returns were immaterial.

Cost of Sales – The cost of sales are the direct expenses incurred in producing the pharmaceuticals and cosmetics, which include materials, direct labor, handling charges, and a portion of overhead expenses associated with the manufacture of products.

Selling Expense– Selling expense mainly consists of sales commission, salesmen’s salaries, travelling expense, advertising and shipping and handling cost, etc. All advertising costs are changed to selling expenses when incurred or when advertising first takes place.

Research and Development– The Company charges research and development costs to operations in the period incurred. The Company recognizes revenue from research and development activities in accordance with the revenue recognition policy as stated above. Because in many cases the Company cannot be assured that the terms of specific contracts can be fulfilled, the Company recognizes revenue only after all terms of a contract are complete.

Basic and Diluted Earnings per Share– The computation of basic and diluted earnings per share is based on the weighted-average number of shares outstanding during the periods presented. Potentially dilutive securities for the three and nine months ended September 30, 2009 and 2008 include 246,000 warrants that were anti-dilutive due to losses of the Company.

Retirement Benefit Plans– The Company makes monthly contributions to various employee retirement benefit plans organized by provincial governments in the PRC in accordance with rates prescribed by them. The provincial governments undertake to assume the retirement benefit obligations of all existing and future retired employees of the Company. Contributions to these plans are charged to expense as incurred.

Comprehensive Income – Other comprehensive income presented in the consolidated financial statements consists of cumulative foreign currency translation adjustments.

Credit Risk – The carrying amounts of accounts receivable and sales representative advances included in the balance sheets represent the Company’s major exposure to credit risk in relation to its financial assets. No other financial assets carry a significant exposure to credit risk. The Company performs ongoing credit evaluations of each customer’s financial condition. It maintains an allowance for doubtful accounts. Management believes the Company’s current allowance is adequate.

The Company has its cash in bank deposits and money market funds primarily in the PRC. Historically, deposits in Chinese banks have been secure due to the state policy on protecting depositors’ interests. China promulgated a new Bankruptcy Law in August 2006, which came into effect on June 1, 2007, which, together with more specific, complementary regulations to be issued in the future, shall provide the implementation for the bankruptcy of Chinese banks. In the event that bankruptcy laws are enacted for banks in the PRC, the Company’s deposits may be at a higher risk of loss. The Company has maintained its funds in quality financial institutions to mitigate the risk.

Concentration – For the nine months ended September 30, 2009, the Company had concentrations of purchases from one vendor accounting for 29.86% of total purchases.

Business Condition and Liquidity– Although the Company has had a history prior to 2008 of positive net income, working capital and retained earnings, the Company has incurred a net loss for the nine months ended September 30, 2009 of $6,768,971 and had net cash provided by operating activities of $878,694 and proceeds from financing activities of $1,130,538. In addition, the Company had an accumulated deficit of $7,372,543 as of September 30, 2009, primarily due to the losses in the nine months ended September 30, 2009 and the loss of $4.6 million for fiscal 2008. As discussed in Note 8, the Company has $9,139,547in short term loans that mature in the next twelve months.

On August 6, 2009, the Company entered into a one-year term loan facility with the Yunnan Shuang Long Branch of Agricultural Bank of China (“Agricultural Bank”) amounting to RMB 110 million (approximately $16 million) based on the Agricultural Bank’s assessment of the Company’s operations and unencumbered assets. As of September 30, 2009, the Company has drawn RMB 50 million (approximately $7 million) under the term loan and the remaining unused loan facility was RMB 60 million (approximately $9 million). In addition, in July, 2009, the Company signed a factoring agreement with Heping Branch of China Construction Bank (the “Heping Bank”). Heping Bank has agreed to act as an

- 25 -

additional source of capital for the Company based on the Company’s accounts receivable balance from time to time. Under this factoring agreement the Company has drawn bank loans amounting to approximately RMB 9 million.

The Company has expended significant efforts to expand its revenues by assisting its sales representatives and increasing its marketing efforts during the nine months ended September 30, 2009 and during fiscal 2008. The net loss for the nine months ended September 30, 2009 was caused primarily by increased selling expenses, legal, auditing, sales representative assistance and marketing expenses. The increase in the selling expense in 2009 was mainly due to the fact that beginning in March 2009, in order to develop a better channel for selling our products and to increase our revenue in the fierce industry competition, we began to build relationships with high quality agents and terminated our relationships with agents with poor historical performance. Moreover, we believe it is in our -long-term best interest to grow our operations through the over-the-counter (“OTC”) market, which will produce higher profit margins, Accordingly we began developing the OTC market in 2009.We believes that after expending funds to develop new agents in 2009, we will be able to decrease selling and sales representative assistance expenses in the near future as the daily operations between new agents and the Company becomes more efficient. In addition, the Company may be forced to give significant attention to the class action lawsuits discussed above.

Since all of the Company’s operations are conducted in the PRC, the Company is subject to special considerations and significant risks not typically associated with companies operating in the United States of America. These risks include, among others, the political, economic and legal environments and foreign currency exchange rate fluctuations. The Company’s operational results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to medical reforms and other laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. In addition, all of the Company’s revenue is denominated in the PRC’s currency RMB, which must be converted into other currencies before remittance out of the PRC. Both the conversion of RMB into foreign currencies and the remittance of foreign currencies abroad require approval of the PRC government.

Due to changes in current worldwide economic conditions, the Company’s ability to raise capital or borrow funds may be limited and may also adversely affect the Company’s operations.

Recently Enacted Accounting Standards– In June 2009, the FASB issued Accounting Standards Update No. 2009-01, “Generally Accepted Accounting Principles” (ASC Topic 105) which establishes the FASB Accounting Standards Codification (“the Codification” or “ASC”) as the official single source of authoritative U.S. GAAP. All existing accounting standards are superseded. All other accounting guidance not included in the Codification will be considered non-authoritative. The Codification also includes all relevant Securities and Exchange Commission (“SEC”) guidance organized using the same topical structure in separate sections within the Codification.

Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASU”) which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification.

The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented. The Codification is effective for our third-quarter 2009 financial statements and the principal impact on our financial statements is limited to disclosures as all future references to authoritative accounting literature will be referenced in accordance with the Codification. In order to ease the transition to the Codification, we are providing the Codification cross-reference alongside the references to the standards issued and adopted prior to the adoption of the Codification.

Fair Value Accounting

In 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (ASC Topic 820) which defines fair value, establishes a market-based framework or hierarchy for measuring fair value and expands disclosures about fair value measurements. This guidance is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. It does not expand or require any new fair value measures; however the application of this statement may change current practice. We adopted this guidance for financial assets and liabilities effective January 1, 2008 and for non financial assets and liabilities effective January 1, 2009. The adoption did not have a material effect on our financial condition or results of operations.

- 26 -

In April 2009, the FASB issued FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASC Topic 320-10-65). This update requires fair value disclosures for financial instruments that are not currently reflected on the balance sheet at fair value on a quarterly basis. We adopted these updates effective June 30, 2009 and the adoption did not have a material effect on our financial condition or results of operations.

Business Combinations and Noncontrolling Interests

In 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (ASC Topic 805). This guidance requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose the information necessary to evaluate and understand the nature and financial effect of the business combination. We adopted this guidance effective January 1, 2009 and will apply it to all business combinations prospectively from that date. The impact of ASC 805 on our consolidated financial statements will depend upon the nature, terms and size of the acquisitions we consummate in the future.

In April 2009, the FASB issued Staff Position No. 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (ASC Topic 805-20). This updated guidance amended the accounting treatment for assets and liabilities arising from contingencies in a business combination and requires that pre-acquisition contingencies be recognized at fair value, if fair value can be reasonably determined. If fair value cannot be reasonably determined, measurement should be based on the best estimate in accordance with SFAS No. 5, “Accounting for Contingencies” (ASC Topic 405). This updated guidance was effective January 1, 2009 and the adoption did not have a material effect on our financial condition or results of operations.

- 27 -

In 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51”, (ASC Topic 810-10-65). This guidance requires companies to present noncontrolling (minority) interests as equity (as opposed to a liability) and provided guidance on the accounting for transactions between an entity and noncontrolling interests. In addition, it requires companies to report a consolidated net income (loss) measure that includes the amount attributable to such noncontrolling interests. We adopted this guidance effective January 1, 2009, and have applied it to noncontrolling interests prospectively from that date. The presentation and disclosure requirements we applied retrospectively for all periods presented. As a result of this adoption, we reclassified noncontrolling interests in the amount of $248,224 from Minority Interest in Net Assets of Subsidiaries to Equity in the December 31, 2008 balance sheet.

Other Accounting Changes

In June 2009, the FASB issued the following standards:

• SFAS No. 167, “Amendments to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities” (ASC Topic 810-10). This updated guidance requires an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. It also requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. This update is effective for our fiscal year beginning January 1, 2010 and we are currently evaluating the impact of adopting this update on our consolidated financial statements.

• SFAS No. 166, “Accounting for Transfers of Financial Assets”, (ASC Topic 810). This updated guidance removed the concept of a qualifying special-purpose entity and removed the exception from applying consolidation guidance to these entities. This update also clarified the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. ASC Topic 810 is effective for our fiscal year beginning on January 1, 2010. We are currently evaluating the impact of adopting this update on our consolidated financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (ASC Topic 855). This guidance is intended to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. It requires disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting this date, that is, whether this date represents the date the financial statements were issued or were available to be issued. This guidance was effective for our second quarter ended June 30, 2009.

- 28 -

Results of Operations

Three Months Ended September 30, 2009 and 2008

The following table sets forth our statements of operations for the three months ended September 30, 2009 and 2008 in U.S. dollars (unaudited):

	Three months ended September 30,
	2009			2008			Change ($)			Variance (%)
	Unaudited			Unaudited
Sales	$	10,558,218		$	7,281,384			3,276,834			45	%
Cost of Sales		2,947,511			1,973,865			973,646			49	%
Gross Margin		7,610,707			5,307,519			2,303,188			43	%
Operating Expenses:
Selling expenses		6,988,017			2,989,486			3,998,531			134	%
General and administrative expenses		1,063,981			1,819,573			(755,592	)		(42	%)
Research and development expenses		10,534			66,052			(55,518	)		(84	%)
		8,062,532			4,875,111			3,187,421			65	%
(Loss) Income from Operations		(451,825	)		432,408			(884,233	)		(204	%)
Other Income (Expense):
Interest income		1,349			588			761			129	%
Income from research and development activities		49,723			5,745			43,978			766	%
Interest expense		(184,228	)		(272,002	)		87,774			(32	%)
Non-operating expenses		(2,847	)		(330	)		(2,517	)		763	%
		(136,003	)		(265,999	)		129,996			(49	%)
(Loss) Income Before Income Tax (expense) benefit and non-controlling interest		(587,828	)		166,409			(754,237	)		(453	%)
Income tax (expense) benefit		401,012			(4,471	)		405,483			(9096	%)
Net (Loss) Income		(186,816	)		161,938			(348,754	)		(215	%)
Net loss (income) attributable to noncontrolling interest		154,892			(7,652	)		162,544			(2124	%)
Net (Loss) Income attributable to shareholders	$	(31,924	)	$	154,286			(186,210	)		(121	%)
Basic and diluted earnings (loss) per share	$	0		$	0.01			(0.01	)		(100	%)
Weighted-average number of shares outstanding-basic and diluted		19,679,400			19,679,400			—			—

Sales:Sales for the three months ended September 30, 2009 was approximately $10.56 million, an increase of approximately $3.28 million, or 45.00 %, from $7.28 million for the three months ended September 30, 2008. The increase in sales was primarily due to the Company’s implementation of a new sales policy that has stimulated the enthusiasm of sales representatives, resulted in the increased sales of products.

- 29 -

Cost of sales:Our cost of sales for the three months ended September 30, 2009 was approximately $2.94 million, an increase of $0.97 million, or 49.29%, from approximately $1.97 million for the three months ended September 30, 2008. The increase in cost of sales was primarily due to the increase of sales.

Gross margin:Our gross margin for the three months ended September 30, 2009 was approximately $7.61 million as compared with approximately $5.30 million for the three months ended September 30, 2008, an increase of $2.31 million, or 43.41%. Gross margin as a percentage of revenues was approximately 72.09% for the three months ended September 30, 2009, a decrease of 0.80 % from 72.89% for the three months ended September 30, 2008. The decrease in gross margin percentage was primarily due to the increasing price of raw material.

Selling expense: Selling expenses were approximately $6.99 million for the three months ended September 30, 2009, an increase of $4 million, or 133.79%, from $2.99 million for the three months ended September 30, 2008. The primary reason for the increase in selling expenses was the change in our marketing policy. Our main product has been sold to patients through hospitals, which customer relationships were cultivated by sales representatives. However, we believe it is in our long-term best interest to grow our operations through the over-the-counter (“OTC”) market, which will produce higher profit margins. Accordingly, we began developing the OTC market in 2009 and as of September 30, 2009, revenue from the OTC market comprises approximately 10% of the total sales revenue for Medicine. As of September 30, 2009, we estimate that our expenditures for developing the Company’s presence in the OTC market through such in 2009 are approximately RMB 10 million and that we will have to dedicate significant funds in the future to continue to develop in the OTC market.. Although we are focusing our operations on the OTC market, we have adopted a policy to absorb a significantly higher percentage of costs incurred by our sales representatives than in the past in order to foster their cooperation in developing the OTC market. The costs being borne by us with respect to developing the OTC market are being accrued in selling expenses.

The Company reimburses the sales representatives their selling and marketing expenses when they submit the appropriate documentation to be reimbursed and their sales are collected. The accrued selling expenses are due within one to six months. The Company reimburses the sales representatives their accrued selling expenses when related accounts receivable are collected.

General and administrative expense: General and administrative expenses were approximately $1.06 million for the three months ended September 30, 2009, a decrease of $0.76 million, or 41.54%, from approximately $1.82 million for the three months ended September 30, 2008. The decrease was primarily due to (i) reduction of the professional service fees relating to maintain our status as a public company with its securities traded on a U.S. national exchange; and (ii)) our strengthened budget control over expense disbursements to reduce unnecessary expense.

Research and development expense:Research and development expense for the three months ended September 30, 2009 was $10,534 as compared to $66,052 for the period ended September 30, 2008, a decrease of approximately $55,000. The decrease was primarily due to our focus on a few innovative pharmaceuticals instead of on a number of generic drugs.

Net (Loss) Income attributable to shareholders:Net loss decreased to $31,924 for the three months ended September 30, 2009 as compared to net profit of $154,286 for the three months ended September 30, 2008. The increase in net loss was primarily due to the sharp increase of $4 million in selling expense for the three months ended September 30, 2009.

- 30 -

Nine Months Ended September 30, 2009 and 2008

The following table sets forth our statements of operations for the nine months ended September 30, 2009 and 2008 in U.S. dollars (unaudited):

	Nine months ended September 30,
	2009			2008			Change ($)		Variance (%)
	Unaudited			Unaudited
Sales	$	25,459,077		$	21,359,149		4,099,928		19	%
Cost of Sales		7,643,566			7,061,446		582,120		8	%
Gross Margin		17,815,511			14,297,703		3,517,808		25	%
Operating Expenses:
Selling expenses		19,604,857			8,666,561		10,938,296		126	%
General and administrative expenses		5,230,722			7,001,410		(1,770,688	)	(25	%)
Research and development expenses		24,455			255,241		(230,786	)	(90	%)
		24,860,034			15,923,212		8,936,822		56	%
(Loss) Income from Operations		(7,044,523	)		(1,625,509	)	(7,044,523	)	433	%
Other Income (Expense):
Interest income		2,661			5,701		(3,040	)	(53	%)
Income from research and development activities		194,902			344,370		(149,468	)	(43	%)
Interest expense		(704,242	)		(963,198	)	258,956		(27	%)
Non-operating expenses		(22,038	)		(138,812	)	116,774		(84	%)
		(528,717	)		(751,939	)	223,222		(30	%)
(Loss) Income Before Income Tax (expense) benefit and non-controlling interest		(7,573,240	)		(2,377,448	)	(5,195,792	)	219	%
Income tax (expense) benefit		401,012			(4,484	)	405,496		(9043	%)
Net (Loss) Income		(7,172,228	)		(2,381,932	)	(4,790,296	)	201	%
Net loss (income) attributable to noncontrolling interest		403,257			146,089		257,168		176	%
Net (Loss) Income attributable to shareholders	$	(6,768,971	)	$	(2,235,843	)	(4,533,128	)	203	%
Basic and diluted earnings (loss) per share	$	(0.34	)	$	(0.11	)	(0.23	)	209	%
Weighted-average number of shares outstanding-basic and diluted		19,679,400			19,679,400		—		—

Sales: Sales for the nine months ended September 30, 2009 was approximately $25.46 million, an increase of approximately $4.1 million, or 19.20%, from approximately $21.36 million for the nine months ended September 30, 2008. The increase in sales is due to the increase in sales of our primary product, Xuesaitong Soft Capsules, by $ 4.12 million and an increase in our sales of cosmetic products by $ 0.4 million. The increase in sales was partially offset by the decrease in exports of $ 0. 42 million attributable to the general condition of the global economy.

- 31 -

Cost of sales: Our cost of sales for the nine months ended September 30, 2009 was approximately $7.64 million, an increase of $0.58 million, or 8.26%, from approximately $7.06 million for the nine months ended September 30, 2008. The increase in cost of sales was due primarily to (i) sales volume increased and (ii) increased in the price of raw materials has increased in 2009.

Gross margin: Our gross margin for the nine months ended September 30, 2009 was approximately $17.81 million as compared with approximately $14.30 million for the nine months ended September 30, 2008. Gross margin as a percentage of revenues was approximately 69.98% for the nine months ended September 30, 2009, up from 66.94% for the nine months ended September 30, 2008. The increase was primarily due to the strict implementation of expenditure control over manufacturing expense and labor cost in accordance with our budget. As a result, manufacturing expense was reduced by 12%.

Selling expense: Selling expenses were approximately $19.60 million for the nine months ended September 30, 2009, an increase of approximately $10.93 million, or 126.20%, from approximately $8.67 million for the nine months ended September 30, 2008. The increase in selling expense in 2009 was mainly due to two facts. First, beginning in March 2009, in order to develop a better channel for selling our products and to increase our revenue in the face of fierce industry competition, we began to build relationships with new high-quality agents and terminated our relationships with agents with poor historical performance, as a result of which we were required to pay greater commissions, travelling and entertainment expenses to establish good relationships with the new high-quality agents. Second, we believe it is in our long-term best interest to grow our operations through the over-the-counter (“OTC”) market, which will produce higher profit margins. Accordingly, we began developing the OTC market in 2009 and as of September 30, 2009, revenue from the OTC market comprises approximately 10% of the total sales revenue for Medicine. As of September 30, 2009, we estimate that our expenditures for developing the Company’s presence in the OTC market through such in 2009 are approximately RMB 10 million and that we will have to dedicate significant funds in the future to continue to develop in the OTC market. As we are focusing our operations on the OTC market, we have adopted a policy to absorb a significantly higher percentage of costs incurred by our sales representatives than in the past in order to foster their cooperation in developing the OTC market. The costs being borne by us with respect to developing the OTC market are being accrued in selling expenses

The Company reimburses the sales representatives their selling and marketing expenses when they submit the appropriate documentation to be reimbursed and their sales are collected. The accrued sales expenses are due within one to six months. The Company reimburses the sales representatives their accrued selling expenses when related accounts receivable are collected.

General and administrative expense: General and administrative expenses were approximately $5.23 million for the nine months ended September 30, 2009, a decrease of approximately $1.77 million, or 25.28%, from approximately $7 million for the nine months ended September 30, 2008. The decrease was primarily due to (i) a decrease in the provision for doubtful accounts and (ii) our strengthened budget control over expense disbursements to reduce unnecessary expense.

Research and development expense: Research and development expense for the nine months ended September 30, 2009 was $24,455 as compared to $255,241 for the nine months ended September 30, 2008. The decrease was primarily due to our focus on a few innovative pharmaceuticals instead of on a number of generic drugs.

Net other expense: Net other expense, which includes interest income, income from research and development activities, interest expense and non-operating expenses, was 0.53 million for the nine months ended September 30, 2009 as compared to $0.75 million for the nine months ended September 30, 2008, a decrease of $0.22 million, or 29.79%. The decrease in net other expense was primarily due to a decrease in the interest expense on long-term loans.

Benefits from (provision for) income taxes: Benefit from income taxes was $0.4million for the nine months ended September 30, 2009 as compared to a provision for income tax of approximately $4,000 for the nine months ended September 30, 2008. In China, each of our subsidiary entities files its own individual tax return in the PRC. The Company pays tax on all profits realized by each subsidiary, and any losses generated by a subsidiary can only be carried forward and utilized by the same legal entity, which is subject to approval by the tax bureau. Benefits from income tax were generated from losses carried forward.

- 32 -

Net (Loss) Income attributable to shareholders: We incurred a net loss of $6.77 million for the nine months ended September 30, 2009 as compared to a net loss of $2.24 million for the nine months ended September 30, 2008, an increase in net loss of approximately $4.53 million. The increase in net loss was primarily due to (i) an increase in selling expense of $10.9 million and ii) an offset resulting from the decrease in provision for doubtful accounts of $2.14 million and (iii) in increase in gross margin of $3.5 million.

Liquidity and Capital Resources

General–As of September 30, 2009, we had cash and cash equivalents of $ 2,723,716. We have historically financed our business operations through bank loans, in addition to equity offerings. As of September 30, 2009, we had borrowed short-term loans in the amount of $5,337,043 and long-term loans in the amount of $10,237,510 from banks and other institutions. All loans are secured by land, buildings and machinery as collateral except the loan from the Agricultural Bank of China mentioned below which is secured by land, buildings and machinery, as well as the stock ownership of Kunming Shenghuo Pharmaceuticals Co., Ltd held by the Company as collateral.

Our notes payable consist of short term debt that is payable to banks, governmental financial bureaus, municipalities and a company. The following schedule summarizes our debt obligations and respective balances:

:

	September 30, 2009		December 31, 2008
Short-term note payable to a municipality, interest at 1.8%, due on demand, unsecured	$	73,124	$	72,948
Short-term note payable to a finance bureau, interest at 4.5%, due on demand, unsecured		75,365		75,182
Short-term note payable to a bank, interest at 5.31%, matures April 2010, secured by property(note a)		3,656,254		—
Short-term note payable to a bank, interest at 7.47%, matured April 2009, secured by property (note a)		—		3,647,399
Short-term note payable to a bank secured by insurance company, interest at approximately 5.31%, matures within four months		1,321,329		—
Short-term note payable to a government development zone interest at 2.43%, due on demand, secured by property		—		218,844
Short-term note payable to a bank, interest at 7.72%, matures August 2009, secured by shareholder		—		5,835,838
Discount bills with recourse, matures within six months		210,971		—
Total short-term notes payable	$	5,337,043	$	9,850,211

- 33 -

	September 30, 2009		December 31, 2008
Long-term note payable to a bank, interest at 5.4%, matures March 2010, secured by property, equipment and land use right		1,462,501		1,458,959
Long-term note payable to a bank, interest at 5.84%, matures before March 2010, secured by property and land use right		1,462,501		2,917,919
Long-term note payable to a bank, interest at 5.4%, matures before June 2010, secured by the Company’s shares in Shenghuo (note b)		877,502		—
Long-term note payable to a bank, interest at 5.4%, matures before August 2011, secured by the Company’s shares in Shenghuo (note b)		6,435,006		—
Total long-term notes payable		10,237,510		4,376,878
Less current maturities of long- term notes payable		3,802,504		3,245,685
Long-term notes payable, net of current portion	$	6,435,006	$	1,131,193
Past due notes payable (note c)	$	292,500	$	294,026

(a) In April 2009, a note payable with an interest rate of 7.47% and a balance of $3,647,399 as of December 31, 2008 was refinanced. The new note payable is due in one year and has an interest rate of 5.31%.

(b) On August 24, 2009, the Company drew down $7,312,508(approximately 50 million RMB) from the bank facility with Shuang Long Branch of Agricultural Bank of China executed on August 6 2009, This proportion of the loan has a term of two years, with repayment of $438,751 before December 2009, repayment of $438,751 before June 2010, repayment of $585,001 before December 2010, repayment of $731,251 before April 2011 and repayment of the remainder before August 2011. This drawdown of the loan bears interest at a rate of 5.40% which is due quarterly. The loan was for working capital and is secured by the Company’s 94.95% shares in Shenghuo.

(c) Of the aggregate amount $1,462,501 borrowed from Agricultural Bank of China, $292,500 matured in May 2009, which was past due as of September 30. 2009, However, based on the Company’s good historical credit record, the Company reached an oral agreement with the lender to extend the maturity date for this portion of the loan to March 2010. Therefore the Company did not repay the amount of the loan originally due in May 2009.

(d) All long term notes payable mature during the years ended September 30, 2011 and December 31, 2010, respectively.

- 34 -

The following table provides summary information about net cash flow for the nine months ended September 30, 2009 and 2008:

Cash Flow
Nine months ended September 30,

	2009			2008
	(unaudited in thousands)			audited
Net cash provided by (used in) operating activities	$	879		$	(233	)
Net cash used in investing activities		(902	)		(223	)
Net cash provided by (used in) financing activities		1,131			(1,413	)
Cash and Cash Equivalents at End of Period	$	2,724		$	1,081

Operating Activities: Net cash provided from operating activities for the nine months ended September 30, 2009 was $0.88million, as compared to net cash used in operating activities of $0.23 million for the nine months ended September 30, 2008. These results reflect the impacts of (i) a decrease of approximately $3.25 million in cash used in other receivables and an increase of $0.96 million in cash provided by advances from customers as a result of the Company’s more effective implementation of collection policy; (ii) an increase of approximately $1.27 million in cash provided by accounts payable as a result of increasing purchase volume; and (iii) partially offset by an increase of approximately $4.8 million of cash used in notes and accounts receivables due to increasing sales.

Investing Activities: Net cash used by investing activities was $0.9 million or the nine months ended September 30, 2009, as compared to net cash used in the amount of $0.22 million for the nine months ended September 30, 2008. The increase in net cash used by investing activities was primarily due to increases in capital expenditures, specifically, the construction of Shenghuo Plaza.

Financing Activities: Net cash provided by financing activities was approximately $1.13 million for the nine months ended September 30, 2009 compared to net cash used in the amount of $1.41 million for the nine months ended September 30, 2008. The increase in cash provided was primarily due to the increase of loans borrowed from bank.

Working Capital Deficiency

As of September 30, 2009, our accounts receivable and notes receivable (less allowance for doubtful accounts of approximately $5.98 million) were approximately $13.72 million, a increase of approximately $4.61 million, from accounts receivable of approximately $9.11 million (net of allowance for doubtful accounts of $4.83 million) as of December 31, 2008. The increase of notes and accounts receivables is attributed primarily to the increasing sales.

Our company normally requires one to two months to deliver products once an order is placed with our workshop. Inventory decreased for the nine months ended September 30, 2009 by $0.8 million, a decrease of 18.65% over inventory as of December 31, 2008. The decrease in inventory was primarily due to the increased sales volume stimulated by the newly implemented sales policy.

Our payment cycle is considerably shorter than our receivable cycle, since we typically pay our suppliers all or a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We require our customers to pay a certain percentage of the sales price as deposit before we ship products to them. The percentage varies from customer to customer. The deposit increased approximately $0.83 million for the nine months ended September 30, 2009.

To the extent that we cannot satisfy our cash needs, whether from operations or from a financing source, our business may be impaired in that it may be difficult for us to obtain products which could, in turn, impair our ability to generate sales. We have implemented new policies aimed at improving collection of accounts receivable in the future, including more detailed

- 35 -

reporting from and increased control over provincial sales offices and representatives, incentives for sales representatives more closely tied to timely collection and more stringent enforcement of payment terms with wholesale companies.

In addition, in the course of our business, we make significant deposits to our suppliers when we place an order. As of September 30, 2009, our advance payments to our suppliers totalled approximately $0.27 million. We are confident that our available funds and cash generated from operations will provide us with sufficient capital for a sustainable operation; however, we may require additional capital for acquisitions, for expanding business to related fields, or for the operation of the combined companies. We cannot assure that such funding will be available.

Before 2009, we made significant cash advances to our sales representatives to assist and encourage them to expand the marketing and sales of our products into new markets and to develop new customers. We believed that the sales representatives would be better able to expand into new markets and to secure new customers if they were advanced funds for their travel, meals and other incidental expenses that arose in connection with their sales activities. Prior to September 2006, we did not ask sales representatives to pay off advances immediately because the Chinese economy has grown quickly and because competition in the pharmaceutical industry is intense. Instead, we encouraged sales representatives to expand their markets and gain more customers. However, beginning in September of 2006, we began to more vigorously pursue collection of all sales representative advances. Nonetheless, there are some sales representative advances that have aged so significantly that, based on prior experience, we do not expect to collect on every outstanding advance and have estimated the uncollectible balance based on the age of the advances. Pursuant to the policies adopted at the beginning of 2009, instead of advancing sales representatives money to sustain or develop markets, we reimburse sales representatives their selling and marketing expenses when they present expense vouchers. Management considers this a better way to manage the potential for bad debts on the advances to sales representatives. We pay the accrued selling expenses only when the Company collects an account receivable for which a sales representative has presented his expense receipts. Because we offer a grace period of one-to-six months to our clients for remitting payments due, the accrued sales expenses may remain outstanding for however long it takes to collect the corresponding accounts receivable.

Current and long-term sales representatives and employee advances (net of allowances for doubtful accounts) were approximately $6.55 million at September 30, 2009 and $9.3 million as of December 31, 2008, a decrease of approximately $2.75 million or 29.56%. The decrease was due to the decrease in advances to employees as a result of the Company’s tight cash flow.

The table below sets forth the outstanding gross and net amount of outstanding balances of current and long-term sales representatives and employee advances as of December 31, 2008 and September 30, 2009.

	As of September 30, 2009		As of December 31, 2008
Gross amount of sales representatives and employee accounts	$	10,503,723	$	12,921,134
Allowance for doubtful accounts		3,954,612		3,620,048
Net amount	$	6,549,111	$	9,301,086

Off-Balance Sheet Arrangements

None.

Foreign Currency Risk

Since all of our operations are conducted in the PRC, we are subject to special considerations and significant risks not typically associated with companies operating in the United States of America. These risks include, among others, the political, economic and legal environments and foreign currency exchange rate fluctuations. Our operational results may be

- 36 -

adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to medical reforms and other laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from its operations in the PRC. In addition, all of our revenue is denominated in the Chinese Yuan Renminbi (“RMB”), which must be converted into other currencies before remittance out of the PRC. Both the conversion of RMB into foreign currencies and the remittance of foreign currencies abroad require approval of the PRC government. The effect of the fluctuations of exchange rates is not considered to be material to our business operations.

Interest Rate Risk

We do not have significant interest rate risk, as our debt obligations are primarily fixed interest rate.

- 37 -

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Smaller reporting companies are not required to provide the information required by this Item.

ITEM 4T.CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

Our management, with the participation of our chief executive officer and chief financial officer, Messrs. Gui Hua Lan and Mr. Chuanxiang Huang respectively, evaluated the effectiveness of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this report, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, Mr. Lan and Mr. Huang concluded that despite improvements in areas of previously identified weakness in internal control over financial reporting identified (described below), our disclosure controls and procedures were not effective as of September 30, 2009.

Changes in Internal Controls over Financial Reporting

The Company’s management is focused on compliance with the requirements under Section 404 of the Sarbanes-Oxley Act of 2002. The relevant section of the Act requires the management of smaller reporting companies with equity securities listing in the U.S. securities market to issue report and representations as to the internal control over financial reporting. The Company anticipates that it will be fully compliant with Section 404 of the Sarbanes-Oxley Act of 2002 by the required date for smaller reporting companies and it is currently in the process of improving and rectifying its internal control systems in order to be compliant with Section 404 of the Sarbanes-Oxley Act of 2002.

The Company has continuously refined the policies and standards for the control environment based on the risk control framework established in the Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO”). In the past few months, the Company has: standardized control procedures for monitoring the financial reporting and period end financial closing procedures at the subsidiary and group level and upgraded the business performance review processes and controls; expanded accounting manuals to clearly document key controls and processes for preparing consolidated financial statements in accordance with applicable accounting standards; hired additional accounting professionals with experience in financial reporting and familiarity with international accounting practices and increased technical training for the finance

- 38 -

	and accounting personnel in respect of relevant accounting standards; established and implemented the code of ethics for senior officers and employees, company-wide anti-fraud policies and whistle blowing mechanisms; enhanced internal controls over subsidiaries by assessing the effectiveness of internal controls at subsidiary-level based on our enterprise risk assessment results and preliminarily formulated long term implementation plan on internal control.
	The Company’s management, including the CEO and CFO, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our management is also required to evaluate and report on the effectiveness of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 and to file an annual report pursuant to section 13(a) of the Exchange Act. The CEO and CFO have evaluated several changes to our internal control over financial reporting as of September 30, 2009 that will or are reasonably likely to materially affect our internal control over financial reporting, and based on that evaluation, Management has concluded that our internal control over financial reporting was not effective as of September 30, 2009.
	The information below shows the changes to the internal control over financial reporting that were evaluated and the status of our other material weakness remediation to date:
•	Lack of U.S. GAAP expertise, which is a material weakness. Despite substantial efforts to improve the Company’s controls and procedures, as previously reported by the Company, our current accounting staff is relatively new and inexperienced, and needs substantial additional training to meet the higher demands of being qualified accountants of a U.S. public company. The accounting skills and understanding necessary to fulfill the requirements of U.S. GAAP-based reporting, including the skills of U.S. GAAP-based period end closing, consolidation of financial statements and U.S. GAAP conversion are inadequate and were inadequately supervised. The lack of adequate U.S. GAAP review resulted in some material adjustments for the year ended December 31, 2008, which were not properly and completely reflected in the management accounts. These material audit adjustments were made to eliminate intercompany transactions, reclassify related party transactions, record prior year audit adjustments to adjust the allowance for doubtful accounts, adjust taxes payable for tax provision, record intangibles at gross amounts, and adjust deferred tax. The need for these material adjustments was a result of insufficient period end closing procedures and a deficiency in the reconciliation between the Company’s prior-year audited financial statements and accounting records.
	Remediation:
	Since January 1, 2009, we have maintained a separate set of accounting data to record all U.S. GAAP audit adjustments from 2008 along with the PRC accounting records so as to effectively reconcile PRC accounts to the financial statements under U.S. GAAP.
	In order to enhance our period end procedures, including adding a review of all account balances for

- 39 -

material adjustments, the Company added five new personnel to the financial department in May of 2009, which currently consists of 21 staff members, including one Chinese CPA and one Chinese senior accountant. Additionally, following a vote of the Board of Directors, in October 2009, the Company engaged Essence Consulting and Management Ltd, an independent third party financial advisor to aid in financial reporting procedures and to help with the preparation of the Company’s annual and quarterly filings. In addition, we have allocated significant financial and human resources to strengthen our internal control structure.

We believe that the foregoing steps have helped us remediate the material weakness identified above and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate..

A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

PART II - OTHER INFORMATION

ITEM 1.LEGAL PROCEEDINGS

Mingying Co., Ltd. Lawsuit – On July 20, 2009, the Company appeared before a court sitting in the Tianhe District of Guangzhou, Guandong Province, People’s Republic of China, to defend itself in an action brought by Mingying Co., Ltd. for allegedly failing to satisfy payment obligations for advertising services. Mingying Co., Ltd. is seeking a judgment in the amount of RMB 465,000 (approximately $68,000). The court has informed Mingying Co., Ltd. that it has failed to meet its burden of proof in support of its claims, however the action is still proceeding. The Company lost the lawsuit in the trial of first instance, which was held in September. The Company has applied for a retrial but has not yet received a reply from the court.

The Company intends to continue to vigorously defend the lawsuit. The Company does not believe the outcome of this suit will have a material adverse effect on the Company.

- 40 -

SEC Investigation – The United States Securities and Exchange Commission (“SEC”) had been conducting an informal inquiry regarding the events that resulted in the Company’s restatement of its financial statements for the fiscal year 2007 and the first quarter of 2008. The Company was represented by counsel cooperated with the SEC’s inquiry on a voluntary basis. On September, 2009, the Company received notification from the SEC that it had completed its investigation and reached a determination not to recommend any enforcement.

Class Action Lawsuit – In 2008, putative class action lawsuits were asserted against the Company and certain other parties in the United States District Court for the Southern District of New York (the “Court”). On February 12, 2009, an amended complaint was served on the Company by new lead counsel for the class, consolidating the putative class actions and bearing the caption Beni Varghese, Individually and on Behalf of All Other Similarly Situated v. China Shenghuo Pharmaceutical Holdings, Inc., et al., Index No. 1:08 CIV. 7422. The defendants include the Company, the Company’s controlling shareholders, Lan’s International Medicine Investment Co., Limited, the Company’s chief executive officer, Gui Hua Lan, the Company’s former chief financial officer, Qiong Hua Gao, and the Company’s former independent registered public accounting firm, Hansen, Barnett & Maxwell, P.C. During the second quarter of 2009, the Company and the accounting firm filed motions to dismiss the complaint and the plaintiffs filed a memorandum in opposition to those motions. On August 31, 2009, the Company filed a reply brief in further support of its motion.

The amended consolidated complaint alleges that the Company failed to take adequate steps to ensure its financial reporting comported with U.S. Generally Accepted Accounting Principles (“GAAP”) and, as a result, the Company was required to restate what are alleged to be materially false and misleading financials for accounting periods during the alleged class period from August 2007 through August 20, 2008. The amended consolidated complaint further alleges, among other things, that certain of the Company’s SEC filings and other public statements contained false and misleading statements which resulted in damages to the plaintiffs and the members of the purported class when they purchased the Company’s securities. On the basis of those allegations, plaintiffs in each of the actions seek an unspecified amount of damages under Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated thereunder.

The Company believes the allegations in the amended consolidated complaint are without merit, and intends to vigorously defend the class action lawsuits. The Company does not believe the outcome of this suit will have a material adverse effect on the Company. However, the Company is unable at this time to predict the outcome of this litigation or whether the Company will incur any liability associated with the litigation, or to estimate the effect such outcome would have on the financial condition, results of operations, or cash flows of the Company.

ITEM 1A.RISK FACTORS

Except as reflected in this Form 10-Q, there have been no material changes from the risk factors previously disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008.

- 41 -

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibit Number	Description of Exhibit
10.1	Line of Credit Agreement dated August 6, 2009 by and between the Company and the Agricultural Bank of China Limited Inc.
10.2	Pledge Agreement dated August 21, 2009 by and between the Company and Agricultural Bank of China Shuanglong Branch.
10.3	Insurance Policy dated May 4, 2009 issued by Ping An Property & Casualty Insurance Company of China, Ltd. in favor of the Company.
10.4	Indemnity Agreement dated June 9, 2009 by and among the Company, Ping An Property & Casualty Insurance Company of China, Ltd. and China Construction Bank Kunming Heping Branch.
31.1	Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a).
31.2	Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a).
32.1	Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.*
* This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

- 42 -

SIGNATURES

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

	CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
	(Registrant)
November 16, 2009		By:	/s/ Gui Hua Lan
		Gui Hua Lan
		Chief Executive Officer and Chairman of the Board

- 43 -

EXHIBIT INDEX

Exhibit Number	Description of Exhibit
10.1	Line of Credit Agreement dated August 6, 2009 by and between the Company and the Agricultural Bank of China Limited Inc.
10.2	Pledge Agreement dated August 21, 2009 by and between the Company and Agricultural Bank of China Shuanglong Branch.
10.3	Insurance Policy dated May 4, 2009 issued by Ping An Property & Casualty Insurance Company of China, Ltd. in favor of the Company.
10.4	Indemnity Agreement dated June 9, 2009 by and among the Company, Ping An Property & Casualty Insurance Company of China, Ltd. and China Construction Bank Kunming Heping Branch.
31.1	Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a).
31.2	Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a).
32.1	Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.*
* This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

- 44 -