China Sky One Medical (CSKI) 10-Q 2010 Q3 Quarterly report

UNITD STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the nine months ended: September 30, 2010

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

For the transition period from ____________ to ____________

Commission file number:001-34080

CHINA SKY ONE MEDICAL, INC.

(Exact name of registrant as specified in its charter)

Nevada	87-0430322
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
No. 2158, North Xiang An Road, Song Bei District, Harbin, People’s Republic of China	150028
(Address of principal executive offices)	(Zip Code)

86-451-8703-2617 (China)

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,
if changed since last report)

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

Yes x   No ¨

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

Yes  ¨  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small 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 filer ¨	Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ¨

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

Yes ¨     No x

As of November 1, 2010, the registrant had 16,790,851 shares of common stock issued and outstanding.

QUARTERLY REPORT ON FORM 10-Q

OF CHINA SKY ONE MEDICAL, INC. AND SUBSIDIARIES

FOR THE PERIOD ENDED SEPTEMBER 30, 2010

TABLE OF CONTENTS

			PAGE
PART I	-	FINANCIAL INFORMATION
Item 1.		Financial Statements	2
		Condensed Consolidated Statements of Operations and Comprehensive Income for the Three and Nine Months Ended September 30, 2010 (unaudited) and 2009 (unaudited and restated)	2
		Condensed Consolidated Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009 (restated)	3
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 (unaudited) and 2009 (unaudited and restated)	4
		Notes to Condensed Consolidated Financial Statements (unaudited)	5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	58
Item 4.		Controls and Procedures	58
PART II	-	OTHER INFORMATION
Item 1.		Legal Proceedings	60
Item 1A.		Risk Factors	60
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	61
Item 3.		Defaults Upon Senior Securities	61
Item 4.		Removed and Reserved	61
Item 5.		Other Information	61
Item 6.		Exhibits	61
Signatures			62

-i-

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, together with other statements and information we publicly disseminate, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and include this statement for purposes of complying with these safe harbor provisions.

Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “should”, “would”, “could”, “may”, “plan”, “possible”, “project” or similar expressions.  You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control and which could materially affect actual results, performances or achievements.

Factors that may cause actual results to differ materially from current expectations include, but are not limited to the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended December 31, 2009, as amended.  Accordingly, there is no assurance that our expectations will be realized.  Except as otherwise required by the federal securities laws, we disclaim any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change our expectations with regard thereto, or any change in events, conditions or circumstances on which any such statement is based.

The terms “the Company,” “we,” “us” and “our” refer to China Sky One Medical, Inc., together with our consolidated subsidiaries.

1

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

China Sky One Medical, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Income

(Unaudited, $ in thousands except share and per share data)

	Three Months Ended September 30,				Nine Months Ended  September 30,
	2010		2009 (restated)		2010		2009 (restated)
Revenues	$	36,193	$	43,227	$	105,856	$	100,242
Cost of Goods Sold		9,796		10,897		28,287		24,690
Gross Profit		26,397		32,330		77,569		75,552
Operating Expenses
Depreciation and amortization		879		447		2,547		1,348
Research and development		5,592		4,885		15,266		10,980
Selling		9,673		9,944		23,567		23,707
General and administrative		798		1,024		2,911		2,354
Total operating expenses		16,942		16,300		44,291		38,389
Income from Operations		9,455		16,030		33,278		37,163
Other Income
Interest income		29		20		88		46
Change in fair value of derivative warrant liability		1,833		132		8,847		1,305
Total other income		1,862		152		8,935		1,351
Net Income Before Provision for Income Tax		11,317		16,182		42,213		38,514
Provision for Income Taxes		2,722		3,592		8,787		8,050
Net Income	$	8,595	$	12,590	$	33,426	$	30,464
Basic Earnings Per Share	$	0.51	$	0.76	$	1.99	$	1.84
Basic Weighted Average Shares Outstanding		16,790,851		16,655,697		16,786,240		16,535,924
Diluted Earnings Per Share	$	0.51	$	0.75	$	1.99	$	1.83
Diluted Weighted Average Shares Outstanding		16,790,851		16,741,745		16,825,294		16,606,576
Other Comprehensive Income
Foreign currency translation adjustment	$	2,538	$	122	$	3,094	$	245
Net Income		8,595		12,590		33,426		30,464
Comprehensive Income	$	11,133	$	12,712	$	36,520	$	30,709

See accompanying summary of accounting policies and notes to the condensed consolidated financial statements.

2

China Sky One Medical, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

($ in thousands, except share data)

	September 30,		December 31,
	2010		2009
	(Unaudited)		(Restated)
ASSETS
Current Assets
Cash and cash equivalents	$	71,971	$	52,756
Accounts receivable, net		23,036		21,146
Inventories		4,311		2,413
Prepaid and other current assets		25		74
Total current assets		99,343		76,389
Property and equipment, net		15,505		15,491
Intangible assets, net		23,551		25,114
Construction in progress		13,214		12,932
Land use rights, net		4,610		4,586
Construction and land deposits		13,437		5,851
Total Assets	$	169,660	$	140,363
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses	$	5,233	$	4,186
Taxes payable		4,357		3,873
Derivative warrant liability		1,716		11,435
Total current liabilities		11,306		19,494
Commitments and Contingencies		-		-
Stockholders' Equity
Preferred stock ($0.001 par value, 5,000,000 shares authorized, none issued and outstanding)		-		-
Common stock ($0.001 par value, 50,000,000 shares authorized, 16,790,851 and 16,714,267 issued and outstanding, respectively)		17		17
Additional paid-in capital		38,154		37,188
Retained earnings		111,210		77,785
Accumulated other comprehensive income		8,973		5,879
Total stockholders' equity		158,354		120,869
Total Liabilities and Stockholders' Equity	$	169,660	$	140,363

See accompanying summary of accounting policies and notes to the condensed consolidated financial statements.

3

China Sky One Medical, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited, $ in thousands)

	Nine Months Ended September 30,
	2010			2009 (restated)
Cash flows from operating activities
Net Income	$	33,426		$	30,464
Adjustments to reconcile net cash provided by (used in) operating activities:
Depreciation and amortization		2,895			1,753
Change in fair value of derivative warrant liability		(8,847	)		(1,305	)
Net change in assets and liabilities
Accounts receivable		(1,363	)		(8,660	)
Inventories		(1,816	)		(2,634	)
Prepaid and other current assets		(13	)		(15	)
Accounts payable and accrued expenses		880			3,938
Taxes payable		397			2,391
Net cash provided by operating activities		25,559			25,932
Cash flows from investing activities
Land deposit		(7,335	)		-
Purchase of fixed assets		(473	)		(122	)
Purchase of construction in progress		(14	)		(9,927	)
Net cash used in investing activities		(7,822	)		(10,049	)
Cash flows from financing activities
Proceeds from warrants conversion		94			29
Net cash provided by financing activities		94			29
Effect of exchange rate changes on cash and cash equivalents		1,384			103
Net increase in cash and cash equivalents		19,215			16,015
Cash and cash equivalents at beginning of period		52,756			40,288
Cash and cash equivalents at end of period	$	71,971		$	56,303
Supplemental disclosure of cash flow information
Interest paid	$	-		$	-
Taxes paid	$	8,541		$	6,570

See accompanying summary of accounting policies and notes to the condensed consolidated financial statements.

4

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.           Description of Business

China Sky One Medical Inc. (“China Sky One” or the “Company”), a Nevada corporation, was formed on February 7, 1986, and formerly known as Comet Technologies, Inc. (“Comet”).  On July 26, 2006, the Company changed the name of the reporting company from "Comet Technologies, Inc." to "China Sky One Medical, Inc."

China Sky One is a holding company whose principal operations are conducted through its wholly-owned subsidiaries.  The Company has no revenues separate from its subsidiaries, and has expenses related to its status as a public reporting company and to its ownership interest in American California Pharmaceutical Group, Inc. (“ACPG”) and Harbin City Tian Di Ren Medical Co. (“TDR”).

ACPG, the Company’s non operating United States holding company subsidiary, was incorporated on December 16, 2003, in the State of California, under the name “QQ Group, Inc.” QQ Group, Inc. changed its name to “American California Pharmaceutical Group, Inc.” in anticipation of the Stock Exchange Agreement with China Sky One (then known as “Comet Technologies, Inc.”) and TDR, described herein. On December 8, 2005, ACPG completed a stock exchange transaction with TDR a People’s Republic of China (“China” or “PRC”) based operating company and TDR’s subsidiaries (the “TDR Acquisition”), each of which were fully operating companies in the PRC. Under the terms of the agreement, ACPG exchanged 100% of its issued and outstanding common stock for 100% of the capital stock of TDR and its subsidiaries, described below.

Thereafter, on May 11, 2006, ACPG entered into a Stock Exchange Agreement (the “Exchange Agreement”) with the shareholders of China Sky One. The terms of the Exchange Agreement were consummated and the acquisition was completed on May 30, 2006. As a result of the transaction, the Company issued a total of 10,193,377 shares of its common voting stock to the stockholders of ACPG, in exchange for 100% of the capital stock of ACPG resulting in ACPG becoming the Company’s wholly-owned subsidiary. The transaction is treated as a reverse merger for accounting purposes.

TDR, formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed in 1994 and  its principal executive office is located in Harbin City of Heilongjiang Province, in the PRC. TDR was reorganized and incorporated as a limited liability company on December 29, 2000, under the “Corporation Laws and Regulations” of the PRC. At the time of the TDR Acquisition by ACPG in December of 2005, TDR had two wholly-owned subsidiaries, Harbin First Bio-Engineering Company Limited (“First”) and Kangxi Medical Care Product Factory, until July, 2006, when the two were merged, with First as the surviving subsidiary of TDR. The principal activities of TDR and First are the research, manufacture and sale of over-the-counter non-prescription health care products. TDR commenced its business in the sale of branded nutritional supplements and over-the-counter pharmaceutical products in the Heilongjiang Province. TDR has subsequently evolved into an integrated manufacturer, marketer, and distributor of external use natural Chinese medicine products sold primarily to and through independent agents and China’s large pharmaceutical chains.

5

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

As of October 16, 2006, the Company organized Harbin Tian Qing Biotech Application Company as a wholly-owned PRC subsidiary of TDR (“Tian Qing”), to conduct research and development in the areas of tissue and stem cell banks. As of September 30, 2010, Tian Qing had insignificant operations.

On April 3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical, Inc., a corporation with a multitude of medicines approved by the PRC’s State Food and Drug Administration (“SFDA”) and new medicine applications, organized under the laws of the PRC (“Tianlong”), which is in the business of manufacturing external-use pharmaceuticals. Pursuant to the Equity Transfer Agreement, TDR acquired 100% of the issued and outstanding capital stock of Tianlong from Tianlong’s sole stockholder, in consideration for an aggregate purchase price of approximately $8,300,000, consisting of (i) $8,000,000 in cash, and (ii) 23,850 shares of China Sky One (at $12 per share). The acquisition received regulatory approval and closed on April 3, 2008.

The following table summarizes the approximate estimated fair values of the assets acquired in the Tianlong acquisition.

	($ in thousands)
Property and equipment	$	6,315
Intangible assets – SFDA licenses for drug batch numbers		1,787
Other		170
Net assets acquired	$	8,272

On April 18, 2008, China Sky One through its subsidiary TDR consummated a share acquisition pursuant to an Equity Transfer Agreement with the shareholders of Heilongjiang Haina Pharmaceutical Inc., a recently formed corporation organized under the laws of the PRC (“Haina”) licensed as a wholesaler of TCD, bio-medicines, bio-products, medicinal devices, antibiotics and chemical medicines. Haina does not have an established sales network and was acquired for its primary asset, a Good Supply Practice (GSP) license (License No. A-HLJ03-010) issued by the Heilongjiang office of the State Food and Drug Administration (“SFDA”). The SFDA recently started issuing such licenses to resellers of medicines that maintain certain quality controls. The GSP license was issued as of December 21, 2006 and will expire on January 29, 2012 and will enable the Company to expand its sales of medicinal products without having to go through a lengthy license application process.

The following table summarizes the approximate estimated fair values of the assets acquired in the Haina acquisition.

	($ in thousands)
Cash	$	84
Intangible assets – Goodwill		353
Net assets acquired	$	437

6

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Pursuant to the Equity Transfer Agreement, TDR acquired 100% of the issued and outstanding capital stock of Haina from its three stockholders in consideration for payment of 3,000,000 RMB (approximately $437,000). TDR has been overseeing the operations of Haina since January of 2008 as part of its due diligence prior to closing of this acquisition.

On June 9, 2008, TDR entered into a Merger and Acquisition Agreement (the “Acquisition Agreement”) with Peng Lai Jin Chuang Company, a corporation organized under the laws of the People’s Republic of China (“Peng Lai”), which was organized to develop, manufacture and distribute pharmaceutical, medicinal and diagnostic products in the PRC. Pursuant to the Acquisition Agreement, TDR acquired all of the assets of Peng Lai in consideration for an aggregate of approximately (i) U.S.$2.5 million in cash, and (ii) 381,606 shares of the Company’s common stock with a fair value of approximately $4.6 million (at $12 per share). The acquisition of Peng Lai closed on September 5, 2008.

The following table summarizes the approximate estimated fair values of the assets acquired in the Peng Lai acquisition.

	($ in thousands)
Property and equipment	$	4,177
Intangible assets - SFDA licenses for drug batch numbers		2,917
Net assets acquired	$	7,094

All of the Company’s significant operations and long lived assets are located in the PRC.

2.           Restatement

On May 11, 2010, the Company filed with the Securities and Exchange Commission (“SEC”) a Current Report on Form 8-K, as amended on May 24, 2010, to report management’s determination that the Company’s financial statements for the year ended December 31, 2009, included in its Annual Report on Form 10-K filed with the SEC on March 16, 2010, as amended on March 17, 2010 (the “2009 Form 10-K”), should no longer be relied upon due to an error in such financial statements with respect to the accounting for the 750,000 common stock purchase warrants the Company issued in connection with its January 31, 2008 private placement (the “Warrants”).  The Company received comments from the staff of the SEC, which led to the Company’s conclusion that the historical financial statements for the year ended December 31, 2009 in the 2009 Form 10-K required restatement to properly record the Warrants as a derivative liability.

On June 24, 2010, the Company filed with the SEC an additional Current Report on Form 8-K to report management’s determination that the Company’s financial statements: (i) for the fiscal quarter ended March 31, 2009, included in its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2010, filed with the SEC on May 17, 2010 (the “March 2010 Form 10-Q”); (ii) for the fiscal quarter ended June 30, 2009, included in its Quarterly Report on Form 10-Q filed with the SEC on August 14, 2009 (the “June 2009 Form 10-Q”); and (iii) for the fiscal quarter ended September 30, 2009, included in its Quarterly Report on Form 10-Q filed with the SEC on November 16, 2009 (the “September 2009 Form 10-Q” and, collectively with the March 2010 Form 10-Q and June 2009 Form 10-Q, the “Form 10-Qs”), should no longer be relied upon due to errors in such financial statements with respect to the accounting for the Warrants.  The Company received comments from the staff of the SEC, which led to the Company’s conclusion that the historical financial statements in the Form 10-Qs required restatement to properly record the Warrants as a derivative liability.

7

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company has performed a complete assessment of the Warrants and has concluded that the Warrants are within the scope of Accounting Standards Codification 815-40, “Derivatives and Hedging – Contracts in Entity’s Own Equity” (“ASC 815-40”), formerly Emerging Issues Task Force Issue No. 07-05, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-05”), due to the inclusion in the Warrants of aprovision requiring a weighted average adjustment to the exercise price of the Warrants in the event the Company issues common stock, or securities convertible into or exercisable for common stock, at a price per share lower than such exercise price. Accordingly, ASC 815-40, formerly EITF 07-05, which was effective as of January 1, 2009, should have been applied resulting in a reclassification of the warrants as a liability, measured at fair value, with changes in fair value recognized as part of other income or expense for each reporting period thereafter.

On July 23, 2010, the Company filed amendments to the 2009 Form 10-K and March 2010 Form 10-Q with the SEC, reflecting the restatement.  On August 9, 2010, the Company filed June 2010 Form 10-Q, reflecting the restatement.  The corrections to the quarterly information in the amended March 31, 2010 Form 10-Q and the June 2010 Form 10-Q had no impact on the Company’s previously reported income from operations or cash flows for the periods being restated.

This quarterly report on Form 10-Q for the fiscal quarter ended September 30, 2010 incorporates corrections made in response to the accounting errors described above by restating the Company’s financial statements presented herein for the three and nine months ended September 30, 2009.  The corrections to the quarterly information in this Form 10-Q had no impact on the Company’s previously reported income from operations or cash flows for the periods being restated.

The following tables ($ in thousands, except per share information) show the effects of the restatement on the Company's consolidated statements of operations and comprehensive income and consolidated statements of cash flows for the three and nine month period ended September 30, 2009:

China Sky One Medical, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Income

(Unaudited, $ in thousands except per share data)

	Three Months Ended September 30, 2009				Nine Months Ended September 30, 2009
	As Previously Recorded		As Restated		As Previously Recorded		As Restated
Change in fair value of derivative warrant liability	$	-	$	132	$	-	$	1,305
Total other income	$	20	$	152	$	46	$	1,351
Net Income Before Provision for Income Tax	$	16,051	$	16,182	$	37,209	$	38,514
Net Income	$	12,459	$	12,590	$	29,159	$	30,464
Basic Earnings Per Share	$	0.75	$	0.76	$	1.76	$	1.84
Diluted Earnings Per Share	$	0.74	$	0.75	$	1.76	$	1.83
Other Comprehensive Income
Foreign currency translation adjustment	$	122	$	122	$	245	$	245
Net Income		12,459		12,590		29,159		30,464
Comprehensive Income	$	12,581	$	12,712	$	29,404	$	30,709

8

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The gain resulting from the change in fair value of derivative warrant liability for the three and nine month period ended September 30, 2009 was incurred at the corporate level (a Nevada corporation).  The Company did not recognize any income tax benefits (expense) associated with the change in fair value in the three and nine months ended September 30, 2009 (see Note 14). Therefore, the restatement did not have an effect on the Company’s taxable income for the three and nine months ended September 30, 2009.

China Sky One Medical, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited, $ in thousands)

	Nine Months Ended September 30, 2009
	As Previously Recorded		As Restated
Net Income	$	29,159	$	30,464
Change in fair value of derivative liability		-		(1,305	)
Total:	$	29,159	$	29,159

3.           Summary of Significant Accounting Policies

The Company has established various accounting policies that govern the application of accounting principles generally accepted in the United States of America (“U.S.”), which are utilized in the preparation of the Company’s financial statements. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities.  The judgments and assumptions used by management are based on the Company’s historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of operations.

9

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Principles of Consolidation – The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, ACPG, TDR, First, Tian Qing, Tianlong, Haina and Peng Lai. All significant inter-company transactions and balances were eliminated.

These financial statements are stated in U.S. Dollars and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”). This basis of accounting differs from that used under applicable accounting requirements in the PRC. No material adjustment was required.

Certain items in the Company’s 2009 restated financial statements (see Note 2) have been reclassified to conform with the 2010 financial statements presentation.

Management acknowledges its responsibility for the preparation of the accompanying interim consolidated financial statements, which reflect all adjustments, consisting of normal recurring adjustments, considered necessary, in its opinion, for a fair presentation of its consolidated financial position and the results of its operations for the interim period presented. These consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, as amended.

The accompanying unaudited condensed consolidated  financial statements for China Sky One Medical, Inc. and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

Use of estimates – The preparation of these financial statements in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reported periods.

Significant estimates include values and assigned lives to acquired tangible and intangible assets, uncollectible accounts receivable, impairment testing of goodwill and other long-lived assets, the valuation allowance for income taxes, and the evaluation and estimate for contingencies.  Actual results may differ from these estimates.

Earnings per share - Basic earnings per common share is computed by dividing net earnings applicable to common shareholders by the weighted-average number of common shares outstanding during the period. When applicable, diluted earnings per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that might be issued upon exercise of common stock options and warrants.

10

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Potential common shares issued are calculated using the treasury stock method, which recognizes the use of proceeds that could be obtained upon the exercise of options and warrants in computing diluted earnings per share. It assumes that such proceeds would be used to purchase common stock at the average market price of the common stock during the period.

Cash and cash equivalents – TheCompany considers all highly liquid instruments purchased with a maturity period of three months or less to be cash equivalents. The carrying amounts reported in the accompanying consolidated balance sheets for cash and cash equivalents approximate their fair value.

A significant amount of the Company’s cash and cash equivalents are held in commercial bank checking accounts in the PRC and earn interest income (annual yield of approximately 0.36% for the year ended December 31, 2009, and the nine months ended September 30, 2010). For all the bank accounts in the PRC and in the U.S., the Company earned interest income of approximately $93,000 and $69,000 for the nine months ended September 30, 2010 and 2009, respectively. Management believes it is beneficial to retain sufficient cash in checking accounts so it is readily available for working capital and general corporate purposes, and to fund potential business and asset acquisitions and other opportunities which may arise.

Accounts receivable – Accounts receivable are stated at net realizable value, net of an allowance for doubtful accounts. The allowance for estimated bad debts is based upon the periodic analysis of individual customer balances including an evaluation of days of sales outstanding, payment history, recent payment trends, and perceived credit worthiness. As of September 30, 2010 and December 31, 2009, the Company’s allowance for doubtful accounts was $56,000.

Inventories – Inventories include finished goods, raw materials, freight-in, packing materials, labor, and overhead costs and are valued at the lower of cost or market using the first-in, first-out method. Inventory units are valued using the weighted average method. Provisions are made for slow moving, obsolete and/or damaged inventory based upon the periodic analysis of individual inventory items including an evaluation of historical usage and/or movement, age, expiration date, and general conditions. The Company recorded no inventory reserve position as of September 30, 2010 and December 31, 2009.

Property and equipment – Property and equipment are stated at historical cost less accumulated depreciation. Depreciation on property and equipment is provided using the straight-line method over the estimated useful lives of the assets. The Company uses an estimated residual value of 5% of cost, or valuation for both financial and income tax reporting purposes. The estimated lengths of the useful lives of the Company’s property and equipment are as follows:

Building and Improvements	30 years
Land use rights	50 years
Furniture & Equipment	5 to 7 years
Transportation Equipment	5 to 15 years
Machinery and Equipment	7 to 14 years

11

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Expenditures for renewals and betterments are capitalized while repairs and maintenance costs are charged to the consolidated statement of operations in the year in which they were incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset. Upon sale or disposal of an asset, the historical cost and related accumulated depreciation or amortization of such asset is removed from their respective accounts, and any gain or loss is recorded in the consolidated statements of operations.

Property and equipment are evaluated for impairment in value whenever an event or change in circumstances indicates that the carrying values may not be recoverable. If such an event or change in circumstances occurs and potential impairment is indicated because the carrying value exceeds the estimated future undiscounted cash flows of the asset, the Company will measure the impairment loss as the amount by which the carrying value of the asset exceeds its fair value. The Company did not record any impairment charges of property and equipment in the three or nine months ended September 30, 2010 and 2009.

Construction-in-progress – Properties currently under development are accounted for as construction-in-progress. Construction-in-progress includes the acquisition and land right costs, development expenditures, professional fees, and capitalized interest costs during the period of construction.

Upon completion and readiness for use of the project, the cost of construction-in-progress is transferred as part of property and equipment. In the case of construction-in-progress, management takes into consideration the estimated cost to complete the project when making the lower of cost or market calculation.

Intangible assets – Intangible assets are accounted for in accordance with ASC topic 350, “Intangibles – Goodwill and Other.” Intangible assets with finite useful lives are amortized while intangible assets with indefinite useful lives are not amortized. The Company reviews its long-lived assets and finite-lived intangible assets for impairment on at least an annual basis or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. To determine recoverability of its long-lived assets, the Company evaluates the probability that future undiscounted net cash flows will be less than the carrying amount of the assets. Impairment costs, if any, are measured by comparing the carrying amount of the related assets to their fair value. The Company recognizes an impairment loss based on the excess of the carrying amount of the assets over their respective fair values. Fair value is determined by the use of undiscounted future cash flows, independent appraisals or other appropriate methods. The Company did not record any impairment charges in the three or nine months ended September 30, 2010 and 2009.

The Company’s intangible assets consist of proprietary technologies, SFDA licenses for drug batch numbers, and goodwill. Proprietary technologies are technologies that the Company owns. The SFDA licenses for drug batch numbers and goodwill were acquired in the business acquisitions of Tianlong, Peng Lai and Haina. The Company has registered “Kang Xi” as the Company’s trademark, which is used for all of the Company’s Tradition Chinese Medicine (“TCM”) products. The “Kang Xi” trademark was developed internally and registered by TDR before the Company became a public company. The Company’s cost basis in the trademark is nominal. Therefore, the Company did not have its “Kang Xi” trademark appraised, or recorded an intangible asset for it. Additionally, none of the costs associated with the trademark have been capitalized. As of September 30, 2010, the weighted average amortization period for the Company’s intangible assets is approximately 7.5 years.

12

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Derivative Instruments – The Class A Warrants (“the Warrants”) issued in connection with the private placement the Company consummated on January 31, 2008 include a reset provision triggered if the Company issues common shares below the exercise price of $12.50 as defined under the Warrant Agreement. Effective January 1, 2009 the reset provision of these warrants preclude equity accounting treatment under ASC 815 (formerly EITF 07-05). Accordingly, effective January 1, 2009, the Company was required to reclassify the Warrants at their fair value to liabilities each reporting period under ASC 815-40. At September 30, 2010, the fair value of the Company’s derivative warrants liability was $1,716,000. The Company used the Monte Carlo valuation model to estimate the fair value of the Warrants. Significant assumptions used at September 30, 2010 include a term of approximately 3.4 years; volatility of 69.0% and a risk free interest rate of 0.84%. At September 30, 2009, the fair value of the Company’s derivative warrants liability was $5,323,000. Significant assumptions used at September 30, 2009 include a term of approximately 3.7 years; volatility of 67.0% and a risk free interest rate of 1.97%.  Changes in fair value of these warrants are recognized in earnings each reporting period.

Foreign Currency - The Company’s principal country of operations is in the PRC. The financial position and results of operations of the Company are recorded in Renminbi (“RMB”) as the functional currency. The results of operations denominated in foreign currency are translated at the average rate of exchange during the reporting period. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the market rate of exchange at that date. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of the capital contribution. All translation adjustments resulting from the translation of the financial statements into U.S. Dollars are recorded as accumulated other comprehensive income, a component of stockholders’ equity. At September 30, 2010 the exchange rate was 6.70 RMB to one U.S. dollar compared to 6.84 RMB to one U.S. dollar at December 31, 2009. For the nine months ended September 30, 2010, the average exchange rate was 6.82 RMB to one U.S. dollar compared to 6.84 RMB to one U.S. dollar for the same period of 2009.

Revenue recognition - Revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. The Company believes that all of these criteria are satisfied upon shipment from its facilities. Historically, the Company’s estimated returns, allowances and claims have been deemed immaterial. The Company’s sale agreements only allow a return if the product has quality related issues. In such event, the Company accepts the return for equivalent product exchange from inventory only. The Company’s revenues do not include multiple deliverable arrangements.

The Company occasionally applies to various government agencies for research grants. Revenue from such research grants is recognized when earned. In situations where the Company receives payment in advance for the performance of research and development services, such amounts are deferred and recognized as revenue as the related services are performed.  

13

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Research and development - Research and development expenses include the costs associated with the Company’s internal research and development as well as research and development conducted by third parties. These costs primarily consist of salaries, clinical trials, outside consultants, and materials. All research and development costs are expensed as incurred.

Third-party expenses reimbursed under non-refundable research and development contracts are recorded as a reduction to research and development expense in the consolidated statement of operations.

The Company recognizes in-process research and development in accordance with ASC topic 730, “Research and Development.” Assets to be used in research and development activities, specifically, compounds that have yet to receive new drug approval and would have no alternative use, should approval not be given, are immediately charged to expense when acquired. Certain assets and other technologies acquired that has foreseeable future cash flows are capitalized as intangible assets. Such intangible assets are amortized starting from the year revenue is generated and amortized over the estimated stream of revenues derived from the product sale. Should under any circumstances these capitalized intangible assets have no future benefit; the Company will record an immediate write-off for the remaining net carrying value within the consolidated statement of operations.

The Company incurred research and development expenses of approximately $5,592,000 and $4,885,000, for the three months ended September 30, 2010 and 2009, respectively, and $15,266,000 and $10,980,000, for the nine months ended September 30, 2010 and 2009, respectively.

Advertising – TheCompany signs contracts with agents who then place its advertising in the mediums of television, radio and internet. Advertising expense is incurred in the period the advertisements take place. Thus, costs of advertising are expensed as incurred. Advertising costs were approximately $6,084,000 and $5,031,000 for the three months ended September 30, 2010 and 2009, respectively, and $12,480,000 and $11,245,000 for the nine months ended September 30, 2010 and 2009, respectively. An immaterial amount of the Company’s advertisement expenses were related to advertising production costs. Advertising costs are reported as part of selling expenses in the consolidated statements of operations.

Taxation – The Company uses the asset and liability method of accounting for deferred income taxes. The Company’s provision for income taxes includes income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. The Company records liabilities for income tax contingencies based on the Company’s best estimate of the underlying exposures.

The Company periodically estimates its tax obligations using historical experience in tax jurisdictions and informed judgments. There are inherent uncertainties related to the interpretation of tax regulations in the jurisdictions in which the Company transacts business. The judgments and estimates may change based on the outcome of tax audits, as well as changes to, or further interpretations of, regulations. The Company adjusts income tax expense in the period in which these events occur.

Provision for the PRC enterprise income tax is calculated at the prevailing rate based on the estimated assessable profits less available tax relief for losses brought forward.The Company does not accrue taxes on unremitted earnings from foreign operations as it is the Company’s intention to invest these earnings in the foreign operations indefinitely.

14

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Enterprise income tax

According to “Enterprise Income Tax and Certain Preferential Policies Notice” published by the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise is authorized by the State Council as a special entity, the enterprise income tax rate is reduced to 15%. The following table sets forth the Company’s income tax rate for TDR and its subsidiaries for the nine months ended September 30, 2010 and 2009:

Income Tax Rate	As of September 30,
for Subsidiaries	2010			2009
TDR		15	%		15	%
First		15	%		15	%
Tianlong		15	%		15	%
Haina		25	%		25	%
Peng Lai	2% of Revenue		*	2% of Revenue		*

* Reflects a 25% tax rate on 8% of Peng Lai’s revenue, regardless of its taxable income. As authorized by Peng Lai Municipal Tax Bureau, Peng Lai was not required to pay tax on the remaining 92% of revenue.

Value added tax

The Provisional Regulations of PRC Concerning Value Added Tax promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the PRC Concerning Value Added Tax, value added tax is imposed on goods sold in, or imported into, the PRC and on processing, repair and replacement services provided within the PRC.

Value added tax payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of value added tax included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year.

According to “Agriculture Product Value Added Tax Rate Adjustment and Certain Items’ Value Added Tax Waiver” published by the Ministry of Finance and the National Tax Affairs Bureau, the value added tax for agriculture related products is to be taxed at 13%. Furthermore, traditional Chinese medicine and medicinal plant are by definition agriculture related products.

The Company may from time-to-time be assessed interest or penalties by major tax jurisdictions, although such assessments historically have been minimal and immaterial to the Company’s financial results. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

15

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company files corporate income tax returns in the U.S. for China Sky One and ACPG. ACPG wholly owns 100% of TDR and subsidiaries in the PRC. China Sky One and ACPG are holding companies and do not generate business revenues and management’s intent is not to distribute dividend income from TDR and subsidiaries to either China Sky One or ACPG. As such, management has established a full valuation allowance for the net operating losses incurred by China Sky One and ACPG. The Company files income tax returns in the PRC for TDR and its subsidiaries.

Comprehensive income – Comprehensive income consists of net income and other gains and losses affecting stockholders’ equity that, under generally accepted accounting principles are excluded from net income. For the Company, such items consist entirely of foreign currency translation gains and losses.

Retirement benefit costs – According to the PRC regulations on pension plans, the Company contributes to a defined contribution retirement plan organized by municipal government in the province in which the Company is registered and all qualified employees as defined by statutory regulations are eligible to participate in the plan.

Contributions to the pension or retirement plan are calculated at 22% of the employees’ salaries above a fixed threshold amount. The employees contribute between 2% to 8% to the pension plan, and the Company contributes the balance. The Company has no other material obligations for the payment of retirement benefits beyond the annual contributions under this plan. The Company paid retirement benefit costs of $92,000 and $36,000 for the three months ended September 30, 2010 and 2009, respectively, and $208,000 and $126,000 for the nine months ended September 30, 2010 and 2009, respectively.

Fair value of financial instruments – The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, and other payables approximate their fair values at September 30, 2010 and December 31, 2009 because of the relatively short-term maturity of these instruments.

Subsequent Events

The Company evaluated subsequent events through the date of filing of this Form 10-Q in accordance with the Subsequent Events Topic of the FASB Accounting Standards Codification under ASC topic 855.

Recent accounting pronouncements

The Financial Accounting Standards Board (“FASB”) has codified a single source of authoritative nongovernmental U.S. GAAP, the “Accounting Standards Codification”   (the “Codification” or “ASC”). While the Codification does not change U.S. GAAP, it introduces a new structure that is organized in an easily accessible, user-friendly on-line research system. The Codification supersedes all existing accounting standards documents. All other accounting literature not included in the Codification will be considered non-authoritative. Unless needed to clarify a point to readers, the Company will refrain from citing specific section references when discussing application of accounting principles or addressing new or pending accounting rule changes.

16

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

In April 2010, the FASB issued Accounting Standard Update (“ASU”) 2010-17, Revenue Recognition – Milestone Method, which amended guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration that is contingent upon achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive.

The consideration earned by achieving the milestone should:

1. Be commensurate with either of the following:

a.	The vendor’s performance to achieve the milestone; or
b.	The enhancement of the value of the item delivered as a result of a specific outcome resulting from the vendor’s  performance to achieve the milestone

2. Relate solely to past performance

3. Be reasonable relative to all deliverables and payment terms in the arrangement.

A milestone should be considered substantive in its entirety. An individual milestone may not be bifurcated. An arrangement may include more than one milestone, and each milestone should be evaluated separately to determine whether the milestone is substantive. Accordingly, an arrangement may contain both substantive and non-substantive milestones.

The amendments in this ASU are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted.  The new accounting guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855); Amendments to Certain Recognition and Disclosure Requirements. This ASU amended the guidance on subsequent events and will no longer require that an SEC filer disclose the date through which subsequent events have been evaluated. The amendment is effective for interim and annual periods ending after June 15, 2010.

4.           Revenue By Product Category and Geographic Region

For the nine months ended September 30, 2010 and 2009, overseas (non-PRC) sales were approximately $5,928,000 and $8,956,000, respectively. For the three months ended September 30, 2010 and 2009, overseas (non-PRC) sales were approximately $2,202,000 and $4,530,000, respectively.

The following table sets forth the Company’s principal product categories based on application type and the approximate amount and percentage of revenue from each of such product categories, during the nine months ended September 30, 2010 and 2009:

17

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

For the Nine Months Ended September 30, ($ in thousands)
	# of Products		2010					# of Products		2009					Variance
Product Category			Sales		% of Sales					Sales		% of Sales
Patches		5	$	24,470		23.1	%		5	$	30,842		30.8	%	$	(6,372	)
Ointments		25		31,013		29.3	%		18		23,563		23.5	%		7,450
Sprays		16		11,772		11.1	%		15		14,486		14.5	%		(2,714	)
Drops		10		8,569		8.1	%		4		4,925		4.9	%		3,644
Diagnostic Kits		3		4,446		4.2	%		3		9,411		9.4	%		(4,965	)
Others		59		25,586		24.2	%		44		17,015		16.9	%		8,571
Total		118	$	105,856		100.0	%		89	$	100,242		100.0	%	$	5,614

Please refer to “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for an analysis on changes in revenue by product category.

5.           Concentrations of Business and Credit Risk

Substantially all of the Company's long-lived assets and business operations are located in the PRC.

The Company maintains certain bank accounts in the PRC which are not protected by FDIC insurance or other insurance. As of September 30, 2010, the Company held approximately $1,071,000 of cash and cash equivalent account balances within the U.S. and all of the deposits were within  the FDIC insurance limits. As of September 30, 2010, the Company had approximately $70,888,000 in China bank deposits, which are not insured.

A significant amount of the Company’s sales are concentrated in China. Accordingly, the Company is susceptible to fluctuations in its business caused by adverse economic conditions in China. Difficult economic conditions in other geographic areas into which the Company may expand may also adversely affect its business, operations and finances.

The Company provides credit in the normal course of business. The Company performs ongoing credit evaluations of its customers and maintains allowances for doubtful accounts based on factors surrounding the credit risk of specific customers, historical trends, and other information.

The Company does not require collateral for financial instruments subject to credit risk.

The Company is self-insured for all risks and carries no liability or property insurance coverage of any kind. The Company does not set aside any reserves for product liability risks or other potential claims. The Company’s policy is to record losses associated with its lack of insurance coverage at such time as a realized loss is incurred. Historically, the Company has not had any material losses in connection with its lack of insurance coverage and was not party to any material pending legal proceedings as of September 30, 2010. Management’s intention is to use the Company’s working capital to fund any such losses incurred due to the Company’s exposure to inadequate insurance coverage.

18

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Payments of dividends may be subject to some restrictions due to the Company’s operating subsidiaries all being located in the PRC.

Major Customers

For the nine months ended September 30, 2010, no customer accounted for more than 10% of the Company’s total revenues. For the nine months ended September 30, 2009, Harbin Shiji Baolong and Shanxi Xintai accounted for 14% and 13% respectively of sales revenues. At September 30, 2010, no customer accounted for 10% or more of the Company’s accounts receivable. At September 30, 2009, Harbin Shiji Baolong accounted for 25% of accounts receivable. No other customers accounted for 10% or more of the Company’s total revenues or accounts receivable for the nine months ended September 30, 2010 and 2009. During the third quarter of 2010, Harbin Shiji Baolong, a domestic distributor, and Hangzhou Jiupin, an overseas sales agent, terminated their business relationships with the Company. These two customers accounted for 12% and 24% of the Company’s total revenue for the nine months ended September 30, 2010 and 2009, respectively. For the three months ended September 30, 2010, these two customers did not account for any of the Company’s revenues. For the three months ended September 30, 2009, these two customers accounted for 22% of the Company’s total revenue. The Company expects to replace these customers with new relationships over time.

Major Suppliers

For the nine months ended September 30, 2010, Heilongjiang Kangda Medicine Company, Shenzhen Hongyuan Plastic Packaging Company, and Harbin Zhongjia Chemical Company accounted for approximately 45%, 11%, and 11% of the Company’s total inventory purchases, respectively.  For the nine months ended September 30, 2009, Heilongjiang Kangda Medicine Co. and Harbin Zhongjia Chemical Company accounted for approximately 40% and 16% respectively of the Company’s inventory purchases. No other suppliers accounted for 10% or more of the Company’s total inventory purchases for the nine months ended September 30, 2010 and 2009. The Company believes alternative local suppliers are available to meet the Company’s fulfillment needs if necessary. Therefore, the Company does not believe it is substantially dependent on any specific supplier.

6.           Earnings Per Share

The Company has applied SFAS No. 128, “Earnings Per Share” in the Company’s calculation and presentation of earnings per share - “basic” and “diluted”. Basic earnings per share are computed by dividing net earnings  available to common shareholders (the numerator) by the weighted average number of common shares (the denominator) for the period presented. The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.

Warrants to purchase 593,800 shares of common stock and no stock options to purchase shares of common stock were outstanding and exercisable as of September 30, 2010. Warrants to purchase 750,000 shares of common stock were exercisable and outstanding as of September 30, 2009. These common stock equivalents were included in the computation of diluted earnings per share only if the option exercise prices were less than the average market price of the Company’s common stock during these periods.

19

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The dilutive potential common shares on warrants and options is calculated in accordance with the treasury stock method, which assumes that proceeds from the exercise of all warrants and options are used to repurchase common stock at the average market price of the common stock during the relevant period. The amount of shares remaining after the proceeds are exhausted represent s the potential dilutive effect of the securities.

The following table sets forth the Company’s computation of basic and diluted net income per share for the three months ended September 30, 2010 and 2009:

	For the three months ended  September 30, ($ in thousands, except share and per share data)
	2010			2009 (restated)
Numerator:
Net income used in calculation of basic and diluted earnings per share	$	8,595	*	$	12,590	**
Denominator:
Weighted-average common shares outstanding used in calculation of basic earnings per share		16,790,851			16,655,697
Effect of dilutive securities:
Warrants and Options		-			86,048
Weighted-average common shares used in calculation of diluted earnings per share		16,790,851			16,741,745
Net income per share:
Basic	$	0.51		$	0.76
Diluted	$	0.51		$	0.75

*  Includes a gain of $1,833 and $0.11 per share (basic and diluted) relating to the change  in fair value of  the  derivative warrant liability relating to the Class A Warrants.

** Includes a gain of $132 and $0.008 per share (basic and diluted) relating to the change in fair value of the derivative warrant liability relating to the Class A Warrants.

20

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following table sets forth the Company’s computation of basic and diluted net income per share for the nine months ended September 30, 2010 and 2009:

	For the nine months ended September30, ($ in thousands, except share and per share data)
	2010			2009 (restated)
Numerator:
Net income used in calculation of basic and diluted earnings per share	$	33,426	*	$	30,464	**
Denominator:
Weighted-average common shares outstanding used in calculation of basic earnings per share		16,786,240			16,535,924
Effect of dilutive securities:
Warrants and Options		39,054			70,652
Weighted-average common shares used in calculation of diluted earnings per share		16,825,294			16,606,576
Net income per share:
Basic	$	1.99		$	1.84
Diluted	$	1.99		$	1.83

*  Includes a gain of $8,847 and $0.53 per share (basic and diluted) relating to the change  in fair value of  the  derivative warrant liability relating to the Class A Warrants.

** Includes a gain of $1,305 and $0.08 per share (basic and diluted) relating to the change in fair value of the derivative warrant liability relating to the Class A Warrants.

7.           Equity and Share-based Compensation

Compensation cost for all stock-based compensation awards granted is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Under the fair value recognition provisions of SFAS No. 123R, the Company recognizes stock-based compensation net of an estimated forfeiture rate and only recognizes compensation cost for those shares expected to vest on a straight-line prorated basis over the requisite service period of the award.

In July 2006, the Company’s stockholders approved the 2006 Stock Incentive Plan (the “2006 Plan”). The 2006 Plan, provides for the grant of stock options, restricted stock awards, and performance shares to qualified employees, officers, directors, consultants and other service providers. The 2006 Plan originally authorized the Company to grant options and/or rights to purchase up to an aggregate of 1,500,000 shares of common stock. As of September 30, 2010, awards of an aggregate of 226,407 common shares have been granted pursuant to the 2006 Plan to Company’s employees and consultants.

21

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

8.           Securities Purchase Agreement and Related Transaction

On January 31, 2008 (the “Closing Date”), the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain accredited investors (the “Investors”), for the purchase and sale of units consisting of an aggregate of: (i) 2,500,000 shares of the Company’s common stock, and (ii) Class A Warrants to purchase 750,000 additional shares of the Company’s common stock exercisable at $12.50 per share, and expiring on July 31, 2011 (the “Class A Warrants”), for a purchase price of $10.00 per unit (the “Unit Purchase Price”), or gross offering proceeds of $25.0 million (the “2008 Offering”). The Company received net proceeds of approximately $23.5 million in connection with the 2008 Offering.

Pursuant to the Purchase Agreement, among other things, if, and whenever, within twelve (12) months of the Closing Date, the Company issued or sold, or was deemed to have issued or sold, any shares of common stock, or securities convertible into or exercisable for shares of common stock, or modified any of the foregoing which may be outstanding (with the exception of certain excluded securities), to any person or entity at a price per share, or conversion or exercise price per share less than the Unit Purchase Price, then the Company would have been required to issue, for each such occasion, additional shares of its common stock to the Investors in such number so that the average per share purchase price of the shares of common stock purchased by the Investors in the 2008 Offering would have automatically been reduced to such other lower price per share. This right expired on January 30, 2009.

In addition, as of the Closing Date, the Company entered into a Make Good Agreement (the “Make Good Agreement”) with Liu Yan-qing, its Chairman, Chief Executive Officer and President, and a principal shareholder of the Company, (the “Principal Shareholder”) and the Investors (collectively, the “Make Good Parties”), pursuant to which the Principal Shareholder deposited 3,000,000 shares of his common stock of the Company (the “Escrow Shares”) into escrow, to be released to the Investors in an amount pro rata pro to their initial investments in the 2008 Offering, in the event the Company failed to attain earnings per share, as adjusted, of at least (i) $1.05 per share for the fiscal year ending December 31, 2007 (based on an aggregate of 13,907,696 shares outstanding), and/or (ii) $1.63 per share for the fiscal year ending December 31, 2008 (based on 16,907,696 shares outstanding).

The Company deemed the Escrow Shares arrangement as analogous to the issuance of a fixed number of warrants in an equity transaction. Under the Make Good Agreement these Escrow Shares would have been  reallocated on a pro rata basis to the Investors only if certain earnings targets were not achieved in years 2007 and 2008. If the earnings targets were met, the Escrow Shares would automatically have been released to the Principal Shareholder. As of January 31, 2008, the date the common shares were placed into escrow, the Company achieved the 2007 earnings target and, based upon internal forecasts, was confident the 2008 target would also be met. Based upon certain assumptions, including the low probability that the Escrow Shares would be released to the Investors and not be returned to the Principal Shareholder, the Company considered the fair value of the right held by the Investors through the Escrow Shares provision under the Make Good Agreement to be immaterial. As of December 31, 2008, the Company satisfied the earnings per common share targets for each of fiscal 2007 and 2008 as defined under the Make Good Agreement and, as such, the Escrow Shares were released to the Principal Shareholder in 2009.

In connection with the 2008 Offering, the Company and the Investors entered into a Put Agreement whereby the Investors were granted the right, but not the obligation, to require the Company to repurchase certain common shares issued under the Purchase Agreement at $10.00 per share (the Unit Purchase Price). The Investors could only exercise their Put Right in the event that either:

22

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. the Adjusted EPS of the Company for the fiscal year ending December 31, 2007 was less than $0.80 per share, as set forth in the fiscal year 2007 audited financial statements; or

2. the Company’s accounts receivable exceeded $12.0 million at December 31, 2007, as set forth in the fiscal year 2007 audited financial statements.

As of the Closing Date, based on preliminary financial results for the fiscal year ended December 31, 2007, the Company determined that the events triggering the Investors’ put right did not occur and that the put right would expire unexercised on or prior to March 31, 2008 (the date the Company’s Form 10-KSB was required to be filed with the SEC). Based upon these preliminary results, the Company determined that the value of the put obligation was immaterial and did not record it as a liability. Both of the targets were met upon the filing of the Company’s  Annual Report on Form 10-K for the year ended December 31, 2007 on March 31, 2008, and the Investors’ rights under the Put Agreement were terminated unexercised.

Additional information relating to the Class A Warrants is provided in Note 9.

9.         Outstanding Warrants and Options

The following table summarizes information about stock warrants outstanding and exercisable as of September 30, 2010:

				Weighted				Weighted
				average				average
	Shares			Exercise		Shares		Exercise
	Underlying			Price		underlying		Price
	Warrants			Warrants		Options		Options
Outstanding as of September 30, 2009		750,000		$	12.50		-	$	-
Exercised		-			-		-		-
Outstanding as of December 31, 2009		750,000			12.50		-		-
Exercised		(156,200	)		12.50		-		-
Outstanding as of September 30, 2010		593,800		$	12.50		-	$	-

 As of December 31, 2009, the Class A Warrants granted in connection the Securities Purchase Agreement represented the right to purchase an aggregate of 750,000 shares of Common Stock of the Company, at an exercise price of $12.50 per share. In addition, the Class A Warrants have the following characteristics:

• The Class A Warrants became exercisable beginning on the six-month anniversary of the closing of the January 2008 Offering and will expire July 31, 2011 (subject to extension as described below).

23

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

• Commencing on the one-year anniversary of the Closing Date, in the event the Warrant Shares are not freely salable by the holders of the Class A Warrants due to the Company’s failure to satisfy its registration requirements and an exemption for such sale is not otherwise available to the Warrantholders under Rule 144, the Class A Warrants will be exercisable on a cashless basis.

• The Exercise Price and number of Warrant Shares are subject to adjustment for standard dilutive events, such as dividends or distributions on the Company’s common stock paid in shares of common stock, reclassifications or reorganizations of the common stock, distributions of indebtedness or assets (other than cash) to all holders of the common stock, a merger or consolidation with another corporation in which the Company is not the survivor, or sale, transfer or other distribution of all or substantially all of the Company’s assets to another corporation to prevent dilution to the holders of the Class A Warrants as a result of such event.  The Exercise Price is also subject to adjustment on a weighted-average basis for issuance of common stock, or securities convertible into or exercisable for shares of common stock, at a price per share, or conversion or exercise price per share less than the Class A Warrant exercise price of $12.50 per share (a “Trigger Issuance”).  In the event of a Trigger Issuance, the then-existing Exercise Price shall be reduced, as of the close of business on the effective date of the Trigger Issuance, to a price determined as follows:

Adjusted Warrant Price = (A x B) + D

 A+C

  where

“A” equals the number of shares of the Company’s common stock outstanding, including Additional Shares of Common Stock (as defined below) deemed to be issued hereunder, immediately preceding such Trigger Issuance;

“B” equals the Exercise Price in effect immediately preceding such Trigger Issuance;

“C” equals the number of Additional Shares of Common Stock issued or deemed issued hereunder as a result of the Trigger Issuance; and

“D” equals the aggregate consideration, if any, received or deemed to be received by the Company upon such Trigger Issuance;

provided, however, that in no event shall the Exercise Price after giving effect to such Trigger Issuance be greater than the Warrant Price in effect prior to such Trigger Issuance.

For purposes of hereof, “Additional Shares of Common Stock” shall mean all shares of common stock issued by the Company, or deemed to be issued in connection with a the Trigger Issuance, other than certain excluded issuances (as defined in the Class A Warrants).

24

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

In June 2008, the Emerging Issues Task Force issued EITF Consensus 07-05 (“Issue 07-05) “Determining Whether an Instrument (for Embedded Feature) is Indexed to an Entity’s Own Stock”.  Under Issue 07-05, instruments which contain anti-dilution provisions will no longer be considered indexed to a company’s own stock for purposes of determining whether it meets the first part of the scope exception in paragraph 11(a) of SFAS 133.  Issue 07-05 provides new guidance for determining whether equity instruments are indexed to a company’s own stock, and as a result, whether those contracts should be marked-to-market.  Issue 07-05 contains 20 examples illustrating its application.  In particular, Example 8 addresses an exercise price reset feature that is common in many arrangements.  Example 8, concludes that because of the reset feature, the Class A Warrants will no longer be considered indexed to a company’s own stock for purposes of determining whether it meets the first part of the scope exception in paragraph 11(a) of SFAS 133.  The adoption of Issue 07-05 required the Company to (1) evaluate the Class A Warrants contingent exercise provisions and (2) evaluate the instrument’s settlement provisions.  The Company determined that the Class A Warrants are akin to Example 8 of EITF 07-05 and not Example 16 of EITF 07-05, as the anti-dilution provision is designed to protect the holder from issuances below the exercise price (rather than below market price issuances.).

• At anytime following the date a Registration Statement covering the Warrant Shares is declared effective, the Company will have the ability to call the Class A Warrants at a price of $0.01 per Class A Warrant, upon thirty (30) days prior written notice to the holders of the Class A Warrants, provided (i) the closing price of the Common stock exceeded $18.75 for each of the ten (10) consecutive trading days immediately preceding the date that the call notice is given by the Company, and (ii) the Company has attained an Adjusted EPS of at least $1.75 per share for the fiscal year ending December 31, 2008, as set forth in the Company’s audited financial statements of the Company.

• If, among other things, the Company fails to cause a Registration Statement covering the Warrant Shares to be declared effective prior to the applicable dates set forth in the Registration Rights Agreement, the expiration date of the Class A Warrants shall be extended one day for each day beyond the Effectiveness Deadlines.  The registration rights do not require a cash settlement and the Class A Warrants can be settled in unregistered shares.  Therefore, paragraphs 14-18 of EITF 00-19 does not apply to the registration rights associated with the Class A Warrants.  As a result, no liability accounting is required.

During the nine months ended September 30, 2010, the Warrant holders exercised 156,200 warrants including 148,700 warrants exercised on a cashless basis for a total of 69,084 shares of the Company’s common stock, and 7,500 warrants exercised for cash proceeds of $93,750.

At September 30, 2010, the Company had 593,800 Class A Warrants outstanding. The Company used the Monte Carlo valuation model to estimate the fair value of the Class A Warrants. Significant assumptions used at September 30, 2010 include a term of approximately 3.4 years; volatility of 69.0% and a risk free interest rate of 0.84%. The outstanding Class A Warrants at September 30, 2010 had a fair value of approximately $1,716,000. For the nine months ended September 30, 2010, the Company recorded income of $8,847,000 due to the change in fair value of the related derivative warrant liability. For the three months ended September 30, 2010, the Company recorded income of $1,833,000 due to the change in fair value of the related derivative warrant liability.

25

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

At September 30, 2009, the Company had 750,000 Class A Warrants outstanding. The Company used the Monte Carlo valuation model to estimate the fair value of the Class A Warrants. Significant assumptions used at September 30, 2009 include a term of approximately 3.7 years; volatility of 67.0% and a risk free interest rate of 1.97%.The outstanding Class A Warrants at September 30, 2009 had a fair value of approximately $5,323,000. For the nine months ended September 30, 2009, the Company recorded income of $1,305,000 due to the change in fair value of the related derivative warrant liability. For the three months ended September 30, 2009, the Company recorded income of $132,000 due to the change in fair value of the related derivative warrant liability.

On September 29, 2010, the Company filed a Form S-3 registration statement with the SEC to register 1,004,009 issued and outstanding common shares and the 593,800 common shares underlying the Company’s outstanding Class A Warrants issued in connection with the 2008 Offering.

10.      Inventories

The Company values its inventories at the lower of cost and market method. Inventories are accounted for using the first-in, first-out method. Inventories include packing materials, raw materials, supplemental materials, work-in-process, and finished products.

As of September 30, 2010 and December 31, 2009, inventories consisted of the following:

	($ in thousands)
	September 30, 2010 (Unaudited)		December 31, 2009
Raw Material	$	2,176	$	1,192
Work-in-Process		693		578
Finished Products		1,442		642
Total Inventories	$	4,311	$	2,413

Historically, the Company’s inventory is at its lowest levels at the end of each calendar year and in the first fiscal quarter. The Company draws down the Company’s inventory levels in December of each year for two main reasons. First, the Company’s customers want to receive goods prior to the holiday season.  In addition, the first calendar quarter is traditionally the Company’s slowest sales period. Since a lower volume of sales activity normally occurs during the first quarter of each calendar year, the Company believes it is prudent to avoid incurring unnecessary inventory carrying costs. At the appropriate time toward the end of the first calendar quarter of each fiscal year, the Company begins to ramp up the Company’s inventory levels to prepare for increased demand during the coming stronger selling periods. Historically, the Company signed agreements with suppliers that allow the Company to hold extra raw materials at the cost of the suppliers. As a result, the Company could minimize the Company’s own inventory carrying costs, and improve the Company’s cash management, by keeping the inventory at the minimum level required to support the short-term sales. However, due to anticipated future price increases of raw materials, in addition to overhead costs for storing such raw materials, the Company started to increase the inventory levels at the Company’s own cost from the end of 2009.

26

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Management calculates its inventory turnover rate using total inventory rather than just finished goods, because its production cycle is of an extremely short duration. The inventory turnover rate is further discussed in the Liquidity section in the  Management’s Discussion and Analysis.

11.      Property and Equipment, net

As of September 30, 2010 and December 31, 2009, Property and Equipment, net, consisted of the following:

	($ in thousands)
	September 30,
	2010 (Unaudited)			December 31, 2009
Buildings and improvements	$	11,326		$	10,570
Machinery and equipment		5,878			5,868
Transportation equipment		979			955
Furniture and equipment		385			325
Total Property and Equipment		18,568			17,718
Less: Accumulated Depreciation		(3,063	)		(2,227	)
Property and Equipment, Net	$	15,505		$	15,491

For the nine months ended September 30, 2010 and 2009, depreciation expense totaled $776,000 and $736,000, respectively.

Depreciation expense included within Cost of Goods Sold for the nine months ended September 30, 2010 and 2009 amounted to $348,000 and $405,000, respectively.

12.      Intangible Assets, net

Intangible assets consists of proprietary technologies that the Company purchased during the Company’s normal course of business. The SFDA licenses for drug batch numbers and goodwill were acquired in connection with the Company’s business acquisitions of Tianlong and Peng Lai in 2008.

27

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

A breakdown of the Company’s intangible assets, net, by subsidiaries as of September 30, 2010 is as follows:

	Intangible Assets as of September 30, 2010, net ($ in thousands) (Unaudited)
Item	TDR		Haina		Tianlong		First		Peng Lai		Total
Proprietary Technologies	$	1,187	$	-	$	4,746	$	11,071	$	-	$	17,004
SFDA licenses for drug batch numbers		-		-		1,627		-		4,144		5,771
Goodwill		415		361		-		-		-		776
Total	$	1,602	$	361	$	6,373	$	11,071	$	4,144	$	23,551

 A breakdown of the Company’s intangible assets, net by subsidiaries as of December 31, 2009 is as follows:

	Intangible Assets as of December 31, 2009, net ($ in thousands)
Item	TDR		Haina		Tianlong		First		Peng Lai		Total
Proprietary Technologies	$	1,275	$	-	$	5,034	$	11,854	$	-	$	18,163
SFDA licenses for drug batch numbers		-		-		1,751		-		4,441		6,192
Goodwill		406		353		-		-		-		759
Total	$	1,681	$	353	$	6,785	$	11,854	$	4,441	$	25,114

Historically, the Company included its proprietary technologies and SFDA licenses for drug batch numbers under the category of patents.  The Company now believe it is more accurate to categorize such intangible assets in separate categories.

As of September 30, 2010, the weighted average amortization period for the Company’s proprietary technologies and SFDA licenses for drug batch numbers is approximately 7.5 years.

Amortization expense of the Company’s intangible assets with finite lives for each of the nine months ended September 30, 2010 and 2009 was approximately $2,048,000 and $1,017,000, respectively.

13.      Taxes Payable

Taxes payable as of September 30, 2010 and December 31, 2009 consisted of the following:

	($ in thousands)
	September 30, 2010 (Unaudited)		December 31, 2009
Value Added Tax, net	$	1,488	$	1,291
Enterprise Income Tax		2,754		2,452
City Tax		64		43
Other Taxes and additions		51		86
Total Taxes Payable	$	4,357	$	3,873

28

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

14.      Income Taxes

Under the Provisional Regulations of PRC Concerning Income Tax on Enterprises promulgated by the PRC, income tax is payable by enterprises at a rate of 25% of their taxable income. Preferential tax treatment may, however, be granted pursuant to any law or regulations from time to time promulgated by the State Council.

According to “Enterprise Income Tax and Certain Preferential Policies Notice” published by the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise is authorized by the State Council as a special entity, the enterprise income tax rate is reduced to 15%. The following table sets force the income tax rate for TDR and its subsidiaries for the nine months ended September 30, 2010 and 2009:

	As of September 30,
Income Tax Rate	2010			2009
TDR		15	%		15	%
First		15	%		15	%
Tianlong		15	%		15	%
Haina		25	%		25	%
Peng Lai	2% of Revenue		*	2% of Revenue		*

* Reflects a 25% Tax rate on 8% of Peng Lai’s revenue, regardless of its taxable income. As authorized by Peng Lai Municipal Tax Bureau, Peng Lai was not required to pay tax on the remaining 92% of revenue.

All the favorable tax rates for TDR, First, Tianlong and Peng Lai will expire by the end of fiscal year 2010. The Company plans to seek renewal of these favorable tax rates in the fourth quarter of 2010.

The Company records a full valuation allowance to reduce the Company’s deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would be able to realize the Company’s deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.

Pursuant to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of the Company’s net operating losses and tax credit carryforwards may be limited because of cumulative changes in ownership of more than 50% that have occurred. Net operating loss (“NOL”) carryforwards only apply to the Company’s U.S. holding companies because they incurred certain general and administrative costs without generating any revenue and, therefore, suffered a loss. The Company has no current intentions to distribute dividend income from its China-based subsidiaries to the U.S. holding companies.

29

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Therefore, the Company has established a full valuation allowance for the NOL carryforwards incurred by the U.S. holding companies.Provision for the PRC enterprise income tax is calculated at the prevailing rate based on the estimated assessable profits less available tax relief for losses brought forward. The Company does not accrue taxes on unremitted earnings from foreign operations as it is the Company’s intention to invest these earnings in the foreign operations indefinitely.

As of September 30, 2010, the Company has U.S. net operating loss carryforwards of approximately $10 million which will begin to expire in 2029. Accordingly, as mentioned above, any deferred tax asset that would result from these carryforwards have been fully reserved as of September 30, 2010.

During the nine months ended September 30, 2010 and 2009, the Company’s U.S. holding companies recorded income of approximately $8,847,000 and $1,305,000 respectively related to the change in fair value of its derivative warrant liability with a full valuation allowance. Historically, the Company’s U.S. holding companies have incurred ongoing operating losses, since the U.S. holding companies do not generate any revenue. As such, Management has recorded a full valuation  allowance for its net operating loss carryforwards since Management’s position it is more like than not that the future tax benefits associated with the U.S. holding companies operating loss carryforwards will not be realized. The net operating loss carryforwards at September 30, 2010 and 2009, for tax reporting purposes, exceed the income generated from the change in fair value of the derivative warrant liability of $8,847,000 and $1,305,000 for each of the respective periods. Accordingly, management did not record any unrecognized income tax benefits due to the change in fair value of the derivative warrant liability for each of the nine months ended September 30, 2010 and 2009.

The Company’s effective tax rate was approximately 20.8% and 20.9% for the nine month ended September 30, 2010 and 2009, respectively. A reconciliation of  the statutory tax provision to the Company’s tax provision for the nine months ended September 30, 2010 and 2009 is as follows:

	($ in thousands)
	Nine Months Ended September 30, 2010
	China			U.S.			Total
Pre tax income	$	34,336		$	7,877		$	42,213
Effective statutory tax rate		25	%		34	%
Provision for statutory income  tax		8,584			2,678			11,262
Other (Special Entity, etc. )		203			-			203
Full valuation allowance		-			(2,678	)		(2,678	)
Provision for income taxes	$	8,787		$	-		$	8,787
Effective tax rate		25.6	%		-			20.8	%

30

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Pre-tax income generated by business operations in China during the nine months ended September 30, 2010 were derived from Haina’s business operations which are taxed at a rate of 25%. During the nine months ended September 30, 2010, First incurred an operating loss of approximately $4,351,000, which reduced China’s consolidated Pre Tax Income, and in turn increased China’s effective tax rate.

	($ in thousands - Restated)
	Nine Months Ended September 30, 2009
	China			U.S.			Total
Pre tax income	$	37,835		$	679		$	38,514
Effective statutory tax rate		25	%		34	%
Provision for statutory income  tax		9,459			230			9,689
Other (Special Entity, etc. )		(1,409	)		-			(1,409	)
Full valuation allowance		-			(230	)		(230	)
Provision for income taxes	$	8,050		$	-			8,050
Effective tax rate		21.3	%		-			20.9	%

15.      Land Use Rights and Construction in Progress

The Company considers the fact that, in the PRC, there is no land ownership but rather land use rights and it is more appropriate to allocate land use rights under a separate category and amortize land use rights based on 50 years of the land use rights, or the term of the lease. Land use rights, net, are approximately $4,610,000 and $4,586,000 at September 30, 2010 and December 31, 2009, respectively. Amortization expense for land use right were $71,000 and $43,000 for the nine months ended September 30, 2010 and 2009, respectively.

During the second quarter in 2007 TDR entered into an agreement with the Development and Construction Administration Committee of Harbin Song Bei New Development district to purchase the land use rights for 50 years for the development of a new corporate headquarters. The Company spent approximately $9.9 million, $730,000, and $2.1 million in the years of 2009, 2008, and 2007 respectively for this construction in progress. The majority of the construction was completed in January 2010, and the Company moved into the new facilities in January 2010. There was no expenditure for construction in progress during the nine months ended September 30, 2010. Management estimates the additional cost to complete the Company’s construction in progress in 2010 shall amount to approximately $3.0 million, which should be completed within the fourth quarter of 2010.

During the second quarter of 2010, TDR submitted a bid deposit of approximately $7,335,000 to Harbin High Technology Development Zone to participate in an auction for a parcel of land of approximately 85,000 square meters in the Harbin Song Bei District High Technology Zone. The auction is set to take place during the fourth quarter of 2010. If the Company’s bid is accepted, the Company plans to build a facility for the research and development and production of the Company’s bio-engineering projects. If the Company’s bid is not accepted, the deposit will be returned to TDR.

31

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

16.      Commitments and Contingencies

The formulation, manufacturing, processing, packaging, labeling, advertising, distribution and sale of external use Chinese medicine such as those sold by the Company are subject to regulations by one or more federal agencies. The principal federal agencies include the State Food and Drug Administration of the Government of the Peoples Republic of China, the Food and Drug Administration (the “FDA”), Heilongjiang Provincial Food and Drug Administration of the People's Republic of China (PFDA), National Biology Products Inspection Institute (NBPI) and the National Food and Drug Administration (NFDA) of the People's Republic of China and, to a lesser extent, the Consumer Product Safety Commission. These activities are also regulated by various governmental agencies for the countries, states and localities in which the Company’s products are sold.

Although management believes that the Company is in material compliance with the statutes, laws, rules and regulations of every jurisdiction in which it operates, no assurance can be given that the Company’s compliance with the applicable statutes, laws, rules and regulations will not be challenged by governing authorities or private parties, or that such challenges will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

The Company, like any other distributor or manufacturer of products is exposed to the inherent risk of product liability claims in the events of possible injuries caused by the use of its products. The Company does not have liability insurance with respect to product liability claims; the insurance environment of China is neither sufficient nor mature. Inadequate insurance or lack of contractual indemnification from parties supplying raw materials or marketing its products, and product liabilities related to defective products could have a material adverse effect on the consolidated financial statements of the Company.

The Company is not involved in any legal matters arising in the normal course of business at September 30, 2010. While incapable of estimation, in the opinion of the management, the individual regulatory and legal matters in which the Company might be involved in the future are not expected to have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

On September 4, 2009, the SEC issued a formal order of investigation relating to certain of the Company’s accounting, record-keeping and disclosure practices. The Company has received document and testimonial subpoenas from the SEC and has complied, and intends to continue to comply, with all requests for information.

17.      Fair Value Measurements

The FASB Accounting Standards Codification Topic 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and inputs other then quoted market prices that are observable.

32

China Sky One Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

As of September 30, 2010, the Company had only financial liabilities which were measured at fair value on a recurring basis using significant Level 3 inputs. These financial liabilities as of September 30, 2010 and December 31, 2009 are classified in the table below ($ in thousands):

September 30, 2010
	Level 1:		Level 2:		Level 3:
	Quoted Prices		Significant Other		Significant			Total at
	in Active Markets		Observable		Unobservable			September
Description	for Identical Assets		Inputs		Inputs			30, 2010
Liabilities:
Derivative Class A Warrants	-		-		(1,716		)		(1,716	)
Total		-		-		(1,716	)		(1,716	)

December 31, 2009
	Level 1:		Level 2:		Level 3:
	Quoted Prices		Significant Other		Significant			Total at
	in Active Markets		Observable		Unobservable			September
Description	for Identical Assets		Inputs		Inputs			30, 2010
Liabilities:
Derivative Class A Warrants	-		-		(11,435		)		(11,435	)
Total		-		-		(11,435	)		(11,435	)

The fair value of derivative instruments is provided by the use of an independent third party valuation expert. Certain derivatives with limited marketing activity are valued using externally developed models that consider unobservable market parameters (see Note 9).

The following table provides a roll-forward reconciliation of the beginning balance at December 31, 2009 and the ending balance at September 30, 2010 of the derivative Class A Warrants liability measured at fair value using significant Level 3 inputs ($ in thousands):

	Derivative Liability
Balance at  December 31, 2009		(11,435	)
Unrealized gains included in earnings		4,926
Settlements		873
Balance at March 31, 2010		(5,636	)
Unrealized gains included in earnings		2,087
Balance at June 30, 2010		(3,549	)
Unrealized gains Included in earnings		1,833
Balance at September 30, 2010		(1,716	)

33

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD LOOKING STATEMENTS

The following discussion should be read in conjunction with the information contained in our consolidated financial statements and the notes thereto appearing elsewhere herein and in the risk factors and “Forward Looking Statements” summary set forth in the forepart of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, as amended, as well as the “Risk Factors” section above and are afforded the safe harbor provisions of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended. Readers should carefully review the risk factors disclosed in this Annual Report and other documents filed by us with the SEC.

DISCUSSION

General

We are engaged, through our China-based indirect subsidiaries described below, in the development, manufacture, marketing and sale of over-the-counter, branded nutritional supplements and over-the-counter plant and herb-based pharmaceutical and medicinal products. Our principal products are external use TCMs. We have evolved into an integrated manufacturer, marketer and distributor of external-use TCM products sold primarily in the PRC and through Chinese domestic pharmaceutical chains. All of our business is conducted through our wholly-owned subsidiary, ACPG which, in turn, wholly owns Harbin TDR, and TDR’s subsidiaries.

We achieved continuing growth on the sale of our own product line through our sustained efforts to expand our distribution channels and promote our products. However, during the third quarter of 2010, two of our major customers terminated their business relationships with us negatively impacting our revenues and income. We expect to replace these customers with new relationships over time.

For the nine months ended September 30, 2010, total revenues were $105,856,000, compared to $100,242,000 for the nine months ended September 30, 2009. Net income was $33,426,000, or $1.99 per share (basic and diluted) for the nine months ended September 30, 2010, compared to net income of $30,464,000, or $1.83 per share (basic and diluted) in the same period of 2009. For the three months ended September 30, 2010, total revenues were $36,193,000, compared to $43,227,000 for the three months ended September 30, 2009. Net income was $8,595,000, or $0.51 per share (basic and diluted) for the three months ended September 30, 2010, compared to net income of $12,590,000, or $0.76 per share (basic) and $0.75 per share (diluted) in the same period of 2009.

This Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2010 incorporates corrections made in response to the accounting errors described elsewhere in this Form 10-Q and restates our financial statements for the three and nine months ended September 30, 2009 (see Note 2 to the Notes to Condensed Consolidated Financial Statements). The corrections to the quarterly information in this Form 10-Q had no impact on our previously reported income from operations or cash flows for the periods being restated.

34

Product Line

During  the nine months ended September 30, 2010, we manufactured and marketed 118 products, compared to 89 products for the nine months ended September 30, 2009. Our manufacturing operations are conducted at our subsidiaries’ facilities located in Heilongjiang Province and Shan Dong Province in the PRC. We sell our products under five main categories:

Product Category	2010		2009
Patches		5		5
Ointments		25		18
Sprays		16		15
Drops		10		4
Diagnostic Kits		3		3
Others		59		44
Total:		118		89

            A description of our principle products, which generated a majority of our sales revenue for the nine months ended September 30, 2010 is as follows:

Patch Category:

Sumei Slim Patch

The Sumei Slim Patch is marketed and sold within and outside the PRC as a more natural treatment to lose weight.  The Sumei Slim Patch uses Saponin as its major ingredient, and is effective in regulating and restraining the excessive secretion of certain hormones, while promoting others to foster weight loss as well as prevent weight gain.

Pain Relief  Patch

A pain relief patch is designed to apply to the area of neck, shoulder, and waist.  The patch is used for a number of ailments, including fever, headache, heart dysentery, diarrhea, and stiffness and pain caused by hypertension.

Anti-Hypertension Patch

The anti-hypertension patch is based on five thousand years of Chinese herbal vein therapy that has been adapted to a modern transdermal therapeutic system (“TTS”).  The product utilizes a Body-Yong-Guan point technique, which is believed to maximize the effectiveness of the medicinal ingredients.  The product is believed to stimulate blood capillaries and to be effective in improving circulation and reducing blood pressure.

QiXue Asthma Patch

QiXue asthma patch is designed for the treatment of chronic airways and lung inflammation.

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Ointment Category:

Hemorrhoids Ointment

This product contains Acetate, Radix Notoginseng, and Rhizoma Coptidis.  It is made in soft ointment form that is effective in sterilizing and relieving hemorrhoid symptoms, including itching, distending pain, burning, and bleeding.

Compound Camphor Cream

This product is for the treatment of various pathogens on the skin surface and subcutaneously, such as mycete, trichopytic, staphylococcal bacteria aureus, bacillus coli, and candida albicans (thrush).

Kecuo Yintong Ointment

This product is designed to regulate sebum secretion and to prevent acne outbreaks.

Spray Category:

Stomatitis Spray

This spray is used for the treatment of  dental ulcers, pharyngitis, and faucitis.  It is made with pure herbal medicines and, thus, has  minimum side effects to human bodies.

Drops Category:

Naphazoline Hydrochloride Eye Drops

Naphazoline Hydrochloride Eye Drops are recommended for the temporary relief of eye redness associated with minor irritations.  This product can comfort the eyes by lubricating them and relieving such irritations.

Lomefloxacin Hydrochloride Eye Drops

Lomefloxacin Hydrochloride Eye Drops are used for the treatment of acute and chronic bacterial conjunctivitis, marginalis, meibomian gland, dacryocystisis and keratitis.

Diagnostic Kit Category:

Cardiac Arrest Early Examination Kit

This product is used for early stage diagnosis of myocardial infarction (heart attacks).

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Kidney Disease Testing Kit

The Urinate Micro Albumin Examination Testing Kit is used in connection with early stage diagnosis for primary kidney disease, hypertension and diabetes.

Other Product Category:

We include 59 of our products under the “Other” product category. No category of products or individual product within the Other product category represents 10% or more of our revenues. The Other product category includes suppositories, capsules, granules, injections, syrups, liniments, tablets and wash fluids.

Naftopidil Dispersible Tablet

This tablet is designed to treat benign enlargement of the prostate among males in their middle age.  It is effective in its treatment because its ingredients can be easily digested and absorbed by the human body.

Tinea Liniment

Tinea Liniment is an anti-fungal cream for the treatment of skin fungal infection and yeast infection.

Metronidazole and Chlorhexidine Washing Fluid

This is an anti- pathogenic bacteria fluid for the treatment of Vaginal inflammation.

Please refer to “Sales by Product Line” hereunder for additional information.

Summary of Our Research and Development Activities

Research and Development

We conduct all of our research and development (“R&D”) activities either internally or through collaborative arrangements with universities and research institutions in the PRC. We have our own research, development and laboratory facilities located in the facilities of First and Tianlong.

For the nine months ended September 30, 2010, total research and development expense was approximately $15,266,000. The major research and development projects that accounted for the majority of our total research and development expenses are as follows:

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Major Research and Development Expenses during the Nine Months Ended September 30, 2010
($ in thousands)
Projects	Expense		% of total R&D			Aggregate Expense Since Commencement of Project		Estimated Additional Cost to Complete Research
Diagnostic Kits - 12 products	$	3,198		20.9	%	$	5,928	$	2,595
Optimization Experiments for Five Products		1,653		10.8	%		2,533		-
Monoclonal Antibody		1,408		9.2	%		2,372		592
Endostatin		1,010		6.6	%		1,449		9,000
Antrodia Cinnamomea Extract l		849		5.6	%		1,236		16,000
Tumor Markers		775		5.1	%		775		210
Tiopronin for Injection		644		4.2	%		1,170		150
Omeprazole Sodium for Injection		686		4.5	%		1,691		314
Ozagrel Sodium Injection		730		4.8	%		1,322		270
Aztreonam For Injection		288		1.9	%		288		650
Voriconazole for Injection		236		1.5	%		236		700
Cefmetazole Sodium for Injection		229		1.5	%		229		650
Breast Cancer Technology		497		3.3	%		2,767		8,300
Clindamycin Phosphate for Injection		424		2.8	%		833		1,000
Levofloxacin Hydrochloride Eye Drops		410		2.7	%		746		500
Compound Allantoin VitaminB6-E and Aminoethylsulfonic Acid Eye Drops		354		2.3	%		354		800
Glycosidic Hydroxy Eye Drops		354		2.3	%		354		700
Nimesulide Granules		439		2.9	%		967		800
Total	$	14,184		92.9	%	$	25,250	$	43,231

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For the nine months ended September 30, 2009, total research and development expense is approximately $10,980,000. The major research and development projects that accounted for the majority of our total research and development expenses are as follows:

Major Research and Development Expenses during the Nine Months Ended September 30, 2009
($ in thousands)
Projects	Expense		% of total R&D			Aggregate Expense Since Commencement of Project		Estimated Additional Cost to Complete Research
Breast Cancer Technology	$	1,507		13.7	%	$	1,507	$	9,300
Monoclonal Antibody		964		8.8	%		3,162		2,000
Diagnostic Kits - 6 products		2,084		19.0	%		3,400		100
Change Matrix for 4 Patch Products		1,820		16.6	%		1,820		-
Additional experiments to apply 5 Products to the OTC		1,403		12.8	%		1,403		-
Naftopidil Dispersible tablets		124		1.1	%		380		376
Sertraline Hydrochloride capsules		124		1.1	%		373		376
Radix Isatidis granule and syrup		95		0.9	%		377		405
Omeprazole Sodium for Injection		540		4.9	%		540		1,000
Tiopronin for Injection		526		4.8	%		526		800
Nimesulide Granules		512		4.7	%		512		1,700
Clindamycin Phosphate for Injection		410		3.7	%		410		1,800
Levofloxacin Hydrochloride Eye Drops		336		3.1	%		336		1,300
Ozagrel Sodium for Injection		183		1.7	%		183		1,000
Total	$	10,628		96.8	%	$	14,929		20,157

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Historically, research and development expense fluctuates during each quarter. In general, different project has different requirements and different time span associated with different costs and different payment terms. Some main factors for the R&D expense fluctuation are listed as the following:

• Each project will go through multi stages before being submitted to the SFDA.

• Different drugs require for different amount of testing samples or trials which will result in different time span for the testing and approval process.

• R&D expense is incurred at different stages of the process based on our agreement signed with the third party (qualified hospitals or professional research institutions).

• Since different drugs require different stages of process or different amount of samples to be collected, the same R&D stage for different drugs result in different time span and different expense.

• In some cases, after we submit the completed document to the SFDA, we may be required to supply additional testing or document, which will result in longer time span and increased expense.

• For the R&D projects that are conducted internally, we only record the related personnel and material costs.

Significant Accounting Estimates and Policies

The discussion and analysis of our financial condition and results of operations is based upon our financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities. On an on-going basis, we evaluate our methodologies and assumptions used to derive these estimates. Significant estimates include the reserve allowance for doubtful accounts and inventories, our impairment test for long-lived assets and goodwill, the valuation allowance for income taxes, the remaining useful lives of our long-lived assets and our evaluation and recording contingencies. We base our estimates on historical experience and on other assumptions that we believes to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Our significant estimates include the following:

Long-lived assets are evaluated for impairment whenever indicators of impairment exist. Accounting standards require that if an impairment indicator is present, we must assess whether the carrying amount of the asset is unrecoverable by estimating the sum of the future cash flows expected to result from the asset, undiscounted and without interest charges. If the recoverable amount is less than the carrying amount, an impairment charge must be recognized based on the fair value of the asset.

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As part of the process of preparing our financial statements, we are required to estimate our income taxes. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We have deemed our temporary tax differences related to our principal business operations in the PRC to be immaterial. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent that we establish a valuation allowance or increase this allowance in a period, we must include a tax provision or reduce our tax benefit in the statements of operations. We use our judgment to determine our provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We believe, based on a number of factors including the continued historical operating losses of China Sky and ACPG, that we will not realize the future benefits of a significant portion of our net deferred tax assets and we have accordingly provided a full valuation allowance against our deferred tax assets. China Sky and ACPG do not generate revenues and were established as the Holding Companies of our foreign operations. Management has no intention to remit to either China Sky or ACPG any undistributed earnings of business operations in China. However, various factors may cause those assumptions to change in the near term.

We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we deem it necessary.

We review our accounting policies on a periodic basis to ensure compliance with GAAP. Our most significant accounting policies are those related to intangible assets and research and development.

Derivative liabilities - The Class A Warrants (“the Warrants”) issued in connection with the private placement we consummated on January 31, 2008 private placement include a reset provision triggered if the Company issues common shares below the exercise price of $12.50 as defined under the Warrant Agreement. Effective January 1, 2009 the reset provision of these Warrants preclude equity accounting treatment under ASC 815 (formerly EITF 07-5). Accordingly, effective January 31, 2009, the Company is required to reclassify the Warrants at their fair value to liabilities each reporting period under ASC 815-40. At September 30, 2010, we had 593,800 Warrants outstanding. The Company used the Monte Carlo valuation model to estimate the fair value of the Warrants. Significant assumptions used at September 30, 2010 include a term of approximately 3.4 years; volatility of 69.0% and a risk free interest rate of 0.84%. At September 30, 2009, the Company had 750,000 Warrants outstanding. The Company used the Monte Carlo valuation model to estimate the fair value of the Warrants.  Significant assumptions used at September 30, 2009 include a term of approximately 3.7 years; volatility of 67.0% and a risk free interest rate of 1.97%. The outstanding Warrants at September 30, 2010 and 2009 had a fair value of approximately $1,716,000 and $5,323,000, respectively. Due to the change in fair value of derivative warrant liability the Company realized income of $8,847,000 and $1,305,000 for the nine months ended September 30, 2010 and 2009, respectively. Due to the change in fair value of derivative warrant liability the Company realized income of $1,833,000 and $132,000 for the three months ended September 30, 2010 and 2009, respectively.

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Intangible assets – Our intangible assets consists of proprietary technologies, SFDA licenses for drug batch numbers, and goodwill. Proprietary technologies are technologies that we own. The SFDA licenses for drug batch numbers and goodwill were acquired in the business acquisitions of Tianlong, Peng Lai and Haina. We have registered “Kang Xi” as our trademark, which is used for all of the Company’s Tradition Chinese Medicine (“TCM”) products. The “Kang Xi” trademark was developed internally and registered by TDR before the Company became a public company. The Company’s cost basis in the trademark is nominal. Therefore, the Company did not have its “Kang Xi” trademark appraised, or recorded an intangible asset for it. Additionally, none of the costs associated with the trademark have been capitalized.

Intangible assets with finite useful lives are amortized while intangible assets with indefinite useful lives are not amortized. Goodwill and intangible assets are tested periodically for impairment. Accordingly, the Company reviews its long-lived assets, including property and equipment and finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. To determine recoverability of its long-lived assets, we evaluate the probability that future undiscounted net cash flows will be less than the carrying amount of the assets. Impairment costs, if any, are measured by comparing the carrying amount of the related assets to their fair value. The Company did not record any impairment charges related to its tangible and intangible assets held during the three and nine months ended September 30, 2010 and 2009. As of September 30, 2010, the weighted average amortization period of our intangible assets approximated 7.5 years.

Research and development—Research and development expenses include the costs associated with the Company’s internal research and development as well as research and development conducted by third parties. These costs primarily consist of salaries, clinical trials, outside consultants, and materials. All research and development costs are expensed as incurred.  

Third-party expenses reimbursed under non-refundable research and development contracts are recorded as a reduction to research and development costs in the statement of operations.

Assets to be used in research and development activities, specifically, compounds that have yet to receive new drug approval and would have no alternative use, should approval not be given, are immediately charged to expense when acquired. Certain assets and high technologies acquired that has a foreseeable future cash flows are capitalized as intangible assets. Such intangible assets are amortized starting from the year revenue is generated and amortized over its estimated life. If a capitalized intangible asset is deemed to have no future benefit, the unamortized carrying value will be expensed.

For the nine months ended September 30, 2010 and 2009, we incurred $15,266,000 and $10,980,000, respectively, in research and development expenditures. For the three months ended September 30, 2010 and 2009, we incurred $5,592,000 and $4,885,000, respectively, in research and development expenditures.

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Trends and Uncertainties

In 2008, general worldwide economic conditions declined due to sequential effects of the sub-prime lending crisis, general credit market crisis, collateral effects on the finance and banking industries, concerns about inflation, slower economic activity, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns. However, since all of our business operations, and most of our sales, are currently conducted in the PRC, we have not been greatly affected by the economic downtown. We cannot predict the timing or duration of any economic slowdown or recession or the timing or strength of a subsequent recovery, worldwide, or in the specific markets we serve.  If the markets for our products significantly deteriorate due to these economic effects, our business, financial condition and results of operations may be materially and adversely affected.

We have benefited from the overall economic development in the PRC in recent years and the increase in the number of elderly people in China, which together have resulted in increased expenditures on medicine in the PRC, including TCMs. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for our products and materially and adversely affect our business.

Historically, we signed agreements with suppliers that allowed us to hold extra raw materials at the cost of the suppliers. As a result, we were able to minimize our own inventory carrying costs, and improve our cash management, by keeping the inventory at the minimum level required to support the short-term sales. However, due to our  forecasts for certain cost increases of raw materials and the overhead costs for storing such raw materials in fiscal 2010, we began to increase our inventory levels toward the second half of 2009. We expect this practice to continue for the foreseeable future.

During the third quarter of 2010, Harbin Shiji Baolong, a domestic distributor, and Hangzhou Jiupin, and overseas sales agent, terminated their business relationship with us. These two customers accounted for an aggregate of 12% and 24% of our total revenue for the nine months ended September 30, 2010 and 2009, respectively. These two customers did not account for any of our revenues during the three months ended September 30, 2010. For the three months ended September 30, 2009, these two customers accounted for an aggregate of 22% of our total revenue. We expect to replace these customers with new relationships over time and that our revenues and income will be negatively impacted by this disruption to our distribution channels at least through the end of 2010. We also expect to incur higher selling and marketing costs through the end of 2010 in connection with developing new customer relationships.

Historically, our Slim Patch products have been one of our best selling products both domestically and outside of the PRC. Beginning in the fourth quarter of 2009, China domestic sales of Slim Patch products began to decline. The regulations and restrictions launched at that time by the Chinese government prohibiting television advertisement of  weight loss products in the PRC have negatively impacted the Slim Patch distribution channel in the PRC. The revenue generated from the China domestic market of Slim Patch products was $4,193,000 and $9,879,000 for the nine months ended September 30, 2010 and 2009, respectively. In addition, following Hangzhou Jiupin’s termination of its business relationship with us, our overseas sales of Slim Patch products also decreased.  Revenues generated from the Slim Patch overseas sales were $5,928,000 and $8,956,000 for the nine months ended September 30, 2010 and 2009, respectively. We expect sales of our Slim Patch products in the PRC to remain lower for the foreseeable future due to the Chinese government’s restrictions, and to remain lower overseas until we are able to locate a new overseas sales agent to handle sales in the affected or new markets.

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For the remainder of fiscal year 2010, we anticipate price increases of certain raw materials due to unforeseen natural disasters and inflation that will result in the increase of our cost of goods sold. In addition, our sales and marketing strategy to promote certain of our products which have less market competition by coordinating with reputable distributors who have extensive market channel and will launch these products at lower margins. These factors will have negative impact on our overall gross product margins as discussed below. 

Results of Operations

Restatement of Financial Statements

As discussed in Note 2 to the Financial Statements, we have restated our financial statements for the three and nine month periods ended September 30, 2009.

For the three months ended September 30, 2010 and 2009

Revenue, Cost of Goods Sold, Gross Profit and Gross Profit Margin

The following table sets forth our revenues, cost of goods sold, gross profit and gross profit margin during the three months ended September 30, 2010 and 2009:

	For the Three Months Ended
	September 30,
	($ in thousands)
	2010			2009			Variance
Revenues	$	36,193		$	43,227		$	(7,034	)
Cost of Goods Sold		9,796			10,897			(1,101	)
Gross Profit	$	26,397		$	32,330		$	(5,933	)
Gross Profit Margin		72.9	%		74.8	%		1.9	%

For the three months ended September 30, 2010, total revenues decreased by approximately $7,034,000, or 16.3%, as compared to the same period of 2009. The decrease is primarily due to weaker sales from products in our Patches, Sprays and Diagnostic Kits product categories, due in part to the termination of two major customer relationships during the third quarter of 2010 (see “Sales by Product Line” below).

Cost of goods sold decreased by $1,101,000, or 10.1%, compared to the same period in the prior year. The lower cost of goods sold is principally attributable to our lower sales volume. However, the ratio of cost of goods sold to revenues increased to 27.1%, compared to 25.2% in the prior year, due to inflation and unforeseen natural disasters which caused an increase in the price of raw materials we use to produce certain of our products, including Honey Suckle Flower and Notoginseng. For the remainder of fiscal year 2010, we anticipate price increases of certain raw materials due to inflation, and the overhead costs for storing raw materials, that will result in the increase of our cost of goods sold.

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Our sales and marketing strategy is to promote certain of our products which have less market competition by coordinating with reputable distributors who have extensive market channels. However, these distributors seek lower sales prices which will have a negative impact on our overall gross product margins.

Sales by Product Line

We believe that the most meaningful presentation of our products is by categories of method of delivery. The following table sets forth our principal product categories based on application type, and the approximate amount and percentage of revenue from each of such product categories, during each of the three months ended September 30, 2010 and 2009:

For the Three Months Ended September 30, ($ in thousands)
	2010								2009							Variance
Product Category	# of Products			Sales		% of Sales			# of Products		Sales		% of Sales
Patches		5		$	6,529		18.0	%		5	$	11,783		27.3	%	$	(5,254	)
Ointments		24			11,602		32.1	%		18		10,823		25.0	%		779
Sprays		15			3,645		10.1	%		15		6,775		15.7	%		(3,130	)
Drops		10			3,877		10.7	%		4		3,074		7.1	%		803
Diagnostic Kits		3			661		1.8	%		3		2,623		6.1	%		(1,962	)
Others		58			9,879		27.3	%		44		8,149		18.8	%		1,730
Total		115	*	$	36,193		100.0	%		89	$	43,227		100.0	%	$	(7,034	)

 * We discontinued sales of 3 products during the third quarter of 2010 due to their low sales volume (one each from our Ointments, Sprays and Others categories).

We marketed 115 products during the three months ended September 30, 2010, compared with 89 products during the three months ended September 30, 2009. The Company’s total revenue decreased by $7,034,000, or 16.3%, as compared to the same period of 2009. The revenue decrease is primarily due to the decreased sales from our Patch, Spray and Diagnostic Kits product categories.

For the three months ended September 30, 2010, revenues from Patch products decreased by $5,254,000, or 44.6%, as compared to the same period of 2009. The decrease is primarily due to the decreased sales of our Slim Patch products both within China and the overseas. Beginning in the fourth quarter of 2009, Chinese domestic sales of our Slim Patch products began to decline. The regulations and restrictions launched at that time by the Chinese government prohibiting television advertisement of  weight loss products in the PRC have negatively impacted the Slim Patch distribution channel. The revenue generated from the China domestic market of our Slim Patch products was $1,571,000 and $2,761,000 for the three months ended September 30, 2010 and 2009, respectively. Sales of the Slim Patch products also accounted for all of our overseas sales during the three months ended September 30, 2009 and 2010. Our overseas sales are realized through Chinese domestic agents whom are appointed by overseas importers. During the third quarter of 2010, Hangzhou Jiupin, an overseas sales agent, terminated its business relationship with us which had a negative impact to the overseas sales of our Slim Patch products. The revenue generated from overseas market of Slim Patch products was $2,202,000 and $4,530,000 for the three months ended September 30, 2010 and 2009, respectively. For the three months ended September 30, 2010, revenues from Pain Relief Patch products decreased by $1,361,000, or 70.5%, as compared to the same period of 2009. The decrease is primarily due to the termination by Hangzhou Jiupin during the third quarter of 2010. Management is currently seeking a new overseas sales agent to replace this customer.

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For the three months ended September 30, 2010, revenues from Ointments increased by $779,000, or 7.2%, as compared to the same period of 2009. The increase is primarily due to the  increased sales from our Compound Camphor Cream. Revenue generated from Compound Camphor Cream was $6,183,000 and $5,484,000 for the three months ended September 30, 2010 and 2009, respectively. This increase is primarily due to our continued efforts to promote and advertise this product during the third quarter of 2010. There are additional 7 new Ointment products launched during the three months ended September 30, 2010 as compared to the same period of 2009. Revenue generated from these 7 new Ointment products was $655,000 for the three months ended September 30, 2010.

For the three months ended September 30, 2010, revenue generated from our Spray products decreased by $3,130,000, or 46.2%, as compared to the same period of 2009, primarily due to the decreased sales of our Stomatitis spray, FuShuang Spray, JiaoShuang Spray, and JieYin Spray. The revenue decrease is primarily due to the termination of our business relationship with Harbin Shiji Baolong during the third quarter of 2010. Management is currently seeking new domestic distributors to replace this customer.

For the three months ended September 30, 2010, revenue from our Drops products increased by $803,000, or 26.1%, as compared to the same period of 2009, primarily due to $532,000 of sales of the 6 Drops products we introduced during the three months ended September 30, 2010.

For the three months ended September 30, 2010, revenue generated from our Diagnostic Kits decreased by $1,962,000, or 74.8%, as compared to the same period of 2009, primarily due to decreased sales of our Cardiac Arrest Early Examination Kits which was promoted by Harbin Shiji Baolong, a distributor which terminated its business relationship with us. Revenue generated from Cardiac Arrest Early Examination Kits was $206,000 and $2,165,000 for the three months ended September 30, 2010 and 2009, respectively. Management is currently seeking a replacement for this distributor.

For the three months ended September 30, 2010, revenues from our Other products category increased by $1,730,000, or 21.2%, as compared to the same period of 2009. The revenue increase is primarily due to the increases sales of our Metronidazole and Chlorhexidine Washing Fluid, as well as sales of the additional 14 products we introduced during the three months ended September 30, 2010. The revenue generated from the Metronidazole and Chlorhexidine Washing Fluid increased by $425,000 as compared to the same period of 2009. The sales increase from the Metronidazole and Chlorhexidine Washing Fluid is primarily due to sales to a new distributor we engaged in the second quarter of 2010. The revenue generated from the additional 14 products was $1,482,000 for the three months ended September 30, 2010.

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Operating Expenses

The following table summarizes the changes in our operating expenses for the three months ended September 30, 2010 and 2009:

For the Three Months Ended September 30, ($ in thousands)
Operating Expenses	2010			2009			Variance
Selling expense	$	9,673		$	9,944			(2.7	)%
General and administrative expense		798			1,024			(22.1	)%
Depreciation and amortization		879			447			96.6	%
Research and development		5,592			4,885			14.5	%
Total operating expenses		16,942			16,300			3.9	%
Total revenue	$	36,193		$	43,227			(16.3	)%
% of operating expenses to revenue		46.8	%		37.7	%		9.1	%

For the three months ended September 30, 2010, selling expense decreased compared to the same period of 2009, primarily due to our decreased sales volume. For the three months ended September 30, 2010, our advertising costs increased by $1,053,000, or 20.9% as compared to the same period of 2009.

General and administrative expense for the three months ended September 30, 2010 decreased by 22.1% compared to the same period in the prior year, primarily due to the decreased sales volume and a decrease in our professional fees.

Depreciation and amortization expense amounted to $879,000 compared to $447,000 for the three months ended September 30, 2010 and 2009, respectively. This increase of $432,000 was primarily due to the amortization expense of our proprietary technologies, Antroquinonol and Small RNAs Technology, that we acquired during the fourth quarter of 2009. These two proprietary technologies were acquired for approximately $10,969,000 and are being amortized over an estimated useful life of 10 years.

For the three months ended September 30, 2010, total research and development expense was approximately $5,592,000 as compared to $4,885,000 for the same period in 2009. Refer to detailed analysis of research and development expenses for a table of costs by project.

The major research and development projects that accounted for the majority of our total research and development expense are as follows:

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Major Research and Development Expense during the Three Months Ended September 30, 2010
($ in thousands)
Projects	Expense		% of total R&D
Monoclonal Antibody	$	1,408		25.2	%
Diagnostic Kits - 4 products		1,305		23.3	%
Omeprazole Sodium for Injection		686		12.3	%
Ozagrel Sodium Injection		730		13.1	%
Aztreonam For Injection		288		5.2	%
Voriconazole for Injection		236		4.2	%
Cefmetazole Sodium for Injection		229		4.1	%
Compound Allantoin VitaminB6-E and Aminoethylsulfonic Acid Eye Drops		354		6.3	%
Glycosidic Hydroxy Eye Drops		354		6.3	%
Total	$	5,590		99.9	%

For the three months ended September 30, 2009, total research and development expense is approximately $4,885,000. The major research and development projects that accounted for the majority of our total research and development expense is listed are as follows:

Major Research and Development Expense During the Three Months
Ended September 30, 2009
($ in thousands)
Projects	Expense		% of total R&D
Additional experiments to apply 5 Products to the OTC	$	1,403		28.7	%
Diagnostic Kits - 3 products		1,228		25.1	%
Change Matrix for 4 Patch Products		1,820		37.3	%
Naftopidil Dispersible tablets		124		2.5	%
Sertraline Hydrochloride capsules		124		2.5	%
Radix Isatidis granule and syrup		95		1.9	%
Total	$	4,794		98.1	%

Other Income

For the three months ended September 30, 2010 and 2009, we recorded unrealized gains of $1,833,000 and $132,000 (restated), respectively, due to changes in fair value of our derivative warrant liability resulting from the decreases in the estimated fair value of the warrants issued in our January 2008 private placement (as described in Note 8 to the Notes to the financial statements appearing elsewhere in this report).

For the nine months ended September 30, 2010 and 2009

Revenue, Cost of Goods Sold, Gross Profit and Gross Profit Margin

The following table sets forth our revenues, cost of goods sold, gross profit and gross profit margin during the nine months ended September 30, 2010 and 2009:

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	For the Nine Months Ended
	September 30,
	($ in thousands)
	2010			2009			Variance
Revenues	$	105,856		$	100,242			5.6	%
Cost of Goods Sold		28,287			24,690			14.6	%
Gross Profit	$	77,569		$	75,552			2.7	%
Gross Profit Margin		73.3	%		75.4	%		(2.1	)%

For the nine months ended September 30, 2010, total revenues increased by approximately $5,614,000, or 5.6%, as compared to the same period of 2009. The revenue increase is primarily due to the strong sales from Ointment, Drops and Others product categories. The positive variance is partially offset by the decreased revenue from the sales of our  Patch and Diagnostic Kits categories , due in part to the termination of two major customer relationships during the third quarter of 2010 (see “Sales by Product Line” below).

Cost of goods sold increased by $3,597,000, or 14.6%, compared to the same period of the prior year. The higher cost of goods sold is principally attributable to our higher sales volume. However, the ratio of cost of goods sold to revenues increased to 26.7%, compared to 24.6% in the prior year, due to inflation and unforeseen natural disasters which caused an increase in the price of raw materials we use to produce certain of our products, including Honey Suckle Flower and Notoginseng. For the remainder of fiscal year 2010, we anticipate price increases of certain raw materials due to inflation, and the overhead costs for storing such raw materials, that will result in the increase of our cost of goods sold.

Our sales and marketing strategy is to promote certain of our products which have less market competition by coordinating with reputable distributors who have extensive market channels and will resell these products at lower margins. We expect these factors will continue to have a negative impact on our overall gross product margins.

Sales by Product Line

We believe that the most meaningful presentation of our products is by categories of method of delivery. The following table sets forth our principal product categories based on application type, and the approximate amount and percentage of revenue from each of such product categories, during each of the nine months ended September 30, 2010 and 2009:

For the Nine Months Ended September 30,
($ in thousands)
	# of Products		2010					# of Products		2009					Variance
Product Category			Sales		% of Sales					Sales		% of Sales
Patches		5	$	24,470		23.1	%		5	$	30,842		30.8	%	$	(6,372	)
Ointments		25		31,013		29.3	%		18		23,563		23.5	%		7,450
Sprays		16		11,772		11.1	%		15		14,486		14.5	%		(2,714	)
Drops		10		8,569		8.1	%		4		4,925		4.9	%		3,644
Diagnostic Kits		3		4,446		4.2	%		3		9,411		9.4	%		(4,965	)
Others		59		25,586		24.2	%		44		17,015		16.9	%		8,571
Total		118	$	105,856		100.0	%		89	$	100,242		100.0	%	$	5,614

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We marketed 118 products during the nine months ended September 30, 2010, compared to 89 products during the nine months ended September 30, 2009. The Company’s total revenue increased by $5,614,000, or 5.6%, as compared to the same period of 2009. The increase is primarily due to the strong sales from our Ointment, Drops and Others product categories, which was partially offset by the decreased sales generated from our Patches, Spray and Diagnostic Kits. 

For the nine months ended September 30, 2010, revenues from Patch products decreased by $6,372,000, or 20.7%, as compared to the same period of 2009. The decrease is primarily due to the decreased sales of our Slim Patch products both within China and overseas. From the fourth quarter of 2009, China domestic sales of Slim Patch products began to decline. The regulations and restrictions launched at that time by the Chinese government prohibiting television advertisement of  weight loss products in the PRC have negatively impacted the Slim Patch distribution channel in the PRC. The revenue generated from the China domestic market of Slim Patch products was $4,193,000 and $9,879,000 for the nine months ended September 30, 2010 and 2009, respectively. The decrease in overseas sales of our Slim Patch products was primarily due to the termination by Hangzhou Jiupin, a key overseas sales agent, of its business relationship with us during the third quarter of 2010. Revenues generated from the Slim Patch overseas sales were $5,928,000 and $8,956,000 for the nine months ended September 30, 2010 and 2009, respectively. For the nine months ended September 30, 2010, revenues from Anti-Hypertension Patch increased by $1,580,000 or 42.9% as compared to the same period of 2009. The increase is primarily due to the strong revenue generated during the six months ended June 30, 2010. For the three months ended September, 2010, revenue from sales of our Anti-Hypertension Patch decreased by $350,000, or 15.3% as compared to the same period of 2009.

For the nine months ended September 30, 2010, revenues from Ointments increased by $7,450,000, or 31.6%, as compared to the same period of 2009. The increase was primarily due to the  increased sales from our Compound Camphor Cream and additional 7 new Ointment products launched during the nine months ended September 30, 2010 as compared to the same period of 2009. Revenue generated from Compound Camphor Cream was $15,314,000 and $10,203,000 for the nine months ended September 30, 2010 and 2009, respectively. This increase is primarily due to our continued efforts to promote and advertise this product. Revenue generated from the 7 new Ointment products was $781,000 for the nine months ended September 30, 2010.

For the nine months ended September 30, 2010, revenue generated from our Spray products decreased by $2,714,000, or 18.7%, as compared to the same period of 2009, primarily due to the decreased sales of our FuShuang Spray, JiaoShuang Spray, and JieYin Spray. The revenue decrease is primarily due to the termination of business relationship by Harbin Shiji Baolong during the third quarter of 2010. Management is currently seeking new channel distributors to replace this relationship.

For the nine months ended September 30, 2010, revenues from our Drops products increased by $3,644,000, or 74.0%, as compared to the same period of 2009, primarily due to the increase sales of our Naphazoline Hydrochloride Eye Drops and an additional 6 Drops products launched during the nine months ended September 30, 2010. Revenue generated from Naphazoline Hydrochloride Eye Drops was $5,569,000 and $3,118,000 for the nine months ended September 30, 2010 and 2009, respectively. The increase is primarily due to the strong sales revenue generated during the first six months of 2010. For the three months ended September 30, 2010, revenue from Naphazoline Hydrochloride Eye Drops increased by $156,000, or 6.9% as compared to the same period of 2009. Revenue generated from the additional 6 new Drops products was $776,000 for the nine months ended September 30, 2010.

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For the nine months ended September 30, 2010, revenue generated from our Diagnostic Kits decreased by $4,965,000, or 52.8%, as compared to the same period of 2009, primarily due to decreased sales of our Cardiac Arrest Early Examination Kits which was promoted by Harbin Shiji Baolong, a domestic distributor, which terminated its business relationship with us during the third quarter of 2010. Revenue generated from Cardiac Arrest Early Examination Kits was $2,637,000 and $7,468,000 for the nine months ended September 30, 2010 and 2009, respectively. Management is currently seeking a new channel distributor to replace Harbin Shiji Baolong.

For the nine months ended September 30, 2010, revenues from our Other products category increased by $8,571,000, or 50.4%, as compared to the same period of 2009. The revenue increase is primarily due to the sales increase of our Metronidazole and Chlorhexidine Washing Fluid, as well as of 14 additional products we introduced during the nine months ended September 30, 2010. Revenue generated from the Metronidazole and Chlorhexidine Washing Fluid increased by 194.8%, or $1,242,000 as compared to the same period of 2009, primarily due to sales to a new distributor we engaged in the second quarter of 2010. Revenue generated from the additional 14 products was $2,235,000 for the nine months ended September 30, 2010.

Operating Expenses

The following table summarizes the changes in our operating expenses for the nine months ended September 30, 2010 and 2009:

For the Nine Months Ended September 30,
($ in thousands)
Operating Expenses	2010			2009			Variance
Selling expense	$	23,567		$	23,707			(0.6	)%
General and administrative expense		2,911			2,354			23.7	%
Depreciation and amortization		2,547			1,348			88.9	%
Research and development		15,266			10,980			39.0	%
Total operating expenses		44,291			38,389			15.4	%
Total revenue	$	105,856		$	100,242			5.6	%
% of operating expenses to revenue		41.8	%		38.3	%		3.5	%

For the nine months ended September 30, 2010, selling expense remained constant with the same period of 2009, primarily due to the increased advertisement expense and partially offset by the decreased cost associated with transferring of certain logistic expenses to our distributors. For the nine months ended September 2010, advertising costs increased by 1,235,000, or 11.0% as compared to the same period of 2009.

General and administrative expense for the nine months ended September 30, 2010 increased by 23.7% compared to the same period of the prior year, primarily due to increased sales volume and our increased professional fees.

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Depreciation and amortization expense amounted to $2,547,000 compared to $1,348,000 for the nine months ended September 30, 2010  and  2009, respectively. This increase of $1,199,000 is primarily due to the amortization expense of our proprietary technologies, Antroquinonol and Small RNAs Technology, that we acquired during the fourth quarter of 2009. These two proprietary technologies were acquired for approximately $10,969,000 and are being amortized over an estimated useful life of 10 years.

For the nine months ended September 30, 2010, total research and development expense was approximately $15,266,000. The major research and development projects that accounted for the majority of our total research and development expense are as follows:

Major Research and Development Expenses during the Nine Months Ended September 30, 2010
($ in thousands)
Projects	Expense		% of total R&D			Aggregate Expense Since Commencement of Project		Estimated Additional Cost to Complete Research
Diagnostic Kits - 12 products	$	3,198		20.9	%	$	5,928	$	2,595
Optimization Experiments for Five Products		1,653		10.8	%		2,533		-
Monoclonal Antibody		1,408		9.2	%		2,372		592
Endostatin		1,010		6.6	%		1,449		9,000
Antrodia Cinnamomea Extract l		849		5.6	%		1,236		16,000
Tumor Markers		775		5.1	%		775		210
Tiopronin for Injection		644		4.2	%		1,170		150
Omeprazole Sodium for Injection		686		4.5	%		1,691		314
Ozagrel Sodium Injection		730		4.8	%		1,322		270
Aztreonam For Injection		288		1.9	%		288		650
Voriconazole for Injection		236		1.5	%		236		700
Cefmetazole Sodium for Injection		229		1.5	%		229		650
Breast Cancer Technology		497		3.3	%		2,767		8,300
Clindamycin Phosphate for Injection		424		2.8	%		833		1,000
Levofloxacin Hydrochloride Eye Drops		410		2.7	%		746		500
Compound Allantoin VitaminB6-E and Aminoethylsulfonic Acid Eye Drops		354		2.3	%		354		800
Glycosidic Hydroxy Eye Drops		354		2.3	%		354		700
Nimesulide Granules		439		2.9	%		967		800
Total	$	14,184		92.9	%	$	25,250	$	43,231

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For the nine months ended September 30, 2009, total research and development expense was approximately $10,980,000. The major research and development projects that accounted for the majority of our total research and development expenses are as follows:

Major Research and Development Expenses during the Nine Months Ended September 30, 2009
($ in thousands)
Projects	Expense		% of total R&D			Aggregate Expense Since Commencement of Project		Estimated Additional Cost to Complete Research
Breast Cancer Technology	$	1,507		13.7	%	$	1,507	$	9,300
Monoclonal Antibody		964		8.8	%		3,162		2,000
Diagnostic Kits - 6 products		2,084		19.0	%		3,400		100
Change Matrix for 4 Patch Products		1,820		16.6	%		1,820		-
Additional experiments to apply 5 Products to the OTC		1,403		12.8	%		1,403		-
Naftopidil Dispersible tablets		124		1.1	%		380		376
Sertraline Hydrochloride capsules		124		1.1	%		373		376
Radix Isatidis granule and syrup		95		0.9	%		377		405
Omeprazole Sodium for Injection		540		4.9	%		540		1,000
Tiopronin for Injection		526		4.8	%		526		800
Nimesulide Granules		512		4.7	%		512		1,700
Clindamycin Phosphate for Injection		410		3.7	%		410		1,800
Levofloxacin Hydrochloride Eye Drops		336		3.1	%		336		1,300
Ozagrel Sodium for Injection		183		1.7	%		183		1,000
Total	$	10,628		96.8	%	$	14,929		20,157

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Other Income

For the nine months ended September 30, 2010 and 2009, we recorded unrealized gains of $8,847,000 and $1,305,000 (restated), respectively, due to changes in fair value of our  derivative warrant liability resulting from decreases in the fair value of the warrants issued in our January 2008 private placement (as described in Note 8 to the Notes to the financial statements appearing elsewhere in this report).

Liquidity and Capital Resources

The following table summarizes our cash and cash equivalents position, our working capital, and our cash flow activity as of September 30, 2010 and 2009:

	As of September 30,
	($ in thousands, except
	ratio and days)
	2010			2009 (restated)
Cash and cash equivalents	$	71,971		$	56,303
Current ratio		8.8			5.1
Quick ratio		8.4			4.5
Average accounts receivable turnover days		55.7			45.2
Average inventory turnover days		35.7			17.3
Working capital	$	88,037		$	73,741
Inventories	$	4,311		$	3,099
Cash provided by (used in):
Operating activities	$	25,559		$	25,932
Investing activities	$	(7,822	)	$	(10,049	)
Financing activities	$	94		$	29

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As of September 30, 2010, cash and cash equivalents were approximately $71,971,000 as compared to $56,303,000 at September 30, 2009.

We had working capital at September 30, 2010 of approximately $88,037,000, compared to $73,741,000 at September 30, 2009 (restated). Our increase in working capital in 2010 was primarily due to the increased cash flows generated from our operating activities, offset in part by cash used in investing activities. We consider current working capital and borrowing capabilities are adequate to cover our current operating and capital requirements in the near future.

Cash flows provided by operating activities was approximately $25,559,000 for the nine months ended September 30, 2010. Our cash flows from operating activities resulted from net income of $33,426,000 (including a non-cash gain of $8,847,000 from the change in fair value of our warrant derivative liability), further increased by depreciation and amortization of $2,895,000, partially offset by accounts receivable of $1,363,000 and inventories of $1,816,000.

Cash flows used in investing activities was approximately $7,822,000 for the nine months ended September 30, 2010 compared to $10,049,000 in the same period of 2009. Cash flows used in investing activities in 2010 were primarily related to a bid deposit of approximately $7,335,000 we submitted to Harbin High Technology Development Zone to participate in an auction to a parcel of land of approximately 85,000 square meters in the Harbin Song Bei District High Technology Zone.  Cash flows used in investing activities in 2009 were primarily related to the construction costs of our new corporate headquarters in Harbin Song Bei District.

Cash flows provided from financing activities was approximately $94,000 for the nine months ended September 30, 2010 compared to approximately $29,000 for the same period in 2009. Cash flows provided from financing activities in 2010 and 2009 were primarily related to warrants exercised for cash by certain warrant holders of ours.

In January 2010, we completed the construction of two office buildings and moved into these new facilities. It is anticipated that residual work, including road construction,  fire control equipment, amenity improvement, and final acceptance, will be completed on these facilities during the fourth quarter of 2010, at an additional cost of approximately $3.0 million.

Our current ratio was 8.8 at September 30, 2010 compared to 5.1 at September 30, 2009 and the quick ratio was 8.4 at September 30, 2010 compared to 4.5 at September 30, 2009. We endeavor to ensure that funds are available to take advantage of new investment opportunities and that funds are sufficient to meet future liquidity and capital needs.

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We calculate accounts receivable turnover by averaging the opening and closing balances of out accounts receivable during that period and dividing that amount by our average daily sales during that period.  Since accounts receivables fluctuate over the course of each quarter, in order to determine a more representative accountant receivables collection days, management calculates the turnover rate on a quarter-by-quarter basis.

Our average daily sales, average accounts receivable, and accounts receivable turnover days for each of the nine months ended September 30, 2010 and 2009 were as follows:

Nine Months  Ended September 30,	Average Daily Sales ($ in thousands)		Average A/R ($ in thousands)		Turnover Days
2010	$	387	$	21,546		55.7
2009	$	366	$	16,525		45.2

Account receivable turnover days increased to 55.7 in the nine months ended September 30, 2010 comparing to 45.2 in the same period of 2009. The increase is primarily due to the average account receivable increase outpaced the increase of average daily sales. Accounts receivable collections are generally slower during the fourth fiscal quarter and the first fiscal quarter, partly due to the Chinese public holidays within that period (about three weeks in total). During the second and third quarter of each year, due to stronger sales volume, the product turnover rate at our distributors and agents is higher, resulting in their shorter accounts payable periods.

Our inventory turnover days for the nine months ended September 30, 2010 and 2009 calculated by using average daily costs of goods sold and average inventory for each quarter were as follows:

Nine Months  Ended September 30,	Average Daily COGS ($ in thousands)		Average Inventory ($ in thousands)		Turnover Days
2010	$	104	$	3,715		35.7
2009	$	90	$	1,558		17.3

Historically, we signed agreements with suppliers that allowed us to hold extra raw materials at the cost of the suppliers. As a result, we could minimize our own inventory carrying costs, and improve our cash management, by keeping the inventory at the minimum level required to support the short-term sales. However, due to the forecast of certain cost increases of raw materials in 2010, management began to increase the inventory levels toward the second half of 2009. The inventory turnover days increased to 35.7 days for the nine months ended September 30, 2010 compared to 17.3 days in the same period of 2009. This increase is primarily due to the increased inventory level by the end of fiscal year 2009 to support our expected sales growth.

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Contractual Obligations and Commercial Commitments

As of September 30, 2010, we have commitments and contractual obligations as follows:

In January 2010, we completed the construction of two office buildings and moved into the new facilities located in Song Bei District of Harbin city, PRC. It is anticipated that residual work, including road construction, fire control equipment, amenity improvement, and final acceptance, will be completed on these facilities during the fourth quarter of 2010, at an additional cost of approximately $3.0 million.

We do not have any long-term debt obligations, capital lease obligations, operating lease obligations, purchase obligations, and other long term liabilities reflected on our balance sheet under GAAP.

Currency Exchange Fluctuations

All of our revenue and majority of the expenses during the nine months ended September 30, 2010 were denominated primarily in RMB, the currency of China, and were converted into U.S. dollars at the exchange rate of 6.81640 RMB to 1 U.S. Dollar at September 30, 2010 from 6.84251 RMB to 1 U.S. Dollar at September 30, 2009. There can be no assurance that RMB-to-U.S. dollar exchange rates will remain stable. A devaluation of RMB relative to the U.S. dollar would adversely affect our business, financial condition and results of operations. We do not engage in currency hedging.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that are currently material or reasonably likely to be material to our financial position or results of operations.

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Item 3.     Quantitative and Qualitative Disclosures About Market Risk.

We are subject to certain risks and uncertainties as described below.  These risks and uncertainties may not be the only ones we face.  There may be additional risks that we do not presently know of, or that we currently consider immaterial.  All of these risks could adversely affect our business, financial condition, results of operations and cash flows. Our business and operations may be adversely affected if any of such risks are realized.  All investors should consider the following risks before deciding to purchase or sell our securities.

As of September 30, 2010, we do not invest or trade market risk sensitive instrument or have any debt subject to interest rate fluctuations.

Substantially all of our revenues and expenses are denominated in RMB. Since 1994, the exchange rate for the RMB against the U.S. dollar has remained relatively stable, most of the time in the region of approximately RMB8.00 to U.S.$1.00. However, in 2005, the Chinese government announced that would begin pegging the exchange rate of the RMB against a number of currencies, rather than just the U.S. dollar. Currently, exchange rates are approximately RMB6.8 to U.S.$1.00 resulting in the increase in price of Chinese products to U.S. purchasers. As our operations are primarily in China, any significant revaluation of the Chinese RMB may materially and adversely affect cash flows, revenues and financial condition. If we decide to convert RMB into U.S. dollars and the U.S. dollar appreciates against the RMB, the U.S. dollar equivalent of the RMB that we convert would be reduced.

Inflation in China has not materially impacted our results of operations in recent years, but we can provide no assurance that we will not be affected in the future. According to the PRC National Bureau of Statistics, the inflation rate in the consumer price index in China was 5.9%, 4.8%, and 1.9% in 2009, 2008, and 2007, respectively.

A significant amount of our cash and cash equivalents are held in commercial bank checking accounts in the PRC and earned an annual interest income yield of approximately 0.36% for the nine months ended September 30, 2010. For all the bank accounts in the PRC, we earned interest income of approximately $93,000 and $69,000 for the nine months ended September 30, 2010 and 2009, respectively.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures (Revised)

Our management, with the participation of our chief executive officer (principal executive officer) and chief accounting officer (principal financial and accounting officer), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities 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 that it files or submits under the Securities Exchange Act are 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 are 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. Our 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. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as described above. 

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We received comments from the SEC which, for the reasons set forth in our Annual Report on Form 10-K for the year ended December 31, 2009, as amended, under Item 9A. “Management’s Annual Report on Internal Control over Financial Reporting,” led our management to determine that restatements were required for our financial statements for the three month periods ended March 31, 2009, June 30, 2009 and September 30, 2009. As a result of the foregoing and additional comments received from the SEC, on June 18, 2010, management determined that a material weakness existed with respect to our reporting of complex, non-routine transactions. This weakness was a result of our incorrect interpretation of the guidance in ASC 815-40, “Derivative and Hedging – Contracts in an Entity’s own Equity”, and incorrect conclusion regarding its application, which required the restatement of our financial statements as of and for the three months ended March 31, 2009, June 30, 2009, and September 30, 2009.

As result of our remediation of the material weakness identified with respect to our reporting of non-routine complex transactions, our chief executive officer and principle accounting officer have concluded that, as of September 30, 2010, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information required to be disclosed is accumulated and communicated to management, including our chief executive officer and principle accounting officer, to allow timely decisions regarding required disclosures.

Changes in Internal Control Over Financial Reporting

During the three months ended September 30, 2010, to remediate the weakness in our disclosure controls and procedures, we hired third party consultants to assist us in identifying and analyzing complex non-routine transactions and with valuing and determining the appropriate accounting treatment for any such complex non-routine transactions. These are the only changes which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1.  Legal Proceedings.

On September 4, 2009, the SEC issued a formal order of investigation relating to certain of our accounting, record-keeping and disclosure practices.  At such time, we received document and testimonial subpoenas from the SEC and have complied with those requests for information.  In September 2010, we received a supplemental document subpoena from the SEC.  To date, we have produced documents and remain in the process of evaluating the supplemental request and whether additional productions are appropriate.

Item 1A.  Risk Factors.

We are dependent on a limited number of customers for a significant portion of our revenues and accounts receivable and this dependence is likely to continue.

We have been dependent on a limited number of customers for a significant portion of our revenue.  For the nine months ended September 30, 2010, no customer accounted for more than 10% of the Company’s total revenues. For the nine months ended September 30, 2009, Harbin Shiji Baolong and Shanxi Xintai accounted for 14% and 13% respectively of sales revenues.  Dependence on a few customers could make it difficult to negotiate attractive prices for our products and could expose us to the risk of substantial losses if any such customer stops purchasing our products.  During the third quarter of 2010, two of our largest customers terminated their business relationships with us.  As a result, we expect declines in our revenues and income for the remainder of 2010, consistent with those experienced in the three month period ended September 30, 2010.  If we are unable to replace these customers our results of operations will be materially adversely affected.

We expect that a limited number of customers will continue to contribute to a significant portion of our sales in the near future. Our ability to maintain close relationships with these top customers is essential to the growth and profitability of our business.  If we fail to sell our products to our other large customers in any particular period, or if other large customers purchase fewer of our products, defer orders or fail to place additional orders with us, or if we fail to develop additional major customers, our revenue would likely decline and our results of operations would be adversely affected.

In addition, our accounts receivable are concentrated among a small number of our customers.  At September 30, 2010, no customer accounted for 10% or more of the Company’s accounts receivable. At September 30, 2009, Harbin Shiji Baolong accounted for 25% of accounts receivable. If any our customers fail to pay us on a timely basis, or do not pay us at all, our business, cash flow, financial condition and results of operations may be materially and adversely affected.

We are the subject of a formal SEC order of investigation which, if not favorably resolved, could have material adverse consequences to us.

On September 4, 2009, the SEC issued a formal order of investigation relating to, among other things, certain of our accounting, record-keeping and disclosure practices.  At such time, we received document and testimonial subpoenas from the SEC and have complied with those requests for information.  In September 2010, we received a supplemental document subpoena from the SEC.  To date, we have produced documents and remain in the process of evaluating the supplemental request and whether additional productions are appropriate.  We cannot assure you that we will be able to resolve this investigation favorably, or that we will not be materially adversely effected by this investigation  or its outcome.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

In the three month period ended September 30, 2010, we did not engage in any unregistered sales of equity securities.

Item 3.  Defaults Upon Senior Securities.

In the three month period ended September 30, 2010, we did not default upon any senior securities.

Item 4.  Removed and Reserved.

Item 5.  Other Information.

None.

Item 6.  Exhibits

Exhibit No.	Description of Exhibit
31.1	Certification of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended*
31.2	Certification of Principal Financial and Accounting Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended*
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Principal Executive Officer)*
32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Principal Financial and Accounting Officer)*

* Filed herewith

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 SKY ONE MEDICAL, INC.
Dated: November 8, 2010	By:	/s/ Liu Yan-qing
		Liu Yan-qing
		Chairman, Chief Executive Officer and President
Dated: November 8, 2010	By:	/s/ Zhang Yu-kun
		Zhang Yu-kun
		Chief Accounting Officer

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