-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BxQZ5z+NQJnuPQMaKOgTAIt5uBkK/pir7ira4GvzmwHAM/kCElvVIeeWKyA5r4in KkTeqlridCRRCJ20gS9SBw== 0001019687-09-004149.txt : 20091116 0001019687-09-004149.hdr.sgml : 20091116 20091116163808 ACCESSION NUMBER: 0001019687-09-004149 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20081231 FILED AS OF DATE: 20091116 DATE AS OF CHANGE: 20091116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN ORIENTAL BIOENGINEERING INC CENTRAL INDEX KEY: 0001090514 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 911948329 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-32569 FILM NUMBER: 091187450 BUSINESS ADDRESS: STREET 1: NO, 4018 JINTIAN ROAD, ANLIAN PLAZA STREET 2: 12F SUITE B02 CITY: FUTIAN, DISTRICT SHENZHEN STATE: F4 ZIP: 518026 BUSINESS PHONE: 86-451-8666-6601 MAIL ADDRESS: STREET 1: NO, 4018 JINTIAN ROAD, ANLIAN PLAZA STREET 2: 12F SUITE B02 CITY: FUTIAN, DISTRICT SHENZHEN STATE: F4 ZIP: 518026 FORMER COMPANY: FORMER CONFORMED NAME: ORIENTAL BIOENGINEERING INC DATE OF NAME CHANGE: 19990824 10-K/A 1 aob_10ka-123108.htm AMERICAN ORIENTAL BIOENGINEERING, INC. aob_10ka-123108.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K /A

 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2008
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
 
COMMISSION FILE NO: 001-32569


AMERICAN ORIENTAL BIOENGINEERING, INC.
(Exact name of registrant as specified in its charter)

 
NEVADA
84-0605867
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
25th Floor, Great China International Exchange Square, No. 1 Fuhua 1 Rd, Futian District,
Shenzhen, 518034, People’s Republic of China
(Address of principal executive offices) (Zip Code)
 
86-451-8666-6601
(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:
 
Common Stock, Par Value $0.001 Per Share
New York Stock Exchange
(Title of Class)
(Name of exchange on which registered)
Securities Registered Pursuant to Section 12(g) of the Act: None.

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   o     No   o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated 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
 
The aggregate market value of the voting stock held on June 30, 2008 by non-affiliates of the registrant was $610,730,086 based on the closing price of $9.87 per share as reported on the New York Stock Exchange on June 30, 2008, the last business day of the registrant’s most recently completed second fiscal quarter (calculated by excluding all shares held by executive officers, directors and holders known to the registrant of five percent or more of the voting power of the registrant’s common stock, without conceding that such persons are “affiliates” of the registrant for purposes of the federal securities laws).
 
At March 6, 2009, 78,249,264 shares of the registrant’s Class A Common Stock, $0.001 par value and 1,000,000 shares of the registrant’s Preferred Stock, $0.001 par value were outstanding.
 


 
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1

 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Annual Report includes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including, but not limited to, statements regarding our future financial position, business strategy and plans and objectives of management for future operations. When used in this prospectus, the words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements.
 
We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to the risks discussed under the heading “Risk Factors”. Except as required by law, we assume no obligation to update these forward-looking statements publicly or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
 
In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Annual Report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Accordingly, readers are cautioned not to place undue reliance on such forward-looking statements.
 
 
2

 
 

This Amendment No. 1 on Form 10-K/A (the “Form 10-K/A”) amends the Annual Report on Form 10-K for the year ended December 31, 2008 filed by American Oriental Bioengineering, Inc. (the “Company”), which was originally filed with the Securities and Exchange Commission on March 9, 2009 (the “Original Report”).

During the review of its third quarter September 30, 2009 operating results, the Company identified isolated historical accounting errors in: (i) the calculation of stock based compensation, (ii) the recognition of deferred tax liabilities of certain acquired assets and (iii) the provision of deferred tax liabilities on undistributed earnings. The accounting errors have resulted in the misstatement of certain balance sheet and income statement items and the cumulative net earnings since the first quarter of 2007. The Company has no evidence that the errors resulted from any fraud or intentional misconduct. The Company undertook a review to determine the total amount of the errors and the accounting periods in which the errors occurred. The impact of each individual error identified or in aggregate was not material, considering the effects of prior year misstatements when quantifying misstatements in current year financial statements, the Company chose to restate its previously reported financial statements.

The Form 10-K/A includes amended and restated consolidated financial statements and related financial information for the years ended December 31, 2008, 2007 and 2006.  It also includes amended and restated financial results for each of the three interim quarterly periods in the years ended December 31, 2008 and 2007. The nature of the restatement is disclosed in Note 4 to the consolidated financial statements and the amended and restated financial results for each of the three interim quarterly periods is disclosed in Note 22 to the consolidated financial statements. The effects of this restatement are reflected in the Management’s Discussion and Analysis included in this Form 10-K/A.

Items 5, 6, 7, 8, 11 and 15 of the Original Report have been amended and restated in this Amendment to reflect the restatement. This Amendment includes information contained in the Original Report and, except as identified above, we have not modified or updated any other disclosures presented in the Original Report. The disclosures in this Amendment continue to reflect as of the date of the Original Report and have not been updated to reflect subsequent events identified after the filing of the Original Report. Accordingly, this Amendment should be read in conjunction with our other filings issued subsequent to the Original Report.
 
 
Overview
 
We are a leading, fully integrated, pharmaceutical company dedicated to improving health through the development, manufacture and commercialization of a broad range of pharmaceutical and healthcare products. A majority of our current products are offered and derived from Chinese based traditional medicines and are manufactured using plant based materials. Our profitable and diversified business is comprised of prescription pharmaceutical products, over-the-counter pharmaceutical products and nutraceutical products. Our pharmaceutical products are well recognized brands in China and have been approved by the Chinese State Food and Drug Administration, or SFDA, based on demonstrated safety and efficacy. We sell our products primarily to hospitals, clinics, pharmacies and retail outlets at over 100,000 locations in all provinces, including rural areas and major cities in China, through the efforts of our approximately 2,133 sales and marketing professionals. We leverage our relationships with over 320 distributors to distribute our products to both urban and rural areas of China. We have experienced substantial growth in recent years and intend to use our established business as a platform for continued growth both organically and through strategic acquisitions.
 
According to a recent ISI Emerging Markets report, the pharmaceutical industry in China was approximately $27.7 billion in 2005. We estimate the pharmaceutical market size was around $47.8 billion in 2008 assuming a compound annual growth rate of 20% since 2005. China is forecast to become the world’s fifth largest pharmaceutical market by 2010, which includes both western medicine and Traditional Chinese Medicine, or TCM. Our pharmaceutical products are modernized versions of TCM. Plant based TCM products have been widely used in China for thousands of years and are deeply ingrained in the Chinese culture. The market for TCM pharmaceutical products in China was approximately $5.8 billion in 2005, accounting for approximately 20.9% of all expenditures on medicine in China. According to a 2006 Frost & Sullivan report, the market for nutraceutical products in China was approximately $12.5 billion in 2005. Currently, the TCM market in China is highly fragmented, and we believe there are over 1,200 companies currently engaged in the development, manufacture and sale of TCM products, providing significant opportunities to acquire additional businesses, products and technologies.
 
Our revenues increased from $160.5 million in 2007 to $264.6 million in 2008, representing an increase of 64.90% year over year. The following table represents the manufacturing revenues realized from the sale of our Pharmaceutical and Nutraceutical products, as well as our distribution revenue from our newly acquired distribution business for the periods indicated:
 
3

 
 
   
For the Year Ended
December 31,
    Percent  
   
2008
   
2007
   
Change
 
Manufacturing revenue
  $ 259,171,087     $ 160,482,383       61.50 %
Pharmaceutical products
    224,904,348       127,823,297       75.95 %
Nutraceutical products
    34,266,739       32,659,086       4.92 %
Distribution revenue
    5,471,971              
Total sales
  $ 264,643,058     $ 160,482,383       64.90 %
 
Each of our Pharmaceutical products has certain medicinal functions and has demonstrated safety and efficacy in accordance with SFDA requirements for the treatment of at least one or more therapeutic indications. A majority of our pharmaceutical products are based on non-synthetic medicinal compounds that are extracted from various parts of one or more plants. We apply modern production techniques to TCM to produce a variety of pharmaceutical products in different formulations, such as tablets, capsules and powders.
 
We currently market over 60 pharmaceutical products in China. Two flagship prescription pharmaceutical products currently marketed in China are Shuanghuanglian Lyophilized Injection Powder, or SHL Injection Powder, and Cease Enuresis Soft Gel, or CE Gel. SHL Injection Power is an anti-viral injection effective in treating respiratory infections, bronchitis and tonsillitis, and CE Gel is indicated to alleviate bedwetting. We market our SHL Injection Powder through our brand name SHJ, and our CE Gel through Harbin Three Happiness Bioengineering Co., Ltd, or Three Happiness, which are both well-recognized brand names in China. These products are detailed to physicians at hospitals and clinics through the efforts of our sales force and through educational physician conferences and seminars.
 
Over-the-counter pharmaceutical products are similar to our prescription pharmaceutical products in that they are approved by the SFDA, but are sold over-the-counter direct to consumers in pharmacies and other retail outlets. We currently market over 30 over-the-counter pharmaceutical products including our Jinji Series, Cease Enuresis Patch, or CE Patch, and Boke Series. Jinji Series is a line of products approved for the treatment of various women’s health indications including endometritis, annexitis, pelvic inflammation, premenstrual and menopausal symptoms. CE Patch is a product indicated to alleviate bedwetting and for the treatment of incontinence. Boke Series is a line of nasal products indicated to alleviate sinus infections and nasal congestions. Our Jinji line of products, our CE Patch and our Boke Series are proprietary branded products and have leading market positions in the over-the-counter segments in which they compete and are marketed through our extensive direct-to-consumer advertising campaign. We highlight the quality and benefits of these products through television, newspaper and print advertisements.
 
Nutraceutical products, also frequently referred to as functional foods, functional beverages, dietary supplements and general nutritional supplements, are intended to be used to improve overall health and well-being. We market several nutraceutical products as general nutritional supplements in China, including our popular soybean peptide based drinks, tablets, powder and instant coffee. General nutritional supplements are generally not regulated by the SFDA; however, local government agencies may impose certain manufacturing requirements on those products aimed at protecting their hygiene. We promote our nutraceutical products through print advertising campaigns in magazines and newspapers, and distribute these products to supermarkets, fitness centers, healthcare specialty stores and other retail outlets in China.
 
In October 2008, through the acquisition of Nuo Hua Investment Company Ltd. (“Nuo Hua”), distribution form part of our businesses. Nuo Hua is a holding company with a subsidiary and affiliated company that maintain a significant presence in pharmaceutical wholesale and retail distribution in China. We now distribute more than 6,000 pharmaceutical products.
 
In addition to our marketed products, we have a portfolio of over 400 prescription and over-the-counter pharmaceutical products that are approved by SFDA, but have not been commercially launched.
 
We own and operate five manufacturing facilities through which we manufacture all of our products. Each facility is Good Manufacturing Practices, or GMP, International Organization for Standardization, or ISO, and Export Product certified.
 
Industry Background and Market Opportunities
 
The Chinese pharmaceutical and nutraceutical markets are highly fragmented, comprising a large number of small enterprises. We believe that this fragmentation provides opportunities for better managed and more financially sound companies to gain market share by using comparatively strong technical, manufacturing and marketing abilities. Moreover, China’s regulatory agencies have introduced a series of new regulations to control the standards and quality of manufacture and distribution in the pharmaceutical industry. These new regulations require companies to obtain government recognized manufacturing and distribution licenses, GMP and good sales practice certificates, and have resulted in the elimination of many small or poorly managed companies. We believe that this new legislation will precipitate consolidation opportunities and a generally more favorable competitive environment.
 
 
4

 
Pharmaceutical Market
 
The pharmaceutical industry in China was approximately $27.7 billion in 2005 and China is expected to become the world’s fifth largest pharmaceutical market by 2010, which includes western medicine and TCM. This growth is being driven by several factors including improving standards of living and an increase in disposable income fueled by the growing economy, the aging population, the increasing participation in the State Basic Medical Insurance System and the increase in government spending on public health care. In January 2009, the Chinese government approved a healthcare reform plan and has budgeted for RMB850 billion, or $124 billion, over the next three years to make medical services and products more affordable and accessible to the whole population.
 
Traditional Chinese Medicine Market
 
The TCM market for pharmaceutical products in China was approximately $5.8 billion in 2005, accounting for approximately 20.9% of all expenditures on medicine in China. TCM, including prescription and over-the-counter pharmaceuticals, have been widely used in China for thousands of years and are deeply ingrained in the Chinese culture. Historically, TCM consisted primarily of mixtures of dried herbs and, in some cases, animal parts and minerals. These mixtures would be boiled and simmered at home to create a medicinal tea or soup. These liquid concoctions were inconvenient to prepare and take, and their dosage and quality were inconsistent due to varied methods of preparation and differences in the quality of ingredients. Despite these characteristics, we believe that consumers perceive TCM products to have a superior safety profile compared to western pharmaceuticals and TCM are more effective in treating chronic and frequently occurred illnesses. In recent decades, Chinese pharmaceutical manufacturers have applied modern production technologies to produce TCM with consistent quality and a variety of formulations, such as tablets, capsules and powders, which we refer to as modernized TCM.
 
We believe the People’s Republic of China (“PRC”) is committed to supporting and promoting the development of modernized TCM, as evidenced by the government formulating an industry development plan for the modernized TCM sector and adding more modernized TCMs to the national medicine catalog of the National Medical Insurance Program. We believe TCMs will be a major component, in the national medicine catalog. Additionally, in the PRC pharmaceutical industry five-year plan released in June 2006 by the National Development and Reform Commission, or the NDRC, the NDRC identified TCMs, particularly TCMs used for the treatment of diseases prevalent among middle-aged and elderly people, as a priority area that will receive governmental support. The State Administration of Traditional Chinese Medicine, a national government agency, formulates TCM industry policies for the development of TCM and provides research grants for TCM research and development.
 
We believe that TCM will remain mainstream medicines in China and will continue to grow as a result of:
 
 
China’s longstanding preference for TCM remedies;
 
 
government support for modernized TCM as a key component of increasing quality of healthcare;
 
 
existence of well-recognized brands supported by a long history;
 
 
the rapidly growing over-the-counter market, in which TCM makes up more than half; and
 
 
lower pricing as compared to western medicine.
 
Nutraceutical Market
 
According to a 2006 Frost & Sullivan report, the market size of the Chinese nutraceutical market, comprised of functional foods, functional beverages and dietary supplements, was $12.5 billion in 2005. While there are no official definitions of the functional food and beverage categories in China, this is generally accepted to mean conventional food and beverages with added ingredients beneficial to the human body. Functional foods are most commonly fortified with nutritional ingredients such as calcium, soy products or dairy products. Functional beverages are typified by sports drinks, energy drinks, vitamin-enhanced water and other similar nutritional drinks. Dietary supplements are products that are intended to supplement the diet with vitamins, minerals, herbs, amino acids or other plant-based products. These types of supplements are typically ingested in the form of a pill, capsule, tablet or in liquid form. The main channels for distributing nutraceutical products, including health foods, in China are supermarkets and retail outlets. According to the 2006 Frost & Sullivan report, in 2005, the functional beverage market was estimated to be $5.0 billion and the dietary supplement market was estimated to be $4.5 billion.
 
The nutraceutical market in China has been growing rapidly over the past decade. This growth is driven primarily by the convenience associated with taking these products and the marketing investments that early entrants have made. As China’s population is increasingly influenced by western culture, Chinese men and women have begun to pay more attention to body image and weight.
 
 
5

 
Some nutraceuticals may be registered as health foods in China and are subject to approval by the SFDA. Health foods are generally defined as products that are suitable for a specific group of people and that are able to adjust body functions while not aiming at curing a disease. These substances, however, only need to demonstrate safety rather than meet clinical endpoints for efficacy. The SFDA has a list of 27 approved health and beauty benefits that health foods may claim on their packaging or in advertisements. These direct-to-consumer advertisements typically highlight one or more of the approved benefits while focusing on the style and fashion of healthy living. General nutritional supplements are generally not regulated by the SFDA; however, local government agencies may impose certain manufacturing requirements on these products aimed at protecting their hygiene.
 
Financial Information about Industry Segments
 
Since October 2008, we have two operating segments based on our major lines of businesses: manufacturing and distribution. For additional information please refer to Note 3 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.
 
Our Strengths
 
We believe we have the following competitive strengths that could enable us to capitalize on the large, fragmented and growing market for our pharmaceutical and nutraceutical products.
 
 
Fully Integrated Platform for Sustainable Growth. We are a vertically integrated pharmaceutical and nutraceutical company with our own development, manufacturing, commercialization and distribution capabilities for the prescription pharmaceutical, over-the-counter pharmaceutical and nutraceutical markets. Our nationally recognized branded products are distributed to over 100,000 locations in all provinces, including rural areas and major cities in China. We believe these capabilities can be leveraged to provide substantial organic growth across all of our product categories and can serve as a platform for integrating additional acquisitions.
 
 
Diverse Product Categories That Provide Operating Flexibility. Our business consists of three product categories including prescription pharmaceutical products, over-the-counter pharmaceutical products and nutraceutical products. Our pharmaceutical products treat different therapeutic areas including women’s health, nasal, bedwetting and anti viral. Each of these competes in a market segment with differentiated regulatory, economic and general market characteristics. We believe this diversification reduces our dependence on any one market segment and enables us to react quickly to evolving market conditions in China in order to optimize our business operations.
 
 
Well-Recognized Brand Names That Can be Leveraged for Additional Growth. We have nationally recognized brand names in China, including, Jinji, SHJ, Boke and Three Happiness. We believe these brand names will allow continued sales growth for our existing products and can be leveraged further with product line extensions and by establishing brand families for related products.
 
For instance, our Jinji product line enjoys particularly strong brand recognition in the women’s health market. We believe we can significantly capitalize on this strength for future product introductions to treat other women’s health indications and as we expand into other therapeutic categories.
 
 
Demonstrated Ability to Identify and Integrate Acquisitions. We have completed and integrated seven acquisitions in the last five years, each of which has contributed to our revenue and earnings growth. These acquisitions also added value to our brands, enhanced our products development capabilities, expanded our distribution networks and broadened our products offering. Our disciplined approach to acquisitions is based on well-defined criteria and is supported by a 14-person multi-disciplinary team dedicated to these business development activities, which we believe positions us well to participate in further consolidation in our industries.
 
 
Experienced and Results-Oriented Management Team. Several members of our senior management team have worked together for over 15 years and have contributed significantly to the growth of our business. Our revenues have grown at a CAGR of 69% over the past five years from $32.0 million in 2004 to $264.6 million in 2008. Our management team has extensive experience with the People’s Republic of China, or PRC, government and the market for pharmaceutical and nutraceutical products. Our management team encourages a strong corporate culture, which we believe contributes to our overall results.
 
 
6

 
Our Strategy
 
Our objective is to become the market leader for the development, manufacture and commercialization of pharmaceutical products. We intend to achieve this objective by:
 
 
Promoting Our Existing Brands to Maintain National Recognition. We intend to support and grow the existing recognition and reputation of our brands and to maintain our branded pricing strategy through continued sales and marketing efforts. To achieve this goal, we plan to:
 
 
detail the efficacy and safety profile of our established prescription pharmaceutical products to physicians at hospitals and clinics in all provinces in China through the efforts of our sales force and through educational physician conferences and seminars;
 
 
expand our extensive direct-to-consumer advertising campaign highlighting the quality and benefits of our fast growing over-the-counter pharmaceutical products through television, newspaper and print advertisements; and
 
 
Developing and Introducing Additional Products to Expand or Strengthen Our Existing Portfolio. We plan to focus our research and development capabilities towards expanding our existing portfolio of approved products. We have over 400 prescription and over-the-counter pharmaceutical products in our portfolio that are currently approved but have not been commercially launched. In addition, we intend to conduct clinical trials for new modernized products and product line extensions for our existing products. We plan to introduce new modernized products to leverage our branded market leadership position, particularly in the therapeutic areas we already have an establishment to develop product line extensions for our existing products.
 
 
Expanding Our Distribution Network For Further Market Penetration. We intend to expand our reach beyond the current approximately 100,000 distribution points in China to drive additional growth of our existing and future products. We currently contract with over 320 distributors in China and plan to expand upon these relationships to target new markets. In addition, we plan to continue to broaden our marketing efforts outside of major cities in China and increase our market penetration in cities and rural areas where we already have a presence.
 
We also intend to expand our presence beyond China to international markets. We plan to work with other international pharmaceutical companies in cross selling of our products.
 
 
Acquiring Complementary Products Lines, Technologies, Distribution Networks and Companies. We intend to selectively pursue strategic acquisition opportunities that we believe would grow our customer base, expand our product lines and distribution network, enhance our manufacturing and technical expertise or otherwise complement our business or further our strategic goals. Pursuing additional acquisitions is a significant component of our growth strategy.
 
Our Products
 
Our business consists of three main product categories, including prescription pharmaceutical products, over-the-counter pharmaceutical products and nutraceutical products. Majority of our pharmaceutical products are based on non-synthetic medicinal compounds that are extracted from leaves and roots of one or more plants. All of our pharmaceutical products have demonstrated safety and efficacy in clinical trials that has been sufficient to obtain approval by the SFDA. Nutraceutical products, also frequently referred to as functional foods, functional beverages, dietary supplements or general nutritional supplements, are intended to promote overall health and well-being. Our nutraceutical products are generally considered general nutritional supplements and are not subject to regulatory approval by the SFDA.
 
 
7

 
We currently manufacture and sell over 60 products. The following table summarizes our principal marketed pharmaceutical and nutraceutical products that comprised the majority of our revenue in the year of 2008.
 
Product
 
Distribution
Point
 
Indication
 
Year of AOB
Commercial
Launch
Pharmaceutical Products
           
             
Shuanghuanglian Lyophilized Injection Powder
 
Rx
 
Respiratory infections, bronchitis and tonsillitis
 
2004
             
Cease Enuresis Soft Gel
 
Rx
 
Bedwetting
 
2004
             
Cease Enuresis Patch
 
OTC
 
Bedwetting and incontinence
 
2005
             
Jinji Capsule
 
OTC
 
Endometritis, annexitis and pelvic inflammations
 
2006
             
Jinji Yimucao
 
OTC
 
Premenstrual syndrome, or PMS, and other PMS and menopause-related symptoms
 
2007
             
Boke Nasal Spray
 
OTC
 
Nasal congestion and sinus infection
 
2007
             
Nutraceutical Products
           
             
Soy Peptide Series
 
OTC
 
Nutritional products for overall health and well-being
 
2003
 
Prescription Pharmaceutical Products
 
Shuanghuanglian Lyophilized Injection Powder
 
Our SHL Injection Powder is a prescription pharmaceutical product approved and marketed for the treatment of flu symptoms, including high fever, cough and sore throat, as well as upper respiratory infections, mild pneumonia and tonsillitis. Our SHL Injection Powder, marketed under the brand name SHJ, is one of the only two injection formulations of SHL approved by the SFDA. The approved dosage for our SHL Injection Powder is 60 mg for every kilogram of a patient’s body weight. In practice, a medical doctor will decide exactly how much SHL injection powder to use for each patient. This product consists of two plant based ingredients isolated from flowers and leaves.
 
Our SHL Injection Powder was commercially launched in China in 1997 by HSPL, which we acquired in 2004. We detail the safety and efficacy of this product to physicians in hospitals and clinics primarily in rural China. We believe that injectables are of higher quality and offer better bioavailability and efficacy than oral formulations. We are one of the two companies approved by the Ministry of Health to manufacture and commercialize SHL injection powder. This product is manufactured at our Heilongjiang Songhuajiang Pharmaceutical, or HSPL, facility in Harbin.
 
Phase 3 clinical trials for SHL Injection Powder were conducted on 489 patients at Harbin University of Medical Sciences First Affiliated Hospital, Heilongjiang TCM Research Institute and Harbin TCM Hospital. These trials demonstrated safety and efficacy in accordance with SFDA requirements.
 
Cease Enuresis Soft Gel
 
Our CE Gel is a prescription pharmaceutical product approved and marketed to alleviate pediatric bedwetting. This product consists of a formulation that is isolated from the seed of a plant. Our CE Gel is the only SFDA approved Category 1 new pharmaceutical product for this indication. Category 1 approval provides a product with 12 year protection from other companies replicating the product and can be granted when the product is considered to be the first product for a specific indication.
 
Our CE Gel was commercially launched in China in April 2004. We detail the clinical benefits of this product to physicians in hospitals and clinics throughout China. As prescription medications cannot be commercially advertised in China, we rely on physicians to recommend the use of our CE Gel to patients. The Cease Enuresis brand name, however, is well recognized by many patients as our CE Patch is an over-the-counter pharmaceutical product that we promote through direct-to-consumer advertising. This product is manufactured at our Three Happiness facility in Harbin.
 
Phase 3 clinical trials for CE Gel were conducted on 437 pediatric patients at Beijing Children’s Hospital, China University of Medical Sciences No. 2 Clinical Hospital, Liaoning TCM Institute Affiliated Hospital and Liaoning TCM Research Institute. These trials demonstrated safety and efficacy in accordance with SFDA requirements.
 
 
8

 
Over-the-Counter Pharmaceutical Products
 
Cease Enuresis Patch
 
Our CE Patch is an over-the-counter pharmaceutical product approved and marketed for the treatment of bedwetting and incontinence. Our CE Patch is formulated for delivery by a patch and can be used in combination with our CE Gel. This product consists of the same plant based ingredients as our CE Gel. Our CE Patch was commercially launched in China in 2005. We promote our CE Patch through direct-to-consumer advertising on television and in print media in China. This product is manufactured at our Three Happiness facility.
 
Our CE Patch was approved by the Food and Drug Administration Bureau of the Heilongjiang Province, under the medical device regulatory pathway.
 
Jinji Capsule
 
Our Jinji Capsule is an over-the-counter pharmaceutical product approved and marketed for the treatment of endometritis, annexitis and pelvic inflammations. This is our company’s proprietary product with well recognized brand name. This product consists of a combination of many parts of TCM plants, including roots, vines, flowers and stems. We source the majority of our raw materials for our Jinji product line from the Guangxi province, which we believe has a unique natural environment to cultivate high quality plants. We believe the combination of these quality ingredients, our manufacturing processes and our well-recognized brand name position our Jinji products well to compete in the marketplace. A course of treatment requires a dose of four capsules taken three times a day.
 
Our Jinji Capsule was commercially launched approximately 30 years ago in China by GLP, which we acquired in April 2006. With its long history, the Jinji brand name is well-recognized in the women’s health market in China. We promote our Jinji Capsule through direct-to-consumer advertising, including an extensive television commercial campaign featuring popular Chinese celebrity Ms. Ni Ping. These commercials are televised nationally in China. We believe that these advertisements continue to strengthen our brand loyalty, a major driver of the historical popularity of the drug. This product is manufactured at our Guangxi Lingfeng Pharmaceutical Co., or GLP, facility in Hezhou in the Guangxi Province in Southwestern China.
 
Phase 3 clinical trials for Jinji Capsule were conducted on 421 female patients at Wuzhou City People’s Hospital, Wuzhou City Workers’ Hospital and Hezhou TCM Hospital. These trials demonstrated safety and efficacy in accordance with SFDA requirements.
 
Jinji Yimucao
 
Our Jinji Yimucao is an over-the-counter pharmaceutical product approved and marketed for the treatment of premenstrual syndrome, or PMS, and other PMS and menopause-related symptoms. Jinji Yimucao is approved by the SFDA in China and marketed as a branded generic drug. This product consists of a combination of many parts of TCM plants, including roots, vines, flowers and stems. We source the majority of our raw materials for our Jinji product line from the Guangxi province, which we believe has a unique natural environment to cultivate high quality plants. We believe the combination of these quality ingredients, our manufacturing processes and our well-recognized brand name position our product well to compete in the marketplace. Each treatment requires a dose of two packets of powder for oral suspension taken two times a day.
 
In early 2007 we commercially launched Jinji Yimucao. We own this product as a result of the acquisition of GLP, which we completed in April 2006. We promote Jinji Yimucao through direct-to-consumer advertising, including an extensive television commercial campaign. We believe that these advertisements continue to strengthen our brand loyalty, a major driver of the historical popularity of the drug. This product is manufactured at our GLP facility in Hezhou.
 
Boke Nasal Spray
 
Our Boke nasal spray is an over-the-counter pharmaceutical product approved and marketed for the treatment of sinus congestion from common cold, stuffy nose, chronic rhinitis, allergic rhinitis and nasosinusitis. The spray is marketed under the product name of Ditong Biyanshui Penwuji (“Ditong”). Ditong is approved by the SFDA in China and marketed as a branded drug. This product consists of a combination of many parts of TCM plants, including roots, vines, flowers and stems. Treatment dosage is three to four times a day and two sprays into each nostril.
 
Ditong was commercially launched by Boke in China approximately 10 years ago. We own this product as a result of the acquisition of Boke, which we completed in October 2007. We promote Boke nasal spray through direct-to-consumer advertising, including an extensive television commercial campaign. We believe that these advertisements continue to strengthen our brand loyalty, a major driver of the historical popularity of the drug. This product is manufactured at our Boke facility in Nanning.
 
 
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Principal Nutraceutical Products
 
Soy Peptide Series
 
Our Soy Peptide Series is our primary line of nutraceutical products, all of which are available in supermarkets, fitness centers, specialty nutraceutical stores and other retail outlets. These products include tablets, powders, drinks and instant coffee that are non-genetically modified and derived from soybeans through a biochemical process involving decomposition, conversion and synthesis of soybean protein. They are used as food and beverage supplements and are easily digested, increase metabolism and can replenish body strength. We have four distinct formulations: anti-fatigue, menopause, immunoenhancer and balanced formula. The benefit of our peptide formulation compared with the soybean itself is that our formulation is more readily absorbable by the human body. We manufacture these products at our Three Happiness facility in Harbin.
 
Our Soy Peptide Series was commercially launched in China in 2002. We do not have any exclusivity under Chinese law for these products but we own trademarks and market all of our nutraceutical products through print advertising campaigns. While the nutraceutical market is highly fragmented with many competitors, we believe that our product branding and multiple forms for delivery of the peptide will continue to support additional growth.
 
Product Pipeline
 
We have our own research, development and laboratory facilities and retain our own professional research and development team. We have also entered into joint research and development agreements with outside research institutes in China. We have a portfolio of over 400 approved prescription and over-the-counter pharmaceutical products that have not been commercially launched. We continue to strengthen our research and development efforts and we intend to continue introducing new modernized products to leverage our branded market leadership position, and to develop line extensions for our existing products.
 
We are also exploring opportunities for acquisitions that may complement our existing product lines and leverage our significant sales and distribution capabilities.
 
Marketing and Sales
 
In China, we manufacture and market more than 60 products, consisting of prescription and over-the-counter pharmaceuticals and nutraceutical. Our pharmaceutical and nutraceutical products are marketed to hospitals, clinics, pharmacies and retail stores at over 100,000 distribution points. We maintain 28 regional representative offices throughout China and employ approximately 2,133 sales and marketing professionals. Where appropriate, we leverage the synergies between complementary products and distribution channels to accelerate the market penetration of our new products. Our sales force markets to all provinces, including rural areas and major cities in China.
 
Distributors and Customers
 
We have an extensive third-party distribution network with over 300 distributors that provide us with widespread access to sell our products in all provinces, including rural areas and major cities in China. The breadth of our distribution channel allows us to target approximately 100,000 distribution points comprising hospitals, clinics, pharmacies and retail stores. We select our distributors based on their reputation and market coverage. Because we have our own extensive sales and marketing team we rely on our distributors solely for the transportation of our products to our distribution points and not for sales and marketing services. As a result, we do not enter into exclusive distribution agreements with these third party distributors. We review our distribution agreements on an annual basis to specify designated distribution points, the location and method for delivery of our products to certain distribution points and targets for annual sales volume and receivable collections.
 
The distribution industry in China is fragmented with over 2,000 distributors. Due to the number of distributors, we do not rely on any one distributor for our distribution needs. We estimate that our top 10 distributors account for only approximately 15% of our total sales.
 
In October 2008, through the acquisition of Nuo Hua, distribution form part of our business. Through Nuo Hua’s subsidiary and affiliated company, we now distribute more than 6,000 pharmaceutical products through an extensive sales network covering major urban and rural areas in China.
 
 
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Manufacturing
 
We have five manufacturing facilities in China dedicated exclusively to the manufacture of our products. Each facility is GMP certified. We have fully integrated manufacturing support systems including quality assurance, quality control and regulatory compliance. We have developed our own independent quality control systems in accordance with SFDA regulations. Our quality assurance team devotes significant attention to quality control for designing, manufacturing and testing our products, and is also responsible for ensuring that we are in compliance with all applicable national and local regulations and standards, as well as our internal policies. Our senior management team is also actively involved in setting quality assurance policies and managing internal and external quality performance. These support systems enable us to maintain high standards of quality for our products and deliver reliable products to our customers on a timely basis.
 
The details of our facilities are as follows:
 
 
Three Happiness. Our Three Happiness facility is located in Harbin, the capital of Heilongjiang Province in northeast China. It is approximately 1,532,775 square feet and manufactures both pharmaceutical and nutraceutical products. The Three Happiness facility consists of one pharmaceutical and one nutraceutical manufacturing plant, including a dedicated building for soybean peptide products.
 
 
HSPL. Our HSPL facility is also located in Harbin. It is approximately 532,339 square feet and manufactures our SHL Injection Powder.
 
 
GLP. Our GLP facility is located in Hezhou, in the Guangxi Province in southwest China. It is approximately 1,485,055 square feet and manufactures our Jinji series of women’s health products.
 
 
CCXA. Our CCXA facility is located in ChangChun, the capital of Jilin Province in northeast China. It is approximately 1,077,467 square feet and manufactures a variety of generic pharmaceutical products including Zhitongfengshi tablets for the treatment of osteophyte and Yakangling capsule for the treatment of gingivitis.
 
 
Boke. Our Boke facility is located in Nanning, the capital of Guangxi Province in southwest China. It is approximately 174,280 square feet and manufactures our Boke series of nasal products.
 
We have land use rights to the land on which our manufacturing facilities are located that are granted and allocated to us by the government. According to Chinese law, the government owns all the land in China and companies or individuals are authorized to use the land only through land use rights granted or allocated by, or leased from, the PRC government.
 
We currently have adequate manufacturing capacity for our marketed products.
 
Raw Materials
 
We require a supply of quality raw materials to manufacture our products. Historically, we have not had difficulty obtaining raw materials from suppliers. Currently, we rely on numerous suppliers to deliver our required raw materials. Our products are mainly plant based and derived from flowers, plants and roots which are locally grown by farmers in China. We enter into arrangements with numerous suppliers in China to hedge against the risk of short supply due to irregularities in seasonal temperatures. If we anticipate a shortage, we have the capability and warehouse capacity to store such materials.
 
Intellectual Property
 
We regard our packaging designs, service marks, trademarks, trade secrets, patents and similar intellectual property as part of our core competence that is critical to our success. We rely on patent, trademark and trade secret law, as well as confidentiality agreements with certain of our employees, distributors and others to protect our intellectual property rights.
 
There are three types of patents under the PRC patent law. The first type, an external design patent, refers to a new design of a product’s shape, pattern or a combination of shape and pattern and the combination of a product’s color and its shape and pattern, where such a design is aesthetically appealing and suitable for industrial application. The second type of patent is called an invention patent and the third type of patent is referred to as a new model or utility patent. Invention patents and utility patents are similar in that both of them relate to scientific or technological inventions. A utility patent, compared to an invention patent, requires a lower level of creativity and covers a narrower scope. In addition, an invention patent can be a new technology introduced in respect of an existing product, method or their improvements, while a utility patent is restricted to a product’s shape, constitutions or a combination of these two. Invention patents are valid for 20 years, whereas utility patents and external design patents are each valid for 10 years.
 
To a large extent, we rely on such State Protection law to protect our intellectual property rights with respect to some of our products. As of February 28, 2009, we owned a total of 40 patents and have registered a total of 86 trademarks and the number of trademarks in the process of application is 161.
 
 
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Competition
 
We believe that we are well positioned to compete in the fast-developing Chinese pharmaceutical and nutraceutical market with our strong brand, diverse product portfolio, research and development capabilities, established sales and marketing network and favorable cost structure. We believe that competition and leadership in our industry are based on managerial and technological expertise, and the ability to identify and exploit commercially viable products. Other factors affecting our competitive position include time to market, patent position, product efficacy, safety, convenience, reliability, availability and pricing.
 
Our SHL Injection Powder primarily competes with a similar injection powder product produced by Harbin Pharmaceutical Group. Our marketing strategy with respect to this product is broader than our competitor by focusing on rural markets as well as major cities and continues to maintain high products quality. We believe this strategy has been successful for us against our competition.
 
Our CE Gel competes with several other products having similar functionality. Some of these products include the Jianpizhiyi Tablet produced by Shangdong Zhiling Pharmaceutical Company, Yeniaoying produced by Tianjin Zhongxin Company, Shengjiyiniaokang produced by Shanxi Dingxing Healthcare Scientific Limited and Suoquan Pill produced by Jilin Tianguang Pharmaceutical Limited. Despite the similar products in the market, we believe our CE Gel is the leading product, as currently it is the only SFDA approved first grade medicine for bedwetting.
 
Our Jinji Capsule competes with Huahong Pill produced by Huahong Pharmaceutical Group and Qianjin Pill produced by Qianjin Pharmaceutical Group.
 
Our Boke nasal spray competes with Dezhong Biyankang produced by Guangdong Foshan Dezhong Pharmaceutical Co., Ltd; Zhonglian Rhinitis Tablets produced by Wuhan Zhonglian Pharmaceutical Co., Ltd; and Qianbai Rhinitis Tablet produced by Guangzhou Qixing Pharmaceutical Co., Ltd.
 
Our Soy Peptide Series competes with Leneng Peptide Powder, produced by Leneng Bioengineering Company and Soybean Protein Peptide, produced by Harbin High-Tech Company Limited.
 
Environmental Matters
 
We comply with the Environmental Protection Law of China as well as the applicable local regulations. In addition to statutory and regulatory compliance, we actively ensure the environmental sustainability of our operations. Penalties would be levied upon us if we fail to adhere to and maintain certain standards. Such failure has not occurred in the past, and we generally do not anticipate that it will occur in the future, but no assurance can be given in this regard.
 
Employees
 
We had 4,076 employees as of December 31, 2008. Approximately 1,238 of these employees are principally engaged in manufacturing and services activities, 2,133 in sales and marketing, 122 in research and development and 583 in management and administration. In 2008 we increased our number of employees through hiring and acquisition and retained the best talent during the process of integration and performance review. We continue to monitor our headcount and may add additional employees for sales and marketing, customer service and manufacturing and assembly as our business grows. In general, we consider our relationship with our employees to be good.
 
Insurance
 
We currently carry insurance policies which are customary for enterprises in China providing for total coverage of approximately $37.23 million. We have property coverage of approximately $19.5 million, transport vehicle coverage of approximately $0.75 million and workers’ medical and accident coverage of approximately $1.98 million. We also maintain Director and Officer Insurance coverage of $15 million. We paid aggregate insurance premiums of $1,164,742 in the year of 2008.
 
 
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Our History
 
Three Happiness had been conducting business in China since 1994. In June 2002, through a share exchange with the stockholders of Three Happiness, Three Happiness became our wholly-owned subsidiary and continued its business operations in China. Prior to the share exchange we did not have any business operations. At the time of the share exchange we changed our name to American Oriental Bioengineering, Inc.
 
In February 2003, we acquired the rights to a soybean protein peptide biochemical engineering project, which provided us with the rights to manufacture and commercialize our Soy Peptide Series of nutraceutical products. Also, since the share exchange in 2002, we acquired seven companies in China. In November 2004, we acquired HSPL, which manufactures and commercializes our SHL Injection Powder. In April 2006, we acquired GLP, which manufactures and commercializes our Jinji series. In July 2006, we acquired HQPL, a pharmaceutical distributor that owns a license to distribute pharmaceutical products in China. In August 2007, we acquired CCXA, which manufactures and commercializes a board range of generic pharmaceutical products. In October 2007, we acquired BOKE, which manufactures and commercializes our Boke series of nasal products. In October 2008, we acquired Nuo Hua, a pharmaceutical wholesale and retail distribution company, and GuangXi HuiKe Pharmaceutical Research and Development Co., Ltd. (“GHK”), a company engaged in pharmaceutical research and product development leading to SFDA approval to expedient product launches in China.
 
On July 18, 2005, our common stock commenced trading on the American Stock Exchange, or AMEX, under the ticker symbol “AOB.” On November 14, 2005, our common stock commenced trading on the Archipelago Exchange, or ArcaEx, a facility of the Pacific Exchange.
 
On December 18, 2006, we voluntary elected to delist our common stock from the AMEX and ArcaEx. Our common stock commenced trading on the New York Stock Exchange under the ticker symbol “AOB” on the same day.
 
Regulations of Our Industry
 
Regulations Relating to the Pharmaceutical Industry
 
The pharmaceutical industry in China, including the TCM sector, is highly regulated. The primary regulatory authority is the SFDA, including its provincial and local branches. As a developer, producer and distributor of medicinal products, we are subject to regulation and oversight by the SFDA and its provincial and local branches. The Law of the PRC on the Administration of Pharmaceuticals provides the basic legal framework for the administration of the production and sale of pharmaceuticals in China and covers the manufacturing, distributing, packaging, pricing and advertising of pharmaceutical products. Its implementing regulations set forth detailed rules with respect to the administration of pharmaceuticals in China. We are also subject to other PRC laws and regulations that are applicable to business operators, manufacturers and distributors in general.
 
Registration and Approval of Medicine. A medicine must be registered and approved by the SFDA before it can be manufactured. The registration and approval process requires the manufacturer to submit to the SFDA a registration application containing detailed information concerning the efficacy and quality of the medicine and the manufacturing process and the production facilities the manufacturer expects to use. To obtain the SFDA registration and approval necessary for commencing production, the manufacturer is also required to conduct pre-clinical trials, apply to the SFDA for permission to conduct clinical trials, and, after clinical trials are completed, file clinical data with the SFDA for approval. Our pharmaceutical products are approved by the SFDA and are being sold both as prescription and over-the-counter medicines.
 
New Medicine. If a medicine is approved by the SFDA as a new medicine, the SFDA will issue a new medicine certificate to the manufacturer and impose a monitoring period which shall be calculated starting from the day of approval for manufacturing of the new medicine and may not exceed five years. The length of the monitoring period is specified in the new medicine certificate. During the monitoring period, the SFDA will monitor the safety of the new medicine, and will neither accept new medicine certificate applications for an identical medicine by another pharmaceutical company, nor approve the production or import of an identical medicine by other pharmaceutical companies. For new medicines approved prior to September 2002, the monitoring period could be longer than five years. As a result of these regulations, the holder of a new medicine certificate effectively has the exclusive right to manufacture the new medicine during the monitoring period.
 
 
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Provisional National Production Standard. In connection with the SFDA’s approval of a new medicine, the SFDA will normally direct the manufacturer to produce the medicine according to a provisional national production standard, or a provisional standard. A provisional standard is valid for two years, during which the SFDA closely monitors the production process and quality consistency of the medicine to develop a national final production standard for the medicine, or a final standard. Three months before the expiration of the two-year period, the manufacturer is required to apply to the SFDA to convert the provisional standard to a final standard. Upon approval, the SFDA will publish the final standard for the production of this medicine. In practice, the approval for conversion to a final standard is a time-consuming process. However, during the SFDA’s review period, the manufacturer may continue to produce the medicine according to the provisional standard.
 
Transitional Period. Prior to the latter of (1) the expiration of a new medicine’s monitoring period or (2) the date when the SFDA grants a final standard for a new medicine after the expiration of the provisional standard, the SFDA will not accept applications for an identical medicine nor will it approve the production of an identical medicine by other pharmaceutical companies. Accordingly, the manufacturer will continue to have an exclusive production right for the new medicine during this transitional period.
 
Continuing SFDA Regulation. Pharmaceutical manufacturers in China are subject to continuing regulation by the SFDA. If the labeling or manufacturing process of an approved medicine is significantly modified, a new pre-market approval or pre-market approval supplement will be required by the SFDA. A pharmaceutical manufacturer is subject to periodic inspection and safety monitoring by the SFDA to determine compliance with regulatory requirements. The SFDA has a variety of enforcement actions available to enforce its regulations and rules, including fines and injunctions, recall or seizure of products, the imposition of operating restrictions, partial suspension or complete shutdown of production and criminal prosecution.
 
Pharmaceutical Product Manufacturing
 
Permits and Licenses for Pharmaceutical Manufacturers. A pharmaceutical manufacturer must obtain a pharmaceutical manufacturing permit from the SFDA’s relevant provincial branch. This permit is valid for five years and is renewable upon its expiration. Each of our manufacturing facilities has a pharmaceutical manufacturing permit. We do not anticipate any difficulty in renewing our pharmaceutical manufacturing permits upon expiration.
 
Good Manufacturing Practice. A pharmaceutical manufacturer must meet Good Manufacturing Practice standards, or GMP standards, for each of its production facilities in China in respect of each form of pharmaceutical products it produces. GMP standards include staff qualifications, production premises and facilities, equipment, raw materials, environmental hygiene, production management, quality control and customer complaint administration. If a manufacturer meets the GMP standards, the SFDA will issue to the manufacturer a Good Manufacturing Practice certificate, or a GMP certificate, with a five-year validity period. However, for a newly established pharmaceutical manufacturer that meets the GMP standards, the SFDA will issue a GMP certificate with only a one-year validity period. We have obtained a GMP certificate for all of our production facilities covering all of the products that we produce.
 
Pharmaceutical Distribution. A distributor of pharmaceutical products in China must obtain a pharmaceutical distribution permit from the relevant provincial or local SFDA branches. The distribution permit is granted if the relevant SFDA provincial branch receives satisfactory inspection results of the distributor’s facilities, warehouse, hygiene environment, quality control systems, personnel and equipment. A pharmaceutical distribution permit is valid for five years.
 
Restrictions on Foreign Ownership of Pharmaceutical Wholesale and Retail Businesses in China. Chinese regulations on foreign investment currently permit foreign companies to establish or invest in wholly foreign-owned companies or joint ventures that engage in wholesale or retail sales of pharmaceuticals in China. For retail sales, these regulations restrict the number and size of retail pharmacy outlets that a foreign investor may establish. Retail pharmacy chains with more than 30 outlets that sell a variety of branded pharmaceutical products sourced from different suppliers are limited to less than 50.0% foreign ownership unless the outlets are owned by a third party and operated under a foreign franchise.
 
Good Supply Practice Standards. The SFDA applies Good Supply Practice standards, or GSP standards, to all pharmaceutical wholesale and retail distributors to ensure the quality of distribution in China. The currently applicable GSP standards require pharmaceutical distributors to implement controls on the distribution of medicine, including standards regarding staff qualifications, distribution premises, warehouses, inspection equipment and facilities, management and quality control. A certificate for GSP standards, or GSP certificate, is valid for five years, except for a newly established pharmaceutical distribution company, for which the GSP certificate is valid for only one year.
 
 
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Price Controls. The retail prices of prescription and over-the-counter medicines that are included in the national medicine catalog are subject to price controls administered by the Price Control Office under the National Development and Reform Commission, or the NDRC, and provincial price control authorities, either in the form of fixed prices or price ceilings. The controls over the retail price of a medicine effectively set the limits for the wholesale price of that medicine. From time to time, the NDRC publishes and updates a national list of medicines that are subject to price control. Fixed prices and price ceilings on medicines are determined based on profit margins that the NDRC deems reasonable, the type and quality of the medicine, its production costs, the prices of substitute medicines and the extent of the manufacturer’s compliance with the applicable GMP standards. The NDRC directly regulates the price of some of the medicines on the list, and delegates the power to provincial price control authorities to regulate the remainder on the list. For those medicines under the authority of provincial price control authorities, each provincial price control authority regulates medicines manufactured by manufacturers registered in that province. Provincial price control authorities have the discretion to authorize price adjustments based on the local conditions and the level of local economic development. Only the manufacturer of a medicine may apply for an increase in the retail price of the medicine and it must apply either to the NDRC, if the price of the medicine is nationally regulated, or to the provincial price control authorities in the province where it is registered, if the price of the medicine is provincially regulated. For a provincially regulated medicine, when provincial price control authorities approve an application, they will file the new approved price with the NDRC for confirmation and thereafter the newly approved price will become binding and enforceable across China.
 
Tendering Requirement for Hospital Purchases of Medicines. Provincial and municipal government agencies such as provincial or municipal health departments also operate a mandatory tendering process for purchases by state-owned hospitals of a medicine included in provincial medicine catalogs. These government agencies organize a tendering process once every year in their province or city and typically invite manufacturers of provincial catalog medicines that are on the hospitals’ formularies and are in demand by these hospitals to participate in the tendering process. A government-approved committee consisting of physicians, experts and officials is delegated by these government agencies the power to review bids and select one or more medicines for the treatment of a particular medical condition. The selection is based on a number of factors, including bid price, quality and manufacturer’s reputation and service. The bidding price of a winning medicine will become the price required for purchases of that medicine by all state-owned hospitals in that province or city. The tendering requirement was first introduced in 2001 and has since been implemented across China. We understand that the level of present implementation of the tendering requirement varies among different provinces in China.
 
Reimbursement under the National Medical Insurance Program. As of the end of 2006, approximately 157.4 million people were enrolled into the National Medical Insurance Program. The Ministry of Labor and Social Security, together with other government authorities, determines which medicines are to be included in or removed from the national medicine catalog for the National Medical Insurance Program, and under which tier a medicine should fall, both of which affect the amounts reimbursable to program participants for their purchases of those medicines. These determinations are based on a number of factors, including price and efficacy. A National Medical Insurance Program participant can be reimbursed for the full cost of a Tier 1 medicine and 80 to 90% of the cost of a Tier 2 medicine. Although it is designated as a national program, the implementation of the National Medical Insurance Program is delegated to various provincial governments, each of which has established its own medicine catalog. A provincial government must include all Tier 1 medicines listed in the national medicine catalog in its provincial medicine catalog, but may use its discretion based on its own selection criteria to add other medicines to, or exclude Tier 2 medicines listed in the national medicine catalog from, its provincial medicine catalog, so long as the combined numbers of the medicines added and excluded do not exceed 15% of the number of the Tier 2 medicines listed in the national catalog. In addition, provincial governments may use their discretion to upgrade a nationally classified Tier 2 medicine to Tier 1 in their provincial medicine catalogs, but may not downgrade a nationally classified Tier 1 medicine to Tier 2. The total amount of reimbursement for the cost of prescription and over-the-counter medicines, in addition to other medical expenses, for an individual program participant in a calendar year is capped at the amount in that participant’s individual account. The amount in a participant’s account varies, depending upon the amount of contributions from the participant and his or her employer. Generally, program participants who are from relatively wealthier eastern parts of China and relatively wealthier metropolitan centers have greater amounts in their individual accounts than those from less developed provinces.
 
Regulation Relating to the Nutraceutical Industry
 
Some nutraceuticals produced in China can be labeled as health food, which means the product is aimed at a specific group of people and is able to adjust bodily function but is not aimed at curing disease. Health foods are required to be approved by the SFDA and are subject to its regulation. We currently have only one product approved as a health food by the SFDA.
 
 
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Registration of Health Products
 
The approval of nutraceuticals as health products requires (i) an applicant to perform product research prior to submitting an application for registration of health food; (ii) an applicant to submit the sample and relevant product research materials to the examination institute appointed by the SFDA for required trial and examination; and (iii) the issuance of a report by the examination institute.
 
Provincial food and drug authorities review the product research materials and sample and, if found satisfactory, the food and drug authorities at the provincial level conduct site inspections and sample examinations and thereafter submit their opinion along with the application materials to the SFDA, and in the meantime, send inspection notice together with the sample to be examined to the appointed examination institute. The examination institute conducts examinations and inspections and submits its report to the SFDA. If all the regulatory requirements are satisfied, the SFDA will grant an Approval Certificate of Homemade Health Food to the applicant. The Approval Certificate of Health Food is effective for a period of five years.
 
Any changes to the items stated in the Approval Certificate of Health Food as well as its appendices must be approved by the SFDA. However, pursuant to the Administration Rules for Registration of Health Food (Trial), the product name, raw materials, manufacturing process, usage methods and other items stated in the Approval Certificate of Health Food, which may affect the safety and function of the health food, shall not be alternated.
 
In the case of transfer of technology of the registered health products to be manufactured in PRC, the transferee shall apply for new approval certificate of homemade health food in accordance with the relevant provisions of the Administration Rules for Registration of Health Food (Trial).
 
Permits and Licenses for manufacturing of Health Foods
 
Those enterprises engaging in manufacturing and operation of health food business must also comply with the PRC Food Hygiene Law and the Administration Rules of Food Hygiene Permit. Under the PRC Food Hygiene Law, enterprises engaging in manufacturing and operation of food products in PRC are required to obtain Hygiene Permit from the relevant PRC hygiene administrative authorities. In order to manufacture health food in the PRC, the manufacturing enterprise shall apply to the hygiene administration authorities at the provincial level for approval. If it is qualified, the hygiene administrative authorities at the provincial level will issue a Hygiene Permit with the approved health food specified. Each Hygiene Permit issued to a food manufacturing enterprise is effective for a period of four years. The enterprise is required to apply for renewal of such permit within sixty days prior to its expiry.
 
Manufacturing enterprise of health food shall organize its manufacture in accordance with the approval and shall not change the ingredient, manufacturing process, quality standard, name of the products, label, illustration and so on. The manufacturing procedures and conditions shall be in compliance with hygiene requirements that are applicable to the food manufacturing enterprise.
 
Compliance with GMP
 
Pursuant to the Notice of Circulating the Examination Methods and Assessment Guidelines of Good Manufacturing Practices of Health Food promulgated by the MOH, the Hygiene Permit shall only be issued to those enterprises in compliance with the GMP upon examination of the hygiene administrative authorities at the provincial level. For those enterprises failing to meet the GMP, the Hygiene Permit will be revoked.
 
Label of Health Food
 
The Regulation for Label of Health Food as promulgated by the MOH provides for requirements of the label of health food. According to this regulation, the name, function, functional ingredient, applicable scope and file number of approval of the health food labeled shall be consistent with those corresponding items stated in the Approval Certificate of Health Food issued by the hygiene administrative authorities at the provincial level.
 
Other Regulations
 
In addition to the regulations relating to pharmaceutical industry in China, our operating subsidiaries are also subject to the regulations applicable to a foreign invested enterprise, or FIE, in China.
 
 
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Foreign Currency Exchange. Pursuant to the Foreign Currency Administration Rules promulgated in 1996 and amended in 1997 and various regulations issued by State Administration of Foreign Exchange, or the SAFE, and other relevant PRC government authorities, the Renminbi is freely convertible only to the extent of current account items, such as trade-related receipts and payments, interests and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment, require the prior approval from the SAFE or its local counterpart for conversion of Renminbi into a foreign currency, such as U.S. dollars, and remittance of the foreign currency outside the PRC. Payments for transactions that take place within the PRC must be made in Renminbi. Unless otherwise approved, PRC companies other than FIEs must convert foreign currency payments they receive from abroad into Renminbi. On the other hand, FIEs may retain foreign exchange in accounts with designated foreign exchange banks, subject to a cap set by the SAFE or its local counterpart.
 
Dividend Distribution. The principal regulations governing dividend distributions by wholly foreign-owned enterprises and Sino-foreign equity joint ventures include:
 
Wholly Foreign-Owned Enterprise Law (1986), as amended;
 
Wholly Foreign-Owned Enterprise Law Implementing Rules (1990), as amended;
 
Sino-Foreign Equity Joint Venture Enterprise Law (1979), as amended;
 
Sino-Foreign Equity Joint Venture Enterprise Law Implementing Rules (1983), as amended; and
 
Regulations on the Administration of Foreign Exchange Settlement, Sale and Payment.
 
Under these regulations, wholly foreign-owned enterprises and Sino-foreign equity joint ventures in the PRC may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, these foreign-invested enterprises are required to set aside certain amounts of their accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends.
 
Additional Available Information
 
We can make available free of charge on or through our Internet website, www.bioaobo.com, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, if any, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. We also can make available free of charge on at www.bioaobo.com our website our Business Code of Conduct and Ethics, Nominating and Corporate Governance Committee Charter, Compensation Committee Charter and Audit Committee Charter. The information contained on our website is not intended to be incorporated into this Annual Report on Form 10-K.
 
 
Our business, financial condition, operating results and prospects are subject to the risks listed below. Additional risks and uncertainties not presently foreseeable to us may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or operating results could be materially adversely affected. In such case, the trading price of our common stock could decline, and our stockholders may lose all or part of their investment in the shares of our common stock.
 
Risks Related to Our Business and Industry
 
A disproportionate amount of our sales revenue is derived from six of our products and a disruption in, or a compromise of, our manufacturing or sales operations, or distribution channels related to any of these six products could materially and adversely affect our financial condition and results of operations.
 
Our top six products, which comprise Shuanghuanglian Lyophilized Injection Powder, or SHL Injection Powder, CE Gel, Jinji Capsule, Jinji Yimucao, Soybean Peptide Tablets and Boke Nose Spray, constituted approximately 71% of our total revenues in 2008 and 81.1% of our total revenues in 2007. We expect that these six products will continue to account for a majority of our sales in the near future. Because of our dependence on a few products, any disruption in, or compromise of, our manufacturing operations, sales operations or distribution channels, relating to any of these products could result in our failure to meet shipping and delivery deadlines or meet quality standards, which in turn could result in the cancellation of purchase orders, refusal to accept deliveries or a reduction in purchase prices, any of which could have a material adverse effect on our financial condition and results of operations.
 
A general economic downturn, a recession in China or sudden disruption in business conditions may affect consumer purchases of discretionary items, including pharmaceutical and nutraceutical products, which could adversely affect our business.
 
Consumer spending is generally affected by a number of factors, including general economic conditions, the level of unemployment, inflation, interest rates, energy costs, gasoline prices and consumer confidence generally, all of which are beyond our control. Consumer purchases of discretionary items tend to decline during recessionary periods, when disposable income is lower, and may impact sales of our products. In addition, sudden disruptions in business conditions as a result of a terrorist attack, retaliation and the threat of further attacks or retaliation, war, adverse weather conditions and climate changes or other natural disasters, pandemic situations or large scale power outages can have a short or, sometimes, long-term impact on consumer spending. A downturn in the economy in China, including any recession or a sudden disruption of business conditions in those economies, could adversely affect our business, financial condition, and results of operation.
 
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Intense competition from existing and new companies may adversely affect our revenues and profitability.
 
We compete with other companies, many of whom are developing, or can be expected to develop, products similar to ours. Some of our competitors are more established than we are, have greater brand recognition of products that compete with ours, have more financial, technical, marketing and other resources than we presently possess and a larger customer base. These competitors may be able to respond more quickly to new or changing opportunities and customer requirements and may be able to undertake more extensive promotional activities, offer more attractive terms to customers or adopt more aggressive pricing policies. Our commercial opportunity will be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer side effects, are less expensive or have more attractive product characteristics than our current products or products that we may develop in the future. We cannot assure you that we will be able to compete effectively with current or future competitors or that the competitive pressures we face will not harm our business.
 
We depend on our key management personnel and the loss of their services could adversely affect our business.
 
Our success depends in part on our continued ability to attract, retain and motivate highly qualified management. We place substantial reliance upon the efforts and abilities of our executive officers, including Tony Liu, Yanchun Li, Jun Min and Binsheng Li. The loss of services of any of these individuals or one or more other members of our senior management could delay or prevent the successful execution of our business objectives and could have a material adverse effect on our operations.
 
Replacing key employees may be difficult and costly and may take an extended period of time because of the limited number of individuals in our industry with the breadth of skills and experience required to develop and commercialize products successfully. We do not maintain “key person” insurance policies on the lives of these individuals or the lives of any of our other employees. We have entered into employment agreements with these individuals. We may need to hire additional personnel as we expand our commercial activities. We may not be able to attract or retain qualified management on acceptable terms in the future due to the intense competition for qualified personnel in our industry. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede these objectives.
 
We cannot assure you that we will be able to complete acquisitions or successfully integrate new businesses into our own.
 
We intend to pursue opportunities to grow our business by acquiring businesses, products and technologies that are complementary or related to our existing product lines. Successful completion of an acquisition depends on a number of factors that are not entirely within our control, including our ability to negotiate acceptable terms, conclude satisfactory agreements and obtain all necessary regulatory approvals. We may not be able to locate suitable acquisition candidates at prices that we consider appropriate. If we do identify an appropriate acquisition candidate, we may face competition from other companies interested in acquiring the target company that have greater financial and other resources than we have. Acquisitions of businesses, products, technologies or other material operations may require debt financing or additional equity financing, resulting in leverage or dilution of ownership.
 
Even if we complete one or more strategic transactions, we may be unable to integrate or coordinate successfully the personnel and operations of a business. Integration of acquired business operations could disrupt our business by diverting management away from day-to-day operations. The difficulties of integration may be increased by the necessity of coordinating geographically dispersed organizations, integrating personnel with disparate business backgrounds and combining different corporate cultures. We also may not be able to maintain key employees or customers of an acquired business or realize cost efficiencies or synergies or other benefits we anticipated when selecting our acquisition candidates. In addition, we may incur non-recurring severance expenses, restructuring charges and change of control payments and may need to record write-downs from future impairments of intangible assets, which could reduce our future reported earnings. At times, acquisition candidates may have liabilities or adverse operating issues that we fail to discover through due diligence prior to the acquisition.
 
In addition to the above, acquisitions in China, including of state owned businesses, will be required to comply with laws of the PRC, to the extent applicable. There can be no assurance that any proposed acquisition will be able to comply with PRC requirements, rules and/or regulations, or that we will successfully obtain governmental approvals to the extent required, which may be necessary to consummate such acquisitions.
 
 
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We may face difficulties in implementing our organic growth strategy.
 
Many obstacles to entering new markets exist, such as the costs associated with entering new markets, recruiting and retaining adequate numbers of effective sales and marketing personnel, developing and implementing effective marketing efforts abroad, establishing and maintaining the appropriate regulatory compliance and maintaining attractive foreign exchange ratios. However, there is no assurance that we will be successful in implementing our strategies or that our strategies, even if implemented, will lead to the successful achievement of our objectives. Our business plan and growth strategy is based on currently prevailing circumstances and the assumption that certain circumstances will or will not occur, as well as the inherent risks and uncertainties involved in various stages of development. We cannot, therefore, assure you that we will be able to successfully overcome such difficulties and continue to grow our business.
 
If we fail to manage our growth and current operations, we may not achieve future growth or our expected revenues.
 
In order to maximize potential growth in our current and potential markets, we believe that we must expand our manufacturing and marketing operations. To this end, we are and expect to continue to substantially increase our employee headcount which will place a significant strain on our management and on our operational, accounting, and information systems. Our need to manage our operations and growth effectively requires us to continue to expend funds to improve our financial controls, operating procedures, management information systems, reporting systems and procedures to manage our increased operations. If we are unable to implement improvements to our management information and control systems successfully in an efficient or timely manner, or if we encounter deficiencies in our existing systems and controls, then management may receive inadequate information to manage our day-to-day operations. We will also need to effectively train, motivate and manage our employees. Our failure to manage our growth could disrupt our operations and ultimately prevent us from generating the revenues we expect.
 
We may have difficulty defending our intellectual property rights from infringement which may undermine our competitive position.
 
We regard our service marks, trademarks, trade secrets, patents and similar intellectual property as critical to our success. We rely on trademark, patent and trade secret law, as well as confidentiality agreements to protect our proprietary rights. Certain of our products have received trademark and patent protection in China and Hong Kong. No assurance can be given that such patents and licenses will not be challenged, invalidated, infringed or circumvented, or that such intellectual property rights will provide a competitive advantage to us. Our trade secrets may otherwise become known or be independently discovered by our competitors. Policing the unauthorized use of proprietary technology can be difficult and expensive. Also, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. The outcome of such potential litigation may not be in our favor and any success in litigation may not be able to adequately protect our rights. Such litigation may be costly and divert management attention away from our business. An adverse determination in any such litigation would impair our intellectual property rights and may harm our business, prospects and reputation. Enforcement of judgments in China and Hong Kong is uncertain and even if we are successful in such litigation it may not provide us with an effective remedy. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations. In addition, there can be no assurance that we will be able to obtain licenses from third-parties that we may need to conduct our business or that such licenses can be obtained at a reasonable cost.
 
In addition, third parties may file infringement claims against us asserting that we are infringing on their patents or trademarks. In the event that such claims are filed, regardless of the merit of such a claim, we may incur substantial costs and diversion of management as a result of our involvement in such proceedings.
 
We currently sell our products mainly in China. China will remain our primary market for the foreseeable future. If we expand into additional countries, our risk of intellectual property infringement may be heightened. Laws and enforcement mechanisms in other countries may not protect proprietary rights to the same extent as China and Hong Kong. To date, no trademark or patent filings have been made other than in China and Hong Kong.
 
The measures we take to protect our proprietary rights may be inadequate, and we cannot give you any assurance that our competitors will not independently develop formulations and processes that are substantially equivalent or superior to our own or copy our products.
 
If we cannot procure our raw materials from our current sources we may be forced to seek alternative sources of supply, which may disrupt our operations or may result in the supply of lesser quality products.
 
The loss of any of our primary supply sources, or delays, disruptions or other difficulties in procuring these raw materials from our primary supply sources could have a material adverse effect on our business and results of operations. Additionally, due to the nature of the raw materials, mainly plants, the supply of these raw materials can be adversely affected by any material change in the climatic or environmental conditions in China, which may, in turn, result in increased costs to purchase these raw materials. If we are required to procure alternative sources of supply, our ability to maintain high quality products, lower costs and to provide our products to customers when needed could be impaired, and as a result we could lose business and our results of operations could be materially and adversely affected.
 
 
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We do not have product liability insurance and we could be exposed to substantial liability.
 
We face an inherent business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in adverse side effects. Adverse side effects, marketing or manufacturing problems pertaining to any of our products could result in:
 
 
decreased demand for our products;
 
 
adverse publicity resulting in injury to our reputation;
 
 
product liability claims and significant litigation costs;
 
 
substantial monetary awards to or costly settlements with consumers;
 
 
product recalls;
 
 
loss of revenues; or
 
 
the inability to commercialize future products.
 
These risks will exist for those products in clinical development and with respect to those products that have received regulatory approval for commercial sale or any product we may acquire. To date, we have not experienced any product liability claims. However, that does not mean that we will not have any such claims with respect to our products in the future. We do not carry product liability insurance. The lack of product liability insurance exposes us to risks associated with potential product liability claims, which can be significant.
 
Our international operations require us to comply with a number of U.S. and international regulations.
 
We need to comply with a number of international regulations in countries outside of the United States. In addition, we must comply with the Foreign Corrupt Practices Act, or FCPA, which prohibits U.S. companies or their agents and employees from providing anything of value to a foreign official for the purposes of influencing any act or decision of these individuals in their official capacity to help obtain or retain business, direct business to any person or corporate entity or obtain any unfair advantage. Any failure by us to adopt appropriate compliance procedures and ensure that our employees and agents comply with the FCPA and applicable laws and regulations in foreign jurisdictions could result in substantial penalties or restrictions on our ability to conduct business in certain foreign jurisdictions. The U.S. Department of The Treasury’s Office of Foreign Asset Control, or OFAC, administers and enforces economic and trade sanctions against targeted foreign countries, entities and individuals based on U.S. foreign policy and national security goals. As a result, we are restricted from entering into transactions with certain targeted foreign countries, entities and individuals except as permitted by OFAC which may reduce our future growth.
 
We may incur significant costs to ensure compliance with U.S. corporate governance and accounting requirements.
 
We may incur significant costs associated with our public company reporting requirements, costs associated with applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, and other rules implemented by the Securities and Exchange Commission and the New York Stock Exchange, or NYSE. We expect all of these applicable rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect that these applicable rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors, on committees of our board of directors or as executive officers.
 
 
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As a public company, we are required to comply with Sarbanes-Oxley and the related rules and regulations of the SEC, including expanded disclosure, accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of Sarbanes-Oxley and other requirements resulted in increased compliance costs and will continue to require additional management resources. We upgraded our finance and accounting systems, procedures and controls and will need to continue to implement additional finance and accounting systems, procedures and controls as we grow to satisfy these reporting requirements. In addition, we may need to hire additional legal and accounting staff with appropriate experience and technical knowledge, and we cannot assure you that if additional staffing is necessary that we will be able to do so in a timely fashion. If we are unable to complete the required annual assessment as to the adequacy of our internal reporting or if our independent registered public accounting firm is unable to provide us with an unqualified report as to the effectiveness of our internal controls over financial reporting in the future, we could incur significant costs to become compliant.
 
We continuously evaluate and monitor developments with respect to Section 404 of Sarbanes-Oxley and other applicable rules, however, we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
 
Risks Related to China
 
There could be changes in government regulations toward the pharmaceutical and nutraceutical industries that may adversely affect our business.
 
The manufacture and sale of pharmaceutical products in China is heavily regulated by many state, provincial and local authorities. These regulations significantly increase the difficulty and costs involved in obtaining and maintaining regulatory approvals for marketing new and existing products. Our future growth and profitability depend to a large extent on our ability to obtain regulatory approvals. Additionally, the law could change so as to prohibit the use of certain pharmaceuticals. If one of our products becomes prohibited, this change would cease the productivity of that product. The China National Development and Reform Commission, or CNDRC, has recently implemented price adjustments on many marketed pharmaceutical products. We have no control over such governmental policies, which may impact the pricing and profitability of our products.
 
The State Food and Drug Administration of China requires pharmaceutical manufacturers to obtain Good Manufacturing Practices, or GMP, certifications. We have received our GMP certifications. However, should we fail to receive or maintain the GMP certifications in the future, we would no longer be able to manufacture pharmaceuticals in China, and our businesses would be materially and adversely affected.
 
Moreover, the laws and regulations regarding acquisitions in the pharmaceutical industry in China may change, which could significantly impact our ability to grow through acquisitions.
 
Certain political and economic considerations relating to China could adversely affect our company.
 
China is transitioning from a planned economy to a market economy. While the PRC government has pursued economic reforms since its adoption of the open-door policy in 1978, a large portion of the Chinese economy is still operating under five-year plans and annual state plans. Through these plans and other economic measures, such as control on foreign exchange, taxation and restrictions on foreign participation in the domestic market of various industries, the PRC government exerts considerable direct and indirect influence on the economy. Many of the economic reforms carried out by the PRC government are unprecedented or experimental, and are expected to be refined and improved. Other political, economic and social factors can also lead to further readjustment of such reforms. This refining and readjustment process may not necessarily have a positive effect on our operations or future business development. Our operating results may be adversely affected by changes in China’s economic and social conditions as well as by changes in the policies of the PRC government, such as changes in laws and regulations, or the official interpretation thereof, which may be introduced to control inflation, changes in the interest rate or method of taxation, and the imposition of additional restrictions on currency conversion.
 
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
 
 
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The recent nature and uncertain application of many PRC laws applicable to us create an uncertain environment for business operations and they could have a negative effect on us.
 
The PRC legal system is a civil law system. Unlike the common law system, the civil law system is based on written statutes in which decided legal cases have little value as precedents. In 1979, the PRC government began to promulgate a comprehensive system of laws and has since introduced many laws and regulations to provide general guidance on economic and business practices in China and to regulate foreign investment. Progress has been made in the promulgation of laws and regulations dealing with economic matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. The promulgation of new laws, changes of existing laws and the abrogation of local regulations by national laws could have a negative impact on our business and business prospects. In addition, as these laws, regulations and legal requirements are relatively recent, their interpretation and enforcement involve significant uncertainty.
 
Currency conversion and exchange rate volatility could adversely affect our financial condition and the value of our common stock.
 
The PRC government imposes control over the conversion of Renminbi, or RMB, into foreign currencies. Under the current unified floating exchange rate system, the People’s Bank of China publishes an exchange rate, which we refer to as the PBOC exchange rate, based on the previous day’s dealings in the inter-bank foreign exchange market. Financial institutions authorized to deal in foreign currency may enter into foreign exchange transactions at exchange rates within an authorized range above or below the PBOC exchange rate according to market conditions.
 
Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the State Council which came into effect on April 1, 1996, and the Regulations on the Administration of Foreign Exchange Settlement, Sale and Payment of the PRC which came into effect on July 1, 1996, regarding foreign exchange control, conversion of RMB into foreign exchange by Foreign Investment Enterprises, or FIEs, for use on current account items, including the distribution of dividends and profits to foreign investors, is permissible. FIEs are permitted to convert their after-tax dividends and profits to foreign exchange and remit such foreign exchange to their foreign exchange bank accounts in China. Conversion of RMB into foreign currencies for capital account items, including direct investment, loans, and security investment, is still under certain restrictions. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and added, among other things, an important provision, which provides that the PRC government shall not impose restrictions on recurring international payments and transfers under current account items.
 
Enterprises in China, including FIEs, which require foreign exchange for transactions relating to current account items, if within a certain limited amount may, without approval of the State Administration of Foreign Exchange, or SAFE, effect payment from their foreign exchange account or convert and pay at the designated foreign exchange banks by providing valid receipts and proofs.
 
Convertibility of foreign exchange in respect of capital account items, such as direct investment and capital contribution, is still subject to certain restrictions, and prior approval from the SAFE or its relevant branches must be sought.
 
Our wholly owned subsidiaries, Three Happiness, HSPL, GLP, HQPL, CCXA, BOKE, Nuo Hua and GHK are FIEs to which the Foreign Exchange Control Regulations are applicable. There can be no assurance that we will be able to obtain sufficient foreign exchange to pay dividends or satisfy other foreign exchange requirements in the future.
 
Between 1994 and 2004, the exchange rate for RMB against the U.S. dollar remained relatively stable, most of the time in the region of approximately RMB8.28 to US$1.00. However, in 2005, the Chinese government announced that it would begin pegging the exchange rate of the RMB against a number of currencies, rather than just the U.S. dollar. As our operations are primarily in China, any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, financial condition and the value of our common stock. For example, to the extent that we need to convert U.S. dollars into RMB for our operations, appreciation of this currency against the U.S. dollar could have a material adverse effect on our business, financial condition, results of operations and the value of our common stock. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the RMB, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.
 
Future inflation in China may inhibit our ability to conduct business in China.
 
In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as 2.2%. These factors have led to the adoption by the PRC government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause the PRC government to impose controls on credit or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.
 
 
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It may be difficult to effect service of process and enforcement of legal judgments upon us and our officers and certain of our directors because they reside outside the United States.
 
As our operations are presently based in China and our officers and certain of our directors reside in China, service of process on us and our officers and certain directors may be difficult to effect within the United States. Also, our main assets are located in China and any judgment obtained in the United States against us may not be enforceable outside the United States.
 
Any future outbreak of avian influenza, or the Asian bird flu, or any other epidemic in China could have a material adverse effect on our business operations, financial condition and results of operations.
 
Since mid-December 2003, a growing number of Asian countries have reported outbreaks of highly pathogenic avian influenza in chickens and ducks. Since all of our operations are in China, an outbreak of the Asian Bird Flu in China in the future may disrupt our business operations and have a material adverse effect on our financial condition and results of operations. For example, a new outbreak of Asian Bird Flu, or any other epidemic, may reduce the level of economic activity in affected areas, which may lead to a reduction in our revenue if our clients cancel existing contracts or defer future expenditures. In addition, health or other government regulations may require temporary closure of our offices, or the offices of our customers or partners, which will severely disrupt our business operations and have a material adverse effect on our financial condition and results of operations.
 
Our business may be affected by unexpected changes in regulatory requirements in the jurisdictions in which we operate.
 
We are subject to many general regulations governing business entities and their behavior in China and in other jurisdictions in which we have operations. In particular, we are subject to laws and regulations covering food, dietary supplements and pharmaceutical products. Such regulations typically deal with licensing, approvals and permits. Any change in product licensing may make our products more or less available on the market. Such changes may have a positive or negative impact on the sale of our products and may directly impact the associated costs in compliance and our operational and financial viability. Such regulatory environment also covers any existing or potential trade barriers in the form of import tariffs and taxes that may make it difficult for us to import our products to certain countries and regions, such as Japan, South Korea and Hong Kong, which would limit our international expansion.
 
Most of our assets are located in China, any dividends or proceeds from liquidation are subject to the approval of the relevant Chinese government agencies.
 
Our assets are predominantly located inside China. Under the laws governing FIEs in China, dividend distribution and liquidation are allowed but subject to special procedures under the relevant laws and rules. Any dividend payment will be subject to the decision of the board of directors and subject to foreign exchange rules governing such repatriation. Any liquidation is subject to both the relevant government agency’s approval and supervision as well the foreign exchange control. This may generate additional risk for our investors in case of dividend payment or liquidation.
 
There have been recent incidents in which patients have experienced severe adverse reactions following the use of pharmaceutical products manufactured in China.
 
There have been recent incidents reported in the Chinese media of a significant number of patients experiencing severe adverse health consequences following their use of pharmaceutical products manufactured by certain pharmaceutical companies in China. A number of patients have become ill and a number of fatalities have been reported. For example, several deaths were caused by drugs sold by the Second Pharmaceutical Factory of Qiqihaer, a Chinese drug manufacturer, in May 2006. Concerns over the safety of pharmaceutical products manufactured in China could have an adverse effect on the sale of such products, including products manufactured by us. If in the future we become involved in incidents of the type described above, such problems could severely and adversely impact our product sales and reputation.
 
Anti-corruption measures taken by the government to correct corruptive practices in the pharmaceutical industry could adversely affect our sales and reputation.
 
The government has recently taken anti-corruption measures to correct corrupt practices. In the pharmaceutical industry, such practices include, among others, acceptance of kickbacks, bribery or other illegal gains or benefits by the hospitals and medical practitioners from pharmaceutical distributors in connection with the prescription of a certain drug. Substantially all of our sales to our ultimate customers are conducted through third-party distributors. We have no control over our third-party distributors, who may engage in corrupt practices to promote our products. While we maintain strict anti-corruption policies applicable to our internal sales force and third-party distributors, these policies may not be effective. If any of our third-party distributors engage in such practices and the government takes enforcement action, our products may be seized and our own practices, and involvement in the distributors’ practices may be investigated. If this occurs, our sales and reputation may be materially and adversely affected.
 
 
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Risks Related to Our Common Stock
 
Our common stock price may be extremely volatile, and you may not be able to resell your shares at or above the price you paid for the stock.
 
Our common stock price has experienced large fluctuations. In addition, the trading prices of stocks for companies in our industry in general have experienced extreme price fluctuations in recent years. Any negative change in the public’s perception of the prospects of companies in our industry could depress our stock price regardless of our results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. Market fluctuations, as well as general political and economic conditions such as terrorism, military conflict, recession or interest rate or currency rate fluctuations, may also decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to various factors, including:
 
 
changes in laws or regulations applicable to our products;
 
 
period to period fluctuations in our operating results;
 
 
announcements of new technological innovations or new products by us or our competitors;
 
 
changes in financial estimates or recommendations by securities analysts;
 
 
conditions or trends in our industry;
 
 
changes in the market valuations of other companies in our industry;
 
 
developments in domestic and international governmental policy or regulations;
 
 
announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
 
 
additions or departures of key personnel;
 
 
disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies;
 
 
additional sales of our common stock by us; and
 
 
sales and distributions of our common stock by our stockholders.
 
In the past, stockholders have often instituted securities class action litigation after periods of volatility in the market price of a company’s securities. If a stockholder files a securities class action suit against us, we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business in order to respond to the litigation.
 
Some of our existing stockholders can exert control over us and may not make decisions that are in the best interest of all the stockholders.
 
Our officers, directors and holders of more than five percent of our outstanding shares of common stock, together control approximately 46.0% of the voting power of our stock, of which approximately 43.4% is controlled by Tony Liu, our Chairman and Chief Executive Officer. In particular, Mr. Liu owns 1,000,000 shares of Series A preferred stock, which shares by their terms have aggregate voting power equal to 25.0% of the combined voting power of our common and preferred stock. Moreover, this voting power cannot be diluted or reduced by the issuance of additional shares of common stock, meaning that the holder or holders of our Series A preferred stock will always possess 25.0% of the aggregate voting power of our common and preferred stock. As a result, Mr. Liu, or these stockholders acting together, will be able to exert a significant degree of influence over our management and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of our company and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of our officers, directors and principal stockholders may not always coincide with our interests or the interests of other stockholders and, accordingly, these control persons could cause us to enter into transactions or agreements that we would not otherwise consider.
 
Provisions of the Nevada Revised Statutes may discourage a change of control.
 
We are incorporated in Nevada. Certain provisions of the Nevada Revised Statutes, or NRS, could delay or make more difficult a change of control transaction or other business combination that may be beneficial to stockholders. We are subject to Nevada’s “Combinations With Interested Stockholders” statutes (NRS Sections 78.411 through 78.444), which provide that specified persons who, together with affiliates and associates, own, or within three years did own, 10% or more of the outstanding voting stock of a Nevada corporation with at least 200 stockholders cannot engage in specified business combinations with the corporation for a period of three years after the date on which the person became an interested stockholder, unless the combination or the transaction by which the person first became an interested stockholder is approved by the corporation’s Board of Directors before the person first became an interested stockholder.
 
 
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Nevada’s “Acquisition of Controlling Interest” statutes (NRS Sections 78.378–78.3793) apply only to Nevada Corporations with at least 200 stockholders, including at least 100 stockholders of record who are Nevada residents, and which conduct business directly or indirectly in Nevada. As of the date of this prospectus, we do not believe we have 100 stockholders of record who are residents of Nevada, although there can be no assurance that in the future the “Acquisition of Controlling Interest” statutes will not apply to us. The “Acquisition of Controlling Interest” statutes provide that persons who acquire a “controlling interest”, as defined in NRS Section 78.3785, in a company may only be given full voting rights in their shares if such rights are conferred by the disinterested stockholders of the company at an annual or special meeting. However, any disinterested stockholder that does not vote in favor of granting such voting rights is entitled to demand that the company pay fair value for their shares, if the acquiring person has acquired at least a majority of all of the voting power of the company. As such, persons acquiring a controlling interest may not be able to vote their shares.
 
We may never pay any dividends to our stockholders.
 
We have not paid any cash dividends on shares of our common stock. We currently intend to retain all available funds and future earnings, if any, to support our operations and finance the growth and development of our business. Our board of directors does not intend to distribute dividends in the foreseeable future. The declaration, payment and amount of any future dividends, if any, will be made at the discretion of the board of directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors the board of directors considers relevant. There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend.
 
 
None.
 
 
According to Chinese law, the government owns all the land in China and companies or individuals are authorized to use the land only through land use rights granted by the Chinese government. Our facilities are located at each of our operating subsidiaries summarized as follow:
 
Subsidiary
 
Facilities
 
Size of Land
 
Land Use Right
Expires
Three Happiness
 
GMP Manufacturing, warehouse and office
 
1,532,775 sq. feet
 
2052-2056
HSPL
 
GMP Manufacturing, warehouse and office
 
532,339 sq. feet
 
2052
GLP
 
GMP Manufacturing, warehouse and office
 
1,485,055 sq. feet
 
2052-2077
CCXA
 
GMP Manufacturing, warehouse and office
 
1,077,467 sq. feet
 
2058
BOKE
 
GMP Manufacturing, warehouse and office
 
174,280 sq. feet
 
2052
 
We also invested and purchased land and properties in Beijing Economic-Technological Development Area during 2008. The size of land is 551,715 sq. feet with land use right expiring in year 2054. We intend to utilize the facilities as our multi-functional headquarters for purposes including administration, research and development, convention and training.
 
In addition to the above, we own a 2,450 square feet office in Hong Kong. We lease 98 sales representative offices throughout China and we lease offices in Shenzhen and New York. All leases are for a term of one year and are renewable.
 
 
We are not involved in any litigation that we believe could have a material adverse effect on our financial position or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of our executive officers or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our companies or our Company’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.
 
 
25

 
 
On December 5, 2008 the Company held its annual meeting of stockholders. There were two proposals presented to the stockholders at the meeting.
 
Proposal 1 was the election of the following nine directors to serve for a one year term or until their respective successors have been duly elected and qualified.
 
DIRECTOR NOMINEE
 
FOR
 
AGAINST
 
WITHHELD
Tony Liu
 
65,014,276
 
0
 
                 1,367,929
Jun Min
 
64,957,784
 
0
 
                 1,424,421
Yanchun Li
 
63,564,176
 
0
 
                 2,818,029
Binsheng Li
 
64,959,442
 
0
 
                 1,422,763
Cosimo Patti
 
65,139,544
 
0
 
                 1,242,661
Xianmin Wang
 
63,740,052
 
0
 
                 2,642,153
Eileen Brody
 
65,139,478
 
0
 
                 1,242,726
Lawrence S. Wizel
 
65,140,093
 
0
 
                 1,242,112
Baiqing Zhang
 
65,134,761
 
0
 
                 1,247,444
 
Proposal 2 was the ratification of the appointment of Weinberg & Company, P.A. as the Company’s independent registered public accounting firm for the 2008. There were 65,480,259 votes FOR, 768,778 votes AGAINST and 133,167 votes ABSTAINED.
 
 
26

 
 
 
Our common stock has been listed for trading on the New York Stock Exchange, or NYSE, under the ticker symbol “AOB” since December 18, 2006. The following table shows the high and low closing sales price for our common stock reported by the NYSE from January 1, 2007 to February 28, 2009.
 
Year
 
Period
 
High
 
Low
2007
 
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
 
$             13.90
$             11.53
$             11.59
$             13.79
 
$             8.52
$              8.39
$              7.11
$             10.55
             
2008
 
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
 
$             10.79
 
$             12.13
$               9.92
$               6.79
 
$             7.46
 
$             8.20
$             6.36
$             4.49
             
2009
 
First Quarter (January 1 – February 28)
 
$               7.39
 
$             3.69
 
Stockholders and Dividends
 
As of March 6, 2009, there were approximately 650 record holders of our common stock. We have not paid any cash dividends on shares of our common stock and do not plan to do so in the near future. We currently plan to retain future earnings to fund the development and growth of our business. Any future determination related to our dividend policy will be made at the discretion of our Board of Directors.
 
Equity Compensation Plan Information
 
The following table sets forth aggregate information regarding our equity compensation plans in effect as of December 31, 2008:
 
   
Number of
securities to be
issued upon
exercise of
outstanding options,
warrants
and rights
   
Weighted-average
exercise price of
outstanding
options, warrants
and rights
   
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans (excluding
securities reflected
in column (a))
 
Plan category
 
(a)
   
(b)
   
(c)
 
Equity compensation plans approved by security holders
    1,697,763     $ 8.68       3,302,237  
Equity compensation plans not approved by security holders(1)
    -0-       -0-       -0-  
Total
    1,697,763     $ 8.68       3,302,237  
 

(1)
Includes shares issuable pursuant to the Company’s 2006 Equity Incentive Plan (the “2006 Plan”), which was approved by the Company’s stockholders.
 
 
27

 
Stock Price Performance Graph
 
The following chart compares the cumulative total stockholder return on the Company’s shares of common stock with the cumulative total stockholder return of (i) the New York Stock Exchange Market Index and (ii) a peer group index consisting of companies reporting under the Standard Industrial Classification Code 2834 (Pharmaceutical Preparations):
 
COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG AMERICAN ORIENTAL BIOENGINEERING, INC.,
NEW YORK STOCK EXCHANGE INDEX AND SIC CODE INDEX
 
Cumulative total stockholder return graph
 
COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE
COMPANIES, PEER GROUPS, INDUSTRY INDEXES AND/OR BROAD MARKETS
 
   
YEAR ENDING
 
COMPANY/INDEX/MARKET
 
12/31/2003
   
12/31/2004
   
12/30/2005
   
12/29/2006
   
12/31/2007
   
12/31/2008
 
American Oriental Bioengineering
    100.00       42.47       120.82       319.73       303.56       186.03  
Pharmaceutical Preparations
    100.00       98.99       105.25       117.74       119.33       99.51  
NYSE Market Index
    100.00       112.92       122.25       143.23       150.88       94.76  
 
The material in this chart is not soliciting material, is not deemed filed with the SEC and is not incorporated by reference in any filing of the Company under the Securities Act of 1933, as amended or the Exchange Act, whether made before or after the date of this proxy statement and irrespective of any general incorporation language in such filing.
 
Issuance of Unregistered Shares
 
On March 31, 2008, the Company issued 26,580 shares of restricted common stock to five of its independent directors. The shares issued were part of the total compensation for their services rendered in 2007. In June 2008, the Company issued 26,748 shares of restricted common stock to consultants firm for advisory services rendered and to be rendered in 2009. The issuance of the foregoing shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.
 
 
28

 
Equity Repurchases
 
In connection with the private placement pursuant to Section 4(2) of the Securities Act of $115,000,000 principal amount of 5% Convertible Senior Notes due 2015 (the “Notes”) at a purchase price of $1,000 per Note to several “qualified institutional buyers,” as defined in Rule 144A under the Securities Act, the Company purchase shares of its common stock in the approximate value of $30.0 million.
 
Issuer Purchases of Equity Securities
Period
 
Total Number of Shares
of Common Stock
Purchased
   
Average Price Paid per
Share of Common Stock
   
Total Number of Shares of Common Stock Purchased as Part of Publicly Announced Plans
   
Maximum Number (or Approximate Dollar Value) of of Common Stock that May Yet Be Purchased Under the Plans or Programs
 
7/15/2008
    3,712,700     $ 8.08       3,712,700     $ 45,000,000  
 
 
The following table sets forth selected historical financial information as of the dates and for the periods indicated.
 
The selected financial information for each of the three years ended December 31, 2008, 2007 and 2006 has been derived from, and should be read in conjunction with, the audited consolidated financial statements and other financial information presented elsewhere herein. The selected financial information for each of the two years ended December 31, 2005 and 2004 has been derived from the Company’s Annual Report on Form 10-KSB for the years ended December 31, 2005 and 2004 and are not included herein. Capitalized terms are as defined and described in the consolidated financial statements or elsewhere herein.
 
The selected financial information for the year ended December 31, 2008 reflects the acquisition of Nuo Hua on October 18, 2008 and the acquisition of GHK on October 20, 2008. The selected financial information for the year ended December 31, 2007 reflects the acquisition of CCXA on September 6, 2007 and the acquisition of Boke on October 18, 2007. The selected financial information for the year ended December 31, 2006 reflects the acquisition of the GLP effective in May 2006 and the acquisition of HQPL effective in July 2006. The selected financial information for the year ended December 31, 2004 reflects the acquisition of HSPL effective in September 2004.
 
 
29


   
Year Ended December 31,
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
Statement of Operations Data:
 
(Restated)
   
(Restated)
                   
                               
REVENUES
  $ 264,643,058     $ 160,482,383     $ 110,182,092     $ 54,732,557     $ 31,966,927  
COST OF GOODS SOLD
    91,031,274       49,364,486       38,318,223       20,524,201       11,775,366  
                                         
GROSS PROFIT
    173,611,784       111,117,897       71,863,869       34,208,356       20,191,561  
Selling and marketing
    39,774,330       20,669,303       8,876,829       3,216,545       2,387,805  
Advertising
    34,102,538       22,865,903       15,174,125       5,238,186       2,926,629  
General and administrative
    19,603,947       13,832,110       10,446,740       7,076,139       4,582,388  
Depreciation and amortization
    4,383,215       1,989,425       988,488       337,537       250,001  
Purchased in-process research and development
    12,255,248                          
                                         
INCOME FROM OPERATIONS
    63,492,506       51,761,156       36,377,687       18,339,949       10,044,738  
Equity in earnings (loss) from unconsolidated entities
    (1,132,986 )     23,711       (3,811 )            
Interest income (expense), net
    (2,571,015 )     617,524       574,172       (505,822 )     (100,765 )
Other income (expense), net
    (65,843 )     (525,065 )     (329,987 )     (6,876 )     44,035  
Minority interests
    (27,575 )                        
                                         
INCOME BEFORE INCOME TAXES
    59,695,087       51,877,326       36,618,061       17,827,251       9,988,008  
Income taxes
    12,635,472       8,011,248       7,416,915       4,400,870       2,216,626  
                                         
NET INCOME
  $ 47,059,615     $ 43,866,078     $ 29,201,146     $ 13,426,381     $ 7,771,382  
                                         
NET INCOME PER SHARE
                                       
BASIC
  $ 0.62     $ 0.63     $ 0.47     $ 0.31     $ 0.23  
DILUTED
  $ 0.61     $ 0.61     $ 0.46     $ 0.31     $ 0.23  
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
                                       
BASIC
    76,504,035       69,870,775       62,679,996       43,827,725       33,595,685  
DILUTED
    82,254,185       71,364,244       62,913,961       43,840,463       33,953,507  
 
   
December 31,
 
     2008      2007      2006      2005      2004  
Balance Sheet Data:
 
(Restated)
   
(Restated)
   
(Restated)
                 
                                         
Cash and cash equivalents
  $ 70,636,510     $ 166,410,075     $ 87,784,419     $ 57,532,049     $ 11,404,149  
Working capital
    87,082,705       180,536,568       92,252,071       66,813,509       14,700,456  
Total assets
    528,675,732       358,351,088       188,468,241       99,422,239       42,836,624  
Total debt (including current maturities of debt)
    8,003,328       9,927,270       10,681,493       3,717,380       5,060,241  
Shareholders’ equity
  $ 348,944,446     $ 313,778,571     $ 156,095,725     $ 90,604,546     $ 33,037,820  
   
Year Ended December 31
 
     2008      2007      2006      2005      2004  
Cash Flow Data:
 
(Restated)
   
(Restated)
   
(Restated)
                 
                                         
Net cash provided by operating activities
  $ 74,809,867     $ 45,364,532     $ 29,093,464     $ 11,402,350     $ 8,236,258  
Net cash used in investing activities
    (257,374,093 )     (69,845,702 )     (26,386,564 )     (5,861,945 )     (8,961,529 )
Net cash provided by financing activities
  $ 80,948,164     $ 96,833,706     $ 26,158,514     $ 39,663,836     $ 6,762,563  
 
 
30

 
 
All of the financial information presented in this Item 7 has been adjusted to reflect the restatement of our consolidated financial statements as of and for the fiscal years ended December 31, 2008 and December 31, 2007. Specifically, we have restated our consolidated balance sheets and the related consolidated statements of income, consolidated statements of stockholders’ equity and consolidated statements of cash flows as of and for the years ended December 31, 2008 and 2007. The restatement is more fully described in the “Explanatory Note” immediately preceding Part I, Item 1 and in Note 4 “Restatement of Consolidated Financial Statements,” which is included in “Financial Statements and Supplementary Data” in Item 8 of this Form 10-K/A. You should read the following discussion in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K/A. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements. See “ — Forward-Looking Statements.”

As used in this report, the terms “Company”, “we”, “our”, “us” and “AOB” refer to American Oriental Bioengineering, Inc., a Nevada corporation.
 
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Annual Report contains forward-looking statements within the meaning of the federal securities laws. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as “anticipate,” “expect,” “intend,” “plan,” “will,” “we believe,” “AOB believes,” “management believes” and similar language. The forward-looking statements are based on the current expectations of AOB and are subject to certain risks, uncertainties and assumptions, including those set forth in the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. Actual results may differ materially from results anticipated in these forward-looking statements. We base the forward-looking statements on information currently available to us, and we assume no obligation to update them.
 
Investors are also advised to refer to the information in our previous filings with the Securities and Exchange Commission (SEC), especially on Forms 10-K, 10-Q, and 8-K, in which we discuss in more detail various important factors that could cause actual results to differ from expected or historic results. It is not possible to foresee or identify all such factors. As such, investors should not consider any list of such factors to be an exhaustive statement of all risks and uncertainties or potentially inaccurate assumptions.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
This section should be read together with the Summary of Significant Accounting Policies included as Note 3 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.
 
Estimates affecting accounts receivable and inventories
 
The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect our reporting of assets and liabilities (and contingent assets and liabilities). These estimates are particularly significant where they affect the reported net realizable value of the Company’s accounts receivable and inventories.
 
At December 31, 2008, the Company provided a $226,330 reserve against accounts receivable. Management’s estimate of the appropriate reserve on accounts receivable at December 31, 2008 was based on the aged nature of these accounts receivable. In making its judgment, management assessed its customers’ ability to continue to pay their outstanding invoices on a timely basis, and whether their financial position might deteriorate significantly in the future, which would result in their inability to pay their debts to the Company.
 
At December 31, 2008, the Company provided an allowance against its inventories amounting to $167,429. Management determination of this allowance was based on potential impairments to the current carrying value of the inventories due to potential obsolescence of aged inventories. In making its estimate, management considered the probable demand for our products in the future and historical trends in the turnover of our inventories.
 
While the Company currently believes that there is little likelihood that actual results will differ materially from these current estimates, if customer demand for our products decreases significantly in the near future, or if the financial condition of our customers deteriorates in the near future, the Company could realize significant write downs for slow-moving inventories or uncollectible accounts receivable.
 
 
31

 
Policy affecting recognition of revenue
 
Among the most important accounting policies affecting our consolidated financial statements is our policy of recognizing revenue in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 104. Under this policy, all of the following criteria must be met in order for us to recognize revenue:
 
 
1.
Persuasive evidence of an arrangement exists;
 
2.
Delivery has occurred or services have been rendered;
 
3.
The seller’s price to the buyer is fixed or determinable; and
 
4.
Collectability is reasonably assured.
 
The majority of the Company’s revenue results from sales contracts with distributors and revenue is recorded upon the shipment of goods. Management conducts credit background checks for new customers as a means to reduce the subjectivity of assuring collectability. Based on these factors, the Company believes that it can apply the provisions of SAB 104 with minimal subjectivity.
 
Estimates affecting purchase price allocated to in-process research and development
 
Approximately $12.2 million of the purchase price of GuangXi HuiKe Pharmaceutical Research and Development Co., Ltd. (“GHK”) represents the estimated fair value of acquired in-process R&D projects that had no alternative future use. Accordingly, this amount was immediately expensed on the acquisition date. The value assigned to purchase in-process R&D comprises seven projects. The estimated fair value of these projects was determined by using estimated future net cash flows expected and then discounting these estimated future net cash flows to their present value using an appropriate discount rate that reflects the stage of risk of the project. This risk adjustment reflected the probability of success of each project based upon the nature of the product, the current patent situation and the stage of completion of the project. In estimating the forecast of future cash flows, we also made the assumptions on:
 
 
1.
Revenue that is likely to result from specific in-process research and development projects, including estimated number of units to be sold, estimated selling prices, estimated market penetration and estimated market share and year over year growth rates over the product life cycles;
 
2.
Cost of sales related to the potential products using historical data, industry data or other sources of market data;
 
3.
Sales and marketing expense using historical financial data, industry data or other market data;
 
4.
General and administrative expense.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
In September 2006, the Financial Accounting Standard Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements,” which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 provides a common definition of fair value and establishes a framework to make the measurement of fair value in generally accepted accounting principles more consistent and comparable. SFAS No. 157 also requires expanded disclosures to provide information about the extent to which fair value is used to measure assets and liabilities, the methods and assumptions used to measure fair value, and the effect of fair value measures on earnings. SFAS No. 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007 and to interim periods within those fiscal years. The Company is currently in the process of evaluating the effect, if any, the adoption of SFAS No. 157 will have on its consolidated results of operations, financial position, or cash flows.
 
In February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115” (FAS 159). FAS 159 will became effective for the Company on January 1, 2008. This standard permits companies to choose to measure many financial instruments and certain other items at fair value and report unrealized gains and losses in earnings. Such accounting is optional and is generally to be applied instrument by instrument. The Company does not anticipate that the election, if any, of this fair-value option will have a material effect on results or operations or consolidated financial position.
 
In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations”, and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” SFAS No. 141 (R) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No.160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 141 (R) and SFAS No. 160 are effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. We have not yet determined the effect on our consolidated financial statements, if any, upon adoption of SFAS No. 141 (R) or SFAS No. 160. We are aware that our accounting for minority interest will change and we are considering those effects now but believe we will only be a reclassification of minority interest from mezzanine equity to our stockholder’s equity section in the balance sheet, in any case we do not believe the implementation of SFAS 160 will be material to our financial position. SFAS 141 (R) will significantly affect the accounting for future business combinations and we will determine the accounting as new combinations are determined.
 
 
32

 
FINANCIAL STATEMENT PRESENTATION

Restatement of Consolidated Financial Statements
 
During the review of its third quarter September 30, 2009 operating results, the Company identified isolated historical accounting errors in: (i) the calculation of stock based compensation, (ii) the recognition of deferred tax liabilities of certain acquired assets and (iii) the provision of deferred tax liabilities on undistributed earnings. The accounting errors have resulted in the misstatement of certain balance sheet and  income statement items and the cumulative net earnings since 2006. The Company has no evidence that the errors resulted from any fraud or intentional misconduct. The Company undertook a review to determine the total amount of the errors and the accounting periods in which the errors occurred. Although the impact of each individual error identified or in aggregate was not material, considering the effects of prior year misstatements when quantifying misstatements in current year financial statements, the Company chose to restate its previously reported financial statements.

The restatement corrects three historical accounting errors identified:

(i)           The Company identified historical accounting errors in stock-based compensation expense for years ended December 31, 2008 and 2007. The errors were identified after the Company re-examined the calculation of expected volatility. The Company used monthly price observations to derive the standard deviation of expected monthly returns but failed to annualize the standard deviation as required by the Black Scholes Model. The Company have understated the expected volatility and thus understated the fair value of option being granted. The impact is the understatement of stock-based compensation expenses being amortized in subsequent periods. The errors also led to an inflated number of options being granted when the grants were approved based on the total estimated fair value instead of the quantity of options.

The Company determined that the aggregate stock-based compensation expense error related to the periods discussed above totaled $1.3 million. To correct these errors, the Company has recorded additional non-cash stock-based compensation expense of $0.8 million in 2008, $0.5 million in 2007. The Company has also cancelled 723,493 options granted in 2008 based the revised options fair value. The cumulative effect of the stock-based compensation adjustments on the consolidated balance sheets for the years ended 2008 and 2007 resulted in an increase in additional paid-in capital offset by a corresponding change in retained earning which resulted in no net effect on shareholders’ equity.
 
(ii)           The Company identified errors in the recognition of deferred tax liabilities of certain acquired assets and the corresponding goodwill for years ended December 31, 2007 and 2006. The errors were identified when the Company reviewed and re-evaluated applicable tax laws at the time of acquisitions.  The Company acquired 100% of Guangxi Lingfeng Pharmaceutical Co., Ltd. (“GLP”) and Guangxi Boke Pharmaceutical Co., Ltd. (“Boke”) in 2006 and 2007, respectively. The acquisitions were accounted under business combination The purchase prices was allocated to assets and liabilities to the extend of their fair value and the excess was accounted for as goodwill. The Company also provided deferred tax for the  fair value adjustments.

GLP and Boke measured the deferred tax related to fair value adjustments at its preferential tax rate at the acquisition date of 15%.  The Company subsequently determined that according to “Cai Shui [2001] 202”issued in 2001, the preferential tax rate of 15% would expire in year 2010. The Company should have been using the then enacted statutory tax rate of 30%, instead of 15%, in measuring its deferred tax for anticipated reversal post 2010. Furthermore, when new Corporate Income Tax Law was enacted in March 2007, the companies’ deferred tax should have been re-measured at the new enacted statutory corporate tax rate of 25%.  This rate change was not recorded by the companies.

The Company determined that the aggregate errors related to the initial recording of the deferred tax at acquisition totaled approximately $4.0 million which was corrected with the off-setting entry  recorded to Goodwill in May 2006 and in October 2007. The Company also corrected the subsequent change in tax rate by reducing the deferred tax of approximately $1.0 million with the off-setting entry to income tax expenses in 2007. The related translation impact was recorded to Other Comprehensive Income accordingly.  The adjustment affected certain applicable financial statements as of and for the years ended December 31, 2008, 2007 and 2006.
 
33

 
(iii)           The Company identified errors in the recording of a deferred tax liability on its foreign subsidiaries’ post-2007 undistributed earnings. The errors were identified after the Company re-examined applicable tax laws and accounting standards. As the Company has asserted permanent reinvestment of its foreign subsidiaries’ undistributed earnings, no deferred tax liability should be recorded for any outside basis differences and related translation adjustments.

The Company determined that the aggregate error related to this issue totaled approximately $3.2 million. To correct this error, the Company wrote-off the deferred tax liability with the off-setting entry to Other Comprehensive Income in 2008. The error has no impact to revenue or cash and cash equivalents but impacted the consolidated balance sheet  and changes in shareholders' equity as of and for the year ended December 31, 2008.
 
The Company has restated certain applicable financial statements as of and for the years ended December 31, 2008, 2007 and 2006. The following discloses each line item on the Company’s consolidated financial statements as originally reported in the Company’s annual report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on March 9, 2009, the increase (decrease) in each line item on the Company’s consolidated financial statements as a result of the restatement and each line item on the Company’s consolidated financial statements as restated.
     
The effects of the restatement on selected income statement line items for the years ended December 31, 2008 and 2007 are as follows:
 
Increase/(Decrease) in income statement line items
 
2008
 
2007
 
General and administrative
$
838,190
 
$
466,954
 
Income before income tax
 
 (838,190)
   
(466,954)
 
Income tax
 
 (91,916)
   
(1,042,151)
 
Net income attributable to common shareholders
 
(746,274)
   
575,197
 
Net income per common share attributable to common shareholders — basic
 
 -
   
0.01
 
Net income per common share attributable to common shareholders — diluted
 $
 -
 
$
0.01
 

The cumulative effects of the restatement on selected balance sheet line items as of December 31, 2008 and 2007 are as follows:

Increase/(Decrease) in balance sheet line items
 
2008
 
2007
 
Goodwill
 $
4,620,895
 
$
4,620,895
 
Deferred tax assets
 
-
   
15,297
 
Deferred tax liability - current
 
(667,095) 
   
(109,733)
 
Deferred tax liability - non current
 
 1,551,743
   
4,050,444
 
Accumulated other comprehensive income
 
2,602,180
   
(346,670)
 
Retained earnings
 
(171,077) 
   
575,197
 
Additional paid-in capital
 
 1,305,144
   
466,954
 
 
34


 
RESULTS OF OPERATIONS – YEAR ENDED DECEMBER 31, 2008 AS COMPARED TO YEAR ENDED DECEMBER 31, 2007
 
The following table sets forth the amounts and the percentage relationship to revenues of certain items in our consolidated statements of income for the years ended December 31, 2008 and 2007:
 
   
Year Ended December 31,
   
Year Ended December 31,
 
   
2008
   
2007
   
2008
   
2007
 
   
Restated
   
Restated
             
REVENUES
  $ 264,643,058     $ 160,482,383       100%       100%  
COST OF GOODS SOLD
    91,031,274       49,364,486       34.40       30.76  
GROSS PROFIT
    173,611,784       111,117,897       65.60       69.24  
Selling and marketing
    39,774,330       20,669,303       15.03       12.88  
Advertising
    34,102,538       22,865,903       12.89       14.25  
General and administrative
    19,603,947       13,832,110       7.4       8.6  
Depreciation and amortization
    4,383,215       1,989,425       1.66       1.24  
Purchased in-process research and development
    12,255,248             4.63        
Total operating expenses
    110,119,278       59,356,741       41.61       36.97  
                                 
INCOME FROM OPERATIONS
    63,492,506       51,761,156       23.99       32.27  
Equity in earnings (loss) from unconsolidated entities
    (1,132,986 )     23,711       (0.43 )     0.01  
Interest income (expense), net
    (2,571,015 )     617,524       (0.97 )     0.38  
Other income (expense), net
    (65,843 )     (525,065 )     (0.02 )     (0.33 )
Minority interests
    (27,575 )           (0.01 )      
                                 
INCOME BEFORE INCOME TAXES
    59,695,087       51,877,326       22.56       32.33  
Income taxes
    12,635,472       8,011,248       4.77       4.99  
                                 
NET INCOME
  $ 47,059,615     $ 43,866,078       17.79%       27.34%  
                                 
NET INCOME PER SHARE
                               
BASIC
  $ 0.62     $ 0.63                  
DILUTED
  $ 0.61     $ 0.61                  
 
Revenues
 
Revenues for the year ended December 31, 2008 were $264,643,058, an increase of $104,160,675 over revenues for the year ended December 31, 2007. Revenues by segments and product categories were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
   
2008
   
2007
   
(Decrease)
   
(Decrease)
 
Revenue from pharmaceutical products
  $ 224,904,348     $ 127,823,297     $ 97,081,051       75.95%  
Revenue from nutraceutical products
    34,266,739       32,659,086       1,607,653       4.92%  
Total manufacturing revenue
    259,171,087       160,482,383       98,688,704       61.5%  
Distribution revenue
    5,471,971             5,471,971       100%  
Total sales revenue
  $ 264,643,058     $ 160,482,383     $ 104,160,675       64.90%  
 
Sales of our pharmaceutical products increased by $97,081,051, or 76%, as compared to the year of 2007 primarily due to the following factors:
 
 
The sales of our prescription pharmaceutical products increased from $59,015,481 in 2007 to $87,423,056 in 2008, or 48% increase. This is primarily due to contributions from the Company’s diversifying product portfolio, including recently launched CCXA prescription products, in addition to existing products. Expanding rural market coverage also drove prescription pharmaceutical revenue performance during 2008.
 
 
The sales of our OTC pharmaceutical products increased from $68,807,816 to $137,481,292, or 99.8 % increase. This was attributable to the continuous increase in sales of our Jinji series , Jinji Yimucao product that was launched in early 2007 and as a result of our marketing campaigns to enhance recognition of such products; and
 
 
35

 
 
The contribution by our newly acquired subsidiaries, CCXA and Boke, of $24,759,539 and $38,182,006, to our revenue for the year ended December 31, 2008, respectively. Boke was consolidated starting October 2007, and CCXA was consolidated starting September 2007, and had contributed $5,402,877 and $3,246,125 to our revenue for the year ended December 31, 2007, respectively.
 
Sales from our nutraceutical products increased from $32,659,086 in the year of 2007 to $34,266,739 in the year of 2008, representing a growth of 5% and it is primarily due to the following factors:
 
 
Sales of our Protein Peptide series of products increased by 1.8%, from $31,560,609 in 2007 to $32,136,951 in 2008. This increase was mainly attributed to the increase in sales of peptide coffee and peptide powder through our expanded distribution network; and
 
 
Sales of our nutraceutical beverage series increased from $583,830 in the year of 2007 to $1,935,402 in the year of 2008.
 
The Company has recorded $5,471,971 distribution revenue from Nuo Hua since its acquisition on October 18, 2008. The Company had no distribution revenue for the years ended December 31, 2007.
 
Cost of Goods Sold and Gross Profit
 
Cost of goods sold was $91,031,274 for the year ended December 31, 2008, compared to $49,364,486 for the year ended December 31, 2007. Expressed as a percentage of revenues, cost of goods sold was 34.40% for the year ended December 31, 2008, compared to 30.76% for the year ended December 31, 2007. The increase in cost of goods sold as a percentage of revenues reflected sales of more lower margin products by CCXA, increase of raw material prices and lower margin distribution business from Nuo Hua.
 
Cost of goods sold for the years ended December 31, 2008 and 2007 by segments and product categories were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
   
2008
   
2007
   
(Decrease)
   
(Decrease)
 
Pharmaceutical products
  $ 72,244,010     $ 37,089,204     $ 35,154,806       94.78%  
Nutraceutical products
    13,543,450       12,275,282       1,268,168       10.33%  
Total manufacturing cost
    85,787,460       49,364,486       36,422,974       73.78%  
Distribution cost
    5,243,814             5,243,814       100%  
Total cost
  $ 91,031,274     $ 49,364,486     $ 41,666,788       84.41%  
 
The cost of goods sold of pharmaceutical and nutraceutical products increased by 95% and 10%, respectively, in the year ended December 31, 2008 compared to the year ended December 31, 2007. These increases are attributed to our increase in sales. The Company had no distribution revenue and thus the corresponding cost of goods sold for the years ended December 31, 2007.
 
Gross profit increased by $62,493,887, or 56.24%, for the year ended December 31, 2008 over the year ended December 31, 2007. This increase reflected higher net sales. Gross profit as a percentage of net revenues decreased from 69.24% in the prior year to 65.60% in the year of 2008 due to lower margin distribution business and CCXA sold lower gross margin products than 2007.
 
Selling and Marketing
 
Selling and marketing expenses, including distribution expenses, increased from $20,669,303 in the year ended December 31, 2007 to $39,774,330 in the year ended December 31, 2008, representing a 92% increase. The details of our sales and marketing expenses were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/
   
2008
   
2007
   
(Decrease)
   
(Decrease)
Promotional materials and fees
  $ 24,062,209     $ 7,249,854     $ 16,812,355       232 %
Payroll
    5,714,423       3,866,200       1,848,223       48 %
Shipping
    3,501,453       2,796,100       705,353       25 %
Trips and traveling
    2,378,241       1,875,526       502,715       27 %
Sales conferences
    2,545,735       1,854,883       690,852       37 %
Office supplies
    756,544       553,844       202,700       37 %
Other
    815,725       2,472,896       (1,657,171 )     (67 )%
TOTAL
  $ 39,774,330     $ 20,669,303     $ 19,105,027       92 %
 
 
36

 
Our increase in selling and marketing expenses in the year ended December 31, 2008 compared to the year of 2007 was primarily due to the following factors:
 
 
Our promotional materials and fees increased by 232% in 2008 as compared to 2007. This was due primarily to our increased promotional activities to support the sales of our SHL injection power, Jinji series, Jinji Yimucao product and Boke Nose Spray in 2008;
 
 
Our payroll expense increased by $1,848,223, or 48% in 2008 as compared to 2007. The increase in the payroll expenses was due to the increase in hiring of sales and marketing professionals in 2008 to support future growth of our businesses as well as the integration of CCXA and Boke. Boke was consolidated starting October 2007, and CCXA was consolidated starting September 2007. The new labor law which became effective starting January 1, 2008 also contributed to the increase;
 
 
Shipping expense increased by 25% in 2008. This increase resulted primarily from the growth of our sales and the increase in fuel cost; and
 
 
The increase in traveling and sales conferences expenses reflects increased spending in organizing promotional activities to increase market awareness of our brand and products.
 
Advertising
 
Advertising expense increased by $11,236,635, from $22,865,903 in 2007 to $34,102,538 in 2008. The increase in advertising expense resulted from an increase in promotional efforts and media advertisement in 2008 to promote the Company’s Jinji series, Boke Nose Spray and Protein Peptide series of products
 
General and Administrative
 
General and administrative expenses increased from $13,832,110 in 2007 to $19,603,947 in 2008, or a 42% increase. The details of general and administrative expenses were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
   
2008
   
2007
   
(Decrease)
   
(Decrease)
 
   
Restated
   
Restated
             
Payroll
  $ 3,666,734     $ 2,152,039     $ 1,514,695       70 %
Professional fees
    2,755,215       1,395,826       1,359,389       97 %
Directors’ remuneration
    903,333       865,344       37,989       4 %
Research
    1,528,991       870,219       658,772       76 %
Stock compensation – directors
    2,077,003       1,063,129       1,013,874       95 %
Office supplies
    726,629       492,884       233,745       47 %
Stock compensation – consultants
    200,500       394,100       (193,600 )     -49 %
Business entertainment
    346,436       348,265       (1,829 )     -1 %
Office rental
    231,056       321,735       (90,679 )     -28 %
Utilities & Vehicles
    583,252       415,463       167,789       40 %
Provision for bad debts
    (94,258 )     76,322       (170,580 )     -224 %
Miscellaneous
    6,679,056       5,436,784       1,242,272       23 %
TOTAL
  $ 19,603,947     $ 13,832,110     $ 5,771,837       42 %
 
Our increase in general and administrative expenses in the year ended December 31, 2008 compared to the year ended December 31, 2007 was primarily due to the following factors:
 
 
Payroll expenses increased by $1,514,695, or 70% compared with 2007, as a result of the increased average salary for administrative employees and the integration of Boke. Boke was consolidated starting October 2007;
 
 
Accounting related professional fees for 2008 increased by $1,359,389, or 97% as compared to 2007, due primarily to the increase in accounting fees relating to our fund raising activities during the second quarter of 2008 and the increase in audit fees relating to our increased number of subsidiaries being audited;
 
 
Directors’ remuneration and stock compensation increased by $37,989 and $1,013,874, or 4% and 95%, respectively, as compared to 2007. This was a result of accrued performance bonus, continuous vesting of 2007 granted stock options and new stock options granted in 2008;
 
 
Research expenses increased by 76% compared to 2007. This reflected our increased spending on research and development of new products;
 
 
37

 
 
Expenses for office supplies increased by $233,745, or 47% compared to 2007, this was a result of the new office building put into use in 2008;
 
 
The Company made specific provision for bad debts based on the age of its accounts receivable. We have been implementing a tight credit control policy and making consistent efforts in collecting long outstanding debts inherited from acquired subsidiaries. The Company reversed $94,258 provision for bad debts during 2008 based on the aging analysis; and
 
 
Miscellaneous expenses increased by $1,242,272, or 28% in 2008 compared to 2007. This increase was due to increases in conference fees cost of $1,107,884.
 
Depreciation and Amortization
 
Depreciation and amortization expense increased by $2,393,790, or 120%, in the year ended December 31, 2008 compared to the year ended December 31, 2007.
 
Purchased in-process research and development
 
Acquisition-related in-process research and development charge of $12,255,248 is related to the acquisition of GuangXi HuiKe Pharmaceutical Research and Development Co., Ltd. (“GHK”). On the date of acquisition, GHK was working on at least seven in progress R&D projects. The Company intends to continue and invest in all the projects leading to either obtaining production licenses for new products or proprietary technology patents of future economic value. We estimate fair value of the IPR&D and recognized them as acquired intangible assets apart from goodwill. However, according to US GAAP applicable at the time or the acquisition, the IPR&D project that have no alternative future use was charged to expense at the acquisition date. The acquired IPR&D charge was a non-recurring expense deducted from operating income.
 
Interest Income (Expense), Net
 
Net interest expense was $2,571,015 for the year ended December 31, 2008, compared to net interest income of $617,524 for the year ended December 31, 2007. The increase was mainly caused by convertible notes interest expense from July 2008.
 
Other Income (Expense), Net
 
Other income (expenses), net, was a net expense of $65,843 for the year ended December 31, 2008, compared to a net expense of $525,065 for the year ended December 31, 2007.
 
Income Taxes
 
Income tax expense for the year ended December 31, 2008 was $12,635,472 as compared to $8,011,248  for the year ended December 31, 2007. The increase was due to the increase in pre-tax income of Three Happiness and HSPL. The Company’s effective tax rate for the year was 21.16%. During this period, income tax was provided for at 15% of pre-tax income for Three Happiness, Boke, HSPL, CCXA and GLP under applicable Chinese law. All these subsidiaries were granted high-tech enterprise status.
 
 
38

 
RESULTS OF OPERATIONS – YEAR ENDED DECEMBER 31, 2007 AS COMPARED TO YEAR ENDED DECEMBER 31, 2006
 
The following table sets forth the amounts and the percentage relationship to revenues of certain items in our consolidated statements of income for the years ended December 31, 2007 and 2006:
 
   
Year Ended December 31,
   
Year Ended December 31,
 
   
2007
   
2006
   
2007
   
2006
 
   
Restated
                   
REVENUES
  $ 160,482,383     $ 110,182,092       100 %     100 %
COST OF GOODS SOLD
    49,364,486       38,318,223       30.76       34.78  
                                 
GROSS PROFIT
    111,117,897       71,863,869       69.24       65.22  
Selling and marketing
    20,669,303       8,876,829       12.88       8.06  
Advertising
    22,865,903       15,174,125       14.25       13.77  
General and administrative
    13,832,110       10,446,740       8.6       9.48  
Depreciation and amortization
    1,989,425       988,488       1.24       0.90  
Total operating expenses
    59,356,741       35,486,182       36.97       32.21  
                                 
INCOME FROM OPERATIONS
    51,761,156       36,377,687       32.27       33.02  
Equity in earnings (loss) from unconsolidated entities
    23,711       (3,811 )     0.01       0  
Interest income (expense), net
    617,524       574,172       0.38       0.52  
Other income (expense), net
    (525,065 )     (329,987 )     (0.33 )     (0.30 )
                                 
INCOME BEFORE INCOME TAXES
    51,877,326       36,618,061       32.33       33.23  
Income taxes
    8,011,248       7,416,915       4.99       6.73  
                                 
NET INCOME
  $ 43,866,078     $ 29,201,146       27.34 %     26.50 %
                                 
NET INCOME PER SHARE
                               
BASIC
  $ 0.63     $ 0.47                  
DILUTED
  $ 0.61     $ 0.46                  
 
Revenues
 
Revenues for the year ended December 31, 2007 were $160,482,383, an increase of $50,300,291 over revenues for the year ended December 31, 2006. Revenues by product categories were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
Product
 
2007
   
2006
   
(Decrease)
   
(Decrease)
 
Pharmaceutical products
  $ 127,823,297     $ 79,367,161     $ 48,456,136       61 %
Nutraceutical products
    32,659,086       30,814,931       1,844,155       6 %
TOTAL
  $ 160,482,383     $ 110,182,092     $ 50,300,291       46 %
 
Sales of our pharmaceutical products increased by $48,456,136, or 61%, as compared to the year of 2006 primarily due to the following factors:
 
 
The sales of our prescription pharmaceutical products increased from $45,385,970 in 2006 to $59,015,481 in 2007, or 30% increase. This is primarily due to the increase in sales of our Shuanghuanglian Injection Powder and Cease Enuresis Soft Gel supported by our continuous marketing efforts, increasing brand recognition and effective pricing strategy as well as expanding coverage to the previously unaddressed rural market;
 
 
The sales of our OTC pharmaceutical products increased from $33,981,191 to $68,807,816, or 102% increase. This was attributable to the increase in sales of our Jinji series and Jinji Yimucao product that was launched early 2007 as a result of improved recognition of our new product supported by our marketing campaigns. Our Jini Yimucao product contributed $11,290,257 to our revenue in 2007; and
 
 
Our newly acquired CCXA and Boke have contributed $5,402,877 and $3,246,125 to our revenue for the year ended December 31, 2007, respectively. CCXA and Boke were not our subsidiaries last year.
 
 
39

 
Sales from our nutraceutical products increased from $30,814,931 in the year of 2006 to $32,659,086 in the year of 2007, representing a growth of 6% and it is primarily due to the following factors:
 
 
Sales of our Protein Peptide series of products increased by 15%, from $27,356,572 in 2006 to $31,560,609 in 2007. This increase was mainly attributed to the increase in sales of peptide coffee and peptide powder through our expanded distribution network; and
 
 
However, the increase of our nutraceutical product sales were offset by the decrease in the sales of our Compound Bio-functional beverage series from $1,693,752 in the year of 2006 to $583,830 in the year of 2007 and our Vitamate nutritional oral liquid product from $1,743,513 in 2006 to $514,647 during 2007. These products are our old products and they are at the end of their product life cycle. We reduced our marketing efforts on promoting those products during the year.
 
Cost of Goods Sold and Gross Profit
 
Cost of goods sold was $49,364,486 for the year ended December 31, 2007, compared to $38,318,223 for the year ended December 31, 2006. Expressed as a percentage of revenues, cost of goods sold was 30.76% for the year ended December 31, 2007, compared to 34.78% for the year ended December 31, 2006. The reduction in cost of goods sold as a percentage of revenues reflected a continued focus on operating cost management, sourcing efficiencies and operation efficiencies.
 
Cost of goods sold for the years ended December 31, 2007 and 2006 by product categories were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
Product
 
2007
   
2006
   
(Decrease)
   
(Decrease)
 
Pharmaceutical products
  $ 37,089,204     $ 26,913,846     $ 10,175,358       38 %
Nutraceutical products
    12,275,282       11,404,377       870,905       8 %
TOTAL
  $ 49,364,486     $ 38,318,223     $ 11,046,263       29 %
 
The cost of goods sold of pharmaceutical and nutraceutical products increased by 38% and 8%, respectively, in the year ended December 31, 2007 compared to the year ended December 31, 2006. These increases are attributed to our increase in sales.
 
Gross profit increased by $39,254,028, or 55%, for the year ended December 31, 2007 over the year ended December 31, 2006. This increase reflected higher net sales, improved margins and operating efficiencies generally across our pharmaceutical and nutraceutical businesses.
 
Gross profit as a percentage of net revenues increased from 65.22% in the prior year to 69.24% in the year of 2007 due to the reductions in cost of goods sold as a percentage of revenues discussed above and improved operational efficiency.
 
Selling and Marketing
 
Selling and marketing expenses, including distribution expense, increased from $8,876,829 in the year ended December 31, 2006 to $20,669,303 in the year ended December 31, 2007, representing a 133% increase. The details of our sales and marketing expenses were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
   
2007
   
2006
   
(Decrease)
   
(Decrease)
 
Promotional materials and fees
  $ 7,249,854     $ 2,048,710     $ 5,201,144       254 %
Shipping
    3,866,200       1,856,743       2,009,457       108 %
Payroll
    2,796,100       1,923,384       872,716       45 %
Offices supplies
    553,844       704,657       (150,813 )     (21 )%
AOB Hong Kong marketing
    90,141       176,079       (85,938 )     (49 )%
Other
    6,113,164       2,167,256       3,945,908       182 %
TOTAL
  $ 20,669,303     $ 8,876,829     $ 11,792,474       133 %
 
 
40

 
Our increase in selling and marketing expenses in the year ended December 31, 2007 compared to the year of 2006 was primarily due to the following factors:
 
 
Our promotional materials and fees increased by 254% in 2007 as compared to 2006. This was due primarily to our increased promotional activities to support the sales of our Jinji series and Jinji Yimucao product in 2007. The increase was also due to additional pharmacies and stores decoration as a new marketing initiative launched by the Company in 2007 to help establish and enforce relationships with retailers by providing decorative posters and print ads for store windows;
 
 
Our payroll expense increased $2,009,457, or 108% in 2007 as compared to 2006. This was a result of our increased average salaries and increase in number of sales and marketing employees;
 
 
Shipping expense increased by 45% in 2007. This increase resulted primarily from the growth of our sales and the increase of fuel cost;
 
 
Selling and marketing expenses in our Hong Kong branch decreased during 2007 as we integrated our showroom from our specialty store to our administrative office. In 2007 we focused on sales to chain stores;
 
 
Other expenses increased by $3,945,908 in 2007 compared to 2006, primarily due to increases in traveling expenses business expense and sales conference fee by $1,120,602, $1,013,026 and $1,649,108, respectively. This reflects increased spending in marketing communications to increase market awareness of our brand and products. More sales conferences in more cities were held in 2007 compared to 2006; and
 
 
Our newly acquired subsidiaries CCXA and Boke also incurred $216,491 and $910,782 in selling and marketing expenses in 2007 respectively.
 
Advertising
 
Advertising expense increased by $7,691,778, from $15,174,125 in 2006 to $22,865,903 in 2007. The increase in advertising expense resulted from an increase in promotional efforts in 2007 to promote the Company’s Shuanghuanglian Injection Powder and Cease Enuresis Soft Gel and media advertisement in Protein Peptide product series as well as our CE Patch. Our Hong Kong branch also increased advertisement on brand building and name recognition in the Hong Kong market in the year of 2007 compared to the year of 2006. GLP incurred $12,933,727 in advertising expense during the year of 2007, which accounts for 57% of the total advertising expense. CCXA, our newly acquired subsidiary, also incurred $380,501 in advertising expense during 2007.
 
General and Administrative
 
General and administrative expenses increased from $10,446,740 in 2006 to $13,832,110 in 2007, or a 32% increase. The details of general and administrative expenses were as follows:
 
   
Year Ended December 31,
    Increase/     Increase/  
   
2007
   
2006
   
(Decrease)
   
(Decrease)
 
   
Restated
                   
Payroll
  $ 2,152,039     $ 1,618,032     $ 534,007       33 %
Professional fees
    1,395,826       2,177,874       (782,048 )     (36 )%
Directors’ remuneration
    865,344       526,167       339,177       64 %
Research
    870,219       742,705       127,514       17 %
Stock compensation – directors
    1,063,129       225,644       837,485       371 %
Office supplies
    492,884       691,370       (198,486 )     (29 )%
Stock compensation – consultants
    394,100       596,885       (202,785 )     (34 )%
Business entertainment
    348,265       361,940       (13,675 )     (4 )%
Office rental
    321,735       317,828       3,907       1 %
Utilities
    208,314       226,361       (18,047 )     (8 )%
Vehicles
    207,149       223,446       (16,297 )     (7 )%
Transportation
    77,167       51,619       25,548       49 %
Provision for bad debts
    76,322       (234,772 )     311,094       133 %
Miscellaneous
    5,359,617       2,921,641       2,437,976       83 %
TOTAL
  $ 13,832,110     $ 10,446,740     $ 3,385,370       32 %
 
 
41

 
Our increase in general and administrative expenses in the year ended December 31, 2007 compared to the year ended December 31, 2006 was primarily due to the following factors:
 
 
Payroll expense increased by $534,007, or 33% compared with 2006, as a result of increase of average salary as well as increase in the number of new employees;
 
 
Professional fees for 2007 decreased by $782,048, or 36% as compared to 2006 as a result of a decrease in our use of legal and accounting services in connection with the listing of our stock on the New York Stock Exchange, such additional services were not used during 2007;
 
 
Directors’ remuneration and stock compensation increased by $339,177 and $837,485, or 64% and 371% respectively, as compared to 2006. This was a result of accrued performance bonus during 2007 and new stock options granted in April 2007;
 
 
Research expense increased by 17% compared to 2006, reflecting the devotion of additional resources to research on our existing and new product development;
 
 
Expense for office supplies decreased by $198,486, or 29% compared to 2006, This was a result of increased cost control on general and administrative activities as well as reallocation of some administrative functions in 2007;
 
 
The Company made specific provision for bad debts based on the age of its accounts receivable. We have been implementing a tight credit control policy and making consistent efforts in collecting long outstanding debts inherited from acquired subsidiaries. The Company increased its provision by $311,094 for bad debts during 2007 based on the aging analysis;
 
 
Miscellaneous expenses increased by $2,437,976, or 83% in 2007 compared to 2006. This increase was due to increases in sales tax, trip and traveling and insurance cost of $778,592, $408,245 and $408,921, respectively; and
 
 
Our newly acquired subsidiaries CCXA and Boke also incurred $334,058 and $311,613 in general and administrative expenses in 2007.
 
Depreciation and Amortization
 
Depreciation and amortization expense increased by $1,000,937, or 101%, in the year ended December 31, 2007 compared to the year ended December 31, 2006. The increase was mainly due to (i) the integration of GLP with the net book value of $9,661,731 in fixed assets and $24,702,995 in intangible assets from May 2006; (ii) the integration of CCXA with the net book value of $9,051,130 in fixed assets and $16,524,939 in intangible assets from September 2007; and (iii) the integration of Boke with the net book value of $4,018,429 in fixed assets and $22,214,455 in intangible assets from October 2007. The depreciation and amortization expense at GLP, CCXA and Boke amounted to $691,056, $123,166 and $491,981during 2007, respectively.
 
Interest Income (Expense), Net
 
Net interest income was $617,524 for the year ended December 31, 2007, compared to net interest income of $574,172 for the year ended December 31, 2006. This was because of the cash proceeds received from our public offering in 2007 as well as the proceeds from the exercise of warrants during 2007. There were no significant fluctuations in interest expense incurred by us.
 
Other Income (Expense), Net
 
Other income (expense), net, was a net expense of $525,065 for the year ended December 31, 2007, compared to a net expense of $329,987for the year ended December 31, 2006. This was resulted primarily from the exchange loss of $680,311 offset by government subsidies of $102,669 in GLP during 2007.
 
Income Taxes
 
Income tax expense for the year ended December 31, 2007 was $8,011,248  as compared to $7,416,915 for the year ended December 31, 2006. The increase was due to the increase in pre-tax income of Three Happiness and HSPL as well as the integration of CCXA and Boke. The Company’s effective tax rate for the year was 15.4%. During this period, income tax was provided for at 15% of pre-tax income for Three Happiness and Boke and 33% of pre-tax income for HSPL and CCXA under applicable Chinese law. GLP enjoys a tax exemption according to applicable Chinese tax laws.
 
 
42

 
LIQUIDITY AND CAPITAL RESOURCES
 
Cash
 
Our cash balance at December 31, 2008 was $70,636,510, representing a decrease of $95,773,565, or 58%, compared with our cash balance of $166,410,075 at December 31, 2007. The decrease was mainly attributable to the investing activities in acquisitions and the purchases of construction in progress, property, plant and land for $248,117,301, offset by net proceeds from the issuance of our convertible notes and prepaid forward repurchase contract, which amounted to $80,359,934 and net cash provided by operating activities of $74,809,867.
 
Cash Flow
 
2008 Compared to 2007
 
Cash flows from operations during 2008 amounted to $74,809,867, representing an increase of approximately 65% compared with cash flows from operations of $45,364,532 in 2007. The increased cash flow was due primarily to the increase of our income from operations by 23%, to $63,492,506  in the year of 2008, compared with operation income of $51,761,156  in the year of 2007.
 
Our cash flows used in investing activities amounted to $257,374,093 in the year ended December 31, 2008. We also used $172,682,150 for the purchase of construction in progress, property, plant and equipment and land use right in PRC. Compared to 2007, our cash flows used in investing activities increased by $187,528,391, which resulted primarily from the acquisition payments and investments in long term assets.
 
Our cash flows from financing activities amounted to $80,948,164 in the year of 2008. During that period, the Company received net proceeds of $110 million from the issuance of our convertible notes and paid $29,998,616 for our prepaid forward stock repurchase contract.
 
2007 Compared to 2006
 
Cash flows from operations during 2007 amounted to $45,364,532, representing an increase of approximately 56% compared with cash flows from operations of $29,011,947 in 2006. The increased cash flow was due primarily to the increase of our net income by 50%, to $43,866,078  in the year of 2007, compared with net income of $29,201,146 in the year of 2006. The increased cash flow was also due in part to an increase in other payables and accrued expenses by $2,856,936 during 2007, due primarily to our increased accrual on advertisement. These increases were partly offset by an increase in our accounts receivable of $4,142,308, other current assets of $2,755,757 and advances to suppliers and prepaid expenses of $2,205,730 during 2007, which resulted from our expanded scale of operations, which required support of increased sales and production activities and additional demands on working capital.
 
Our cash flows used in investing activities amounted to $69,845,702 in the year ended December 31, 2007. During that period, we paid $29,397,657 for the acquisition of CCXA and $36,475,090 for the acquisition of Boke. We also used $1,507,017 for the purchase of plant and equipment. Compared to 2006, our cash flows used in investing activities increased by $43,459,138, which resulted primarily from the acquisition payments.
 
Our cash flows from financing activities amounted to $96,833,706 in the year of 2007. We received $72,984,358 from our secondary offering and we repaid $10,750,915 of bank loans.
 
Working Capital
 
Our working capital decreased by $93,453,863 to $87,082,705, at December 31, 2008, as compared to $180,536,568, at December 31, 2007, primarily due to our decrease in cash of  $95,773,565.
 
We currently generate our cash flow through operations. We believe that our cash flow generated from operations will be sufficient to sustain operations for at least the next twelve months. From time to time, we may identify new expansion opportunities for which there will be a need for use of cash.
 
As of December 31, 2008, the Company entered into unconditional capital commitments for the purchase of land use rights and construction of manufacturing facilities in the PRC for $7,666,839 within one year and $11,734,773 after one year. The Company has no material unconditional purchase commitments for raw materials, packing materials and advertising.
 
 
Issuance of Common Stock
 
See PART II Item 5 for issuance of unregistered common stock during the year ended 2007.
 
 
43

 
Inflation
 
Inflation has not had a material impact on our business.
 
Currency Exchange Fluctuations
 
All of Company’s revenues and majority of the expenses in 2008 were denominated primarily in Renminbi (“RMB”), the currency of China, and was converted into US dollars at the exchange rate of 7.0842 to 1. In the third quarter of 2005, the Renminbi began to rise against the US dollar. As a result of the appreciation of RMB we recognized a foreign currency translation gain of $15,767,870. There could 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.
 
 
The information required by Item 8 appears after the signature page to this report.
 
 
None.
 
 
(a) Evaluation of Disclosure Controls and Procedures
 
AOB maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed by AOB under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and form and that such information is accumulated and communicated to AOB’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer evaluated, with the participation of other members of management, the effectiveness of AOB’s disclosure controls and procedures (as defined in Exchange Act Rule s 13a-15(e) and 15d-15(e)), as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.
 
Although the management of our Company, including the Chief Executive Officer and the Chief Financial Officer, believes that our disclosure controls and internal controls currently provide reasonable assurance that our desired control objectives have been met, management does not expect that our disclosure controls or internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
 
(b) Management’s Report on Internal Control over Financial Reporting
 
The management of AOB is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
 
1. Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
 
2. Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
 
3. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of our assets that could have a material effect on the financial statements.
 
 
44

 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2008. The framework on which such evaluation was based is contained in the report entitled “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”). The scope of the assessment on internal control over financial reporting did not include controls of all consolidated entities. The management excluded from its assessment the internal control over financial reporting at Nuo Hua Investment Company Ltd., which was acquired October 18, 2008, and GuangXi HuiKe Pharmaceutical Research and Development Co., Ltd., which was acquired October 20, 2008, and whose combined financial statements constitute 11% and 10% of net and total assets, respectively, and 2% of revenues and (25)% of net income of the consolidated financial statements as of and for the year ended December 31, 2008. There were no material changes to our internal control over financial reporting due to the above acquisitions.
 
Based on that evaluation and the criteria set forth in the COSO Report, management concluded that its internal control over financial reporting was effective as of December 31, 2008.
 
Our independent registered public accounting firm, Weinberg & Company, P.A., who also audited our consolidated financial statements, independently assessed the effectiveness of our internal control over financial reporting as of December 31, 2008, as stated in their report which is included in this Annual Report.
 
As a result of the errors in our 2007 and 2008 interim and annual period reports, which errors were identified subsequent to the evaluation of our internal controls over financial reporting as of December 31, 2008, we re-evaluated such controls in light of the errors.  Based upon such  re-evaluation, management concluded that there was no impact on its assessment as of December 31, 2008 that the internal controls over financial reporting is effective even considering the error and the restatements.  Management considered the following factors in arriving at such conclusion:
 
 
·
the errors were isolated and not systematic errors;
 
·
the errors unveiled a control deficiency in the internal control system but such deficiency did not rise to the level of a significant deficiency or material weakness in the controls;
 
·
none of the errors resulted in a more than remote likelihood that a material misstatement of the financial statements, that is more than inconsequential, would occur or could lead to non-reliance on such financial statements;
 
·
a reasonable person would conclude, after considering the errors and the restatement that such errors are immaterial to the financial statements; and
 
·
that even with the errors, such errors would not cause a reasonable person to conclude that they did not have sufficient information about the financial condition, results of operations and cash flow to make an informed decision about an investment in the company.
 
We have taken appropriate steps and actions to prevent these errors in the future, including additional review.
 
(c) Changes in Internal Control over Financial Reporting
 
There was no change in our internal control over financial reporting that occurred during the fourth fiscal quarter of the fiscal year covered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
Not applicable.
 
 
45

 
 
 
The following table sets forth the names and ages of our current directors and executive officers, their principal offices and positions and the date each such person became a director or executive officer. Executive officers are elected annually by our Board of Directors. Each executive officer holds his office until he resigns, is removed by the Board or his successor is elected and qualified. Directors are elected annually by our stockholders at the annual meeting. Each director holds his or her office until his or her successor is elected and qualified or his or her earlier resignation or removal.
 
The following persons are the directors and executive officers of our company:
 
Name
 
Age
 
Position
 
Date Of Initial
Appointment
Tony Liu
  56  
Chief Executive Officer and Chairman of the Board
 
December 18, 2001
Jun Min
  50  
Director and Vice President
 
May 8, 2002
Yanchun Li
  40  
Director, Chief Financial Officer and Chief Operations Officer
 
May 8, 2002
Binsheng Li
  45  
Director and Chief Accounting Officer
 
May 8, 2002
Cosimo J. Patti (1)(2)(3)
  59  
Independent Director
 
September 27, 2004
Xianmin Wang (1)(2)(3)
  66  
Independent Director
 
January 1, 2005
Eileen Brody (1)(2)(3)
  47  
Independent Director
 
June 22, 2005
Lawrence S. Wizel (1)(2)(3)
  65  
Independent Director
 
August 21, 2006
Baiqing Zhang (3)
  56  
Independent Director
 
December 15, 2006
 

(1)
Serves as a member of the Audit Committee.
(2)
Serves as a member of the Compensation Committee.
(3)
Serves as a member of the Nominating Committee.
 
There are no family relationships between or among any of the executive officers or directors of the Company. Below are brief descriptions of the backgrounds and experiences of the officers and directors:
 
Tony Liu is the principal founder of our Company and has served as our Chief Executive Officer and the Chairman of our Board of Directors since 2001. He served in the army for over 19 years. After Mr. Liu left the army, he began working for the government in the Heilongjiang province in northeastern China. In addition to serving as a representative to the National People’s Congress in China, with his practical work experience in the Chinese community for many years, Mr. Liu has witnessed and participated in the massive macro economic changes for the past thirty years. He has many years of experience in managing the army, government agencies and pharmaceutical companies. Mr. Liu graduated with a major in Communications & Commands from Wuhan Communication College in 1986 and studied Integrated Marketing and Media at the University of Hong Kong in 2004. Mr. Liu studied in the Program of Sustainable Growth of Large Corporations sponsored by the School of Engineering and the School of Business at Stanford University.
 
Jun Min is one of our founders and has served as our Vice President and as a member of our Board of Directors since 2002. Mr. Min worked at the Price Checking Department Bureau of Heilongjiang Province from 1987 to 1992. Subsequently, he worked for Harbin Three-Happiness Bioengineering, Co. Ltd. from 1994. He has over 20 years of experience in operations management and has an extensive knowledge of the consumer and pharmaceutical products industries in China. Mr. Min received a BA in Business Management from Harbin Broadcast & TV University in 1986.
 
Yanchun Li is one of our partner founders and has served as Chief Financial Officer since May 2007. Prior to her appointment as Chief Financial Officer, she had been the Acting Chief Financial Officer since May 2002, Chief Operating Officer and Secretary since October 2003 and has worked at the Company and served as a member of the Board since 2002. Ms. Li has fifteen years of experience in management in the food industry and the pharmaceutical industry in China. In particular, she has extensive experience and innovative insight in marketing, management, brand building, corporate strategy, human resource and financial capital management. Before joining us, Ms. Li worked for China Ruida Food Limited Company and successfully established the Ruida brand as the number one brand in the instant frozen food industry. Ms. Li joined Three-Happiness Bioengineering, Co. Ltd. in 1994 and was in charge of the marketing and sales. Under her leadership, the functional drink of the Three-Happiness brand has reached stunning achievement nationwide across China. The Three-Happiness brand was later awarded the “Top Ten Well-known Brands in China”. Ms. Li won the China Golden Award in Marketing of Year 2005 and was elected into the “Who’s Who of Chinese Origin Worldwide”. Ms. Li received her BA in English from Beijing University of Industry and Commerce in 1993 and completed the Owner/President Management Program in 2008, an advanced program, at Harvard Business School.
 
 
46

 
Binsheng Li is one of our partner founders and has served as our Chief Accounting Officer and as a member of our Board of Directors since 2002. Mr. Li began his career at Three-Happiness Bioengineering, Co. Ltd. in 1994 in the accounting department. Mr. Li is in charge of all financial management and accounting work for the Company. Mr. Li graduated from Dalian Financial School in 1986 with a major in Finance and Economics.
 
        Cosimo J. Patti has served on our Board of Directors since 2004. Before joining us, Mr. Patti was an arbitrator for the National Association of Securities Dealers and the New York Stock Exchange for 18 years. Since August 1999, Mr. Patti has been the President and Chairman of Technology Integration Group, Inc. In June 2007, Mr. Patti joined the board of directors of Advanced Battery Technologies, Inc. (NASDAQ:ABAT), a company engaged in the business of designing, manufacturing and marketing rechargeable polymer lithium-ion batteries. From 2002 to 2004, Mr. Patti was the Senior Director of Applications Planning with iCi/ADP. He was the Director of Strategic Cross-border Business with Cedel Bank from 1996 to 1999, and President and Founder of FSI Advisors Group from 1998 to 2002. Mr. Patti attended Brooklyn College from 1968 to 1970.
 
Xianmin Wang has served on our Board of Directors since 2005. He was the Vice Governor of Heilongjiang Province from 1998 to 2003, where he was in charge of Financial and Economic affairs. Mr. Wang was Secretary of Daqing Municipal Party Committee from 1996 to 1998, and Vice Secretary of Harbin Municipal Party Committee from 1991 to 1992. Mr. Wang received a post graduate degree in Philosophy from Renmin University of China in 1964. He also holds a bachelor’s degree in Economics from Northeast Forest University and postgraduate degrees in Philosophy from Heilongjiang University and Renmin University of China.
 
Eileen Brody has served on our Board of Directors since 2005. Since August 2005, Ms. Brody has been President of Dawson-Forte Cashmere, an apparel trading company. Since June 2007 Ms. Brody has been a member of the board of directors of Fuqi International, Inc. (NASDAQ:FUQI), a company specializing in designing, developing, promoting, and selling a range of precious metal jewelry products in the Chinese luxury goods market. From 1997 to 2004, she was Vice President of Merchandising and Planning for Carter’s Retail division of The William Carter Company. From 1992 to 1997, she held various management positions for Melville Corporation, a multi-billion dollar retailer. From 1983 to 1990, Ms. Brody worked for KPMG Peat Marwick as a Senior Manager. Ms. Brody is a Certified Public Accountant. She received her Undergraduate and MBA degrees from Pace University and a second MBA from the Harvard Graduate School of Business.
 
Lawrence S. Wizel has served on our Board of Directors since 2006. Prior to joining our Board of Directors, he served as Deputy Professional Practice Director at Deloitte Touche USA LLP, or Deloitte, in Deloitte’s New York office. Mr. Wizel began his career at Deloitte in 1965 and was a partner from 1980 until he retired in June 2006. Mr. Wizel was responsible for serving a diverse client base of publicly held and private companies in a variety of capacities including, SEC filings, initial public offerings, mergers and acquisition transactions and periodic reporting. Since September 2006, Mr. Wizel has been a member of the board of directors of 3SBio Inc. (NASDAQ:SSRX), a biotechnology company focused on researching, developing, manufacturing and marketing biopharmaceutical products primarily in China. Since August 2007, Mr. Wizel has been a member of the board of directors of Puda Coal, Inc. (OTC:PUDC), a supplier of metallurgical coking coal to the industrial sector in China. He received his BA in 1965 in accounting from Michigan State University and is a Certified Public Accountant.
 
Baiqing Zhang has served on our Board of Directors since 2006. Mr. Zhang brings to us two decades of experience in the Chinese government’s regulatory and supervisory divisions. From 1997 until Mr. Zhang retired in 2005, Mr. Zhang served as Deputy Director, Division Chief of the Heilongjiang Regulatory Bureau of the China Securities Regulatory Commission, or CSRC, where he managed and imposed regulatory compliance for all Heilongjiang-based securities issuances, as well as supervised securities trading, investment funds and legal affairs. The CSRC is China’s primary regulatory body overseeing the country’s financial markets. Prior to this, he spent ten years as a member of the Discipline Inspection Committee in the Department of Supervision of the Heilongjiang Province, and previously was the Vice Principal of Hebei Institute of Mechanical and Electrical Technology, where he taught college courses. Since 2005, Mr. Zhang has been a consultant in the fields of law and economics, public policy, and business strategy. He also consults and lectures about regulatory issues in the Chinese securities markets, based on his significant experience at the CSRC. Mr. Zhang received a degree in Management of Economics from the Tianjin Normal University and a degree in Accounting from the Heilongjiang Economics Management Academy.
 
CORPORATE GOVERNANCE
 
Board of Directors
 
We have nine members serving on our Board of Directors. Each board member is nominated for election at our annual meeting to serve until the next annual meeting of stockholders and until their successors are duly elected and qualified.
 
Board Committees
 
The Board of Directors has an Audit Committee, Nominating and Corporate Governance Committee and a Compensation Committee.
 
 
47

 
Nominating and Corporate Governance Committee
 
The purpose of the Nominating and Corporate Governance Committee is to assist the Board of Directors in identifying qualified individuals to become board members, in determining the composition of the Board of Directors and in monitoring the process to assess Board effectiveness. Ms. Brody and Messrs. Patti, Wang and Wizel are members of the Nominating and Corporate Governance Committee. There have been no changes to the procedures by which the stockholders of the Company may recommend nominees to the Board of Directors since the filing of the Company’s Definitive Proxy Statement on October 17, 2008 for its Annual Meeting of Stockholders, which was held on December 5, 2008. The Nominating and Corporate Governance Committee operates under a written charter. The Amended and Restated Nominating and Corporate Governance Committee Charter can be found on our website at www.bioaobo.com and can be made available in print free of charge to any shareholder who requests it.
 
Compensation Committee
 
The Compensation Committee is responsible for (a) reviewing and recommending to the Board of Directors on matters relating to employee compensation and benefit plans, and (b) assisting the Board in determining the compensation of the Chief Executive Officer and make recommendations to the Board with respect to the compensation of the Chief Financial Officer, other executive officers of the Company and independent directors. Ms. Brody and Messrs. Patti, Wang and Wizel are members of the Compensation Committee. Our Compensation Committee Charter was amended on February 25, 2008, in connection with our listing on the New York Stock Exchange. The Compensation Committee operates under a written charter. The Amended and Restated Compensation Committee Charter can be found on our website at www.bioaobo.com and can be made available in print free of charge to any shareholder who requests it.
 
Compensation Committee Interlocks and Insider Participation
 
Members of our Compensation Committee of the Board of Directors during 2008 were Ms. Brody and Messrs. Patti, Wizel and Wang. No member of our Compensation Committee was, or has been, an officer or employee of the Company or any of our subsidiaries. No member of the Compensation Committee has a relationship that would constitute an interlocking relationship with executive officers or directors of the Company or another entity.
 
Compensation Committee Report (1)
 
The Compensation Committee has reviewed and discussed the discussion and analysis of the Company’s compensation which appears below above with management, and, based on such review and discussion, the Compensation Committee recommended to the Company’s Board of Directors that the above disclosure be included in this Annual Report on Form 10-K.
 
The members of the Compensation Committee are:
 
Eileen Brody, Chair
Cosimo J. Patti
Xianmin Wang
Lawrence S. Wizel
 

(1)
The material in the above Compensation Committee reports is not soliciting material, is not deemed filed with the SEC and is not incorporated by reference in any filing of the Company under the Securities Act of 1933, or the Securities Exchange Act of 1934, whether made before or after the date of this Form 10-K and irrespective of any general incorporation language in such filing.
 
Audit Committee
 
The Company has a separately designated standing audit committee in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The audit committee members for the year ended December 31, 2008 consisted of Lawrence S. Wizel, Cosimo J. Patti, Xianmin Wang and Eileen Brody. Each of these members are considered “independent” under Section 303A.02 of the listing standards of New York Stock Exchange, as determined by our board of directors. The audit committee recommends to the board of directors the annual engagement of a firm of independent accountants and reviews with the independent accountants the scope and results of audits, our internal accounting controls and audit practices and professional services rendered to us by our independent accountants. The Audit Committee Charter can be found on our website at www.bioaobo.com and can be made available in print free of charge to any shareholder who requests it.
 
Our board of directors has determined that we have at least one audit committee financial expert, as defined in the Exchange Act, serving on our audit committee. Lawrence S. Wizel is the “audit committee financial expert” and is an independent member of our board of directors.
 
 
48

 
Pursuant to its charter, the audit committee meets at least quarterly with the Company’s internal auditors. The Company does not limit the number of audit committees on which its audit committee members can serve.
 
EXECUTIVE SESSIONS
 
Under the New York Stock Exchange Rules, our non-management directors are required to hold regular executive sessions without management. The chairperson of the executive session will rotate at each session so that each non-management director shall have an opportunity to serve as chairperson. Interested parties may communicate directly with the presiding director of the executive session or with the non-management directors as a group, by directing such written communication to Mr. Cosimo Patti at American Oriental Bioengineering, Inc., 330 Madison Avenue 9th Floor, New York NY 10017
 
CHIEF EXECUTIVE OFFICER CERTIFICATIONS
 
In connection with our listing on the New York Stock Exchange, Mr. Tony Liu, our Chief Executive Officer, submitted an Annual CEO Certification, without qualification, to the New York Stock Exchange certifying that he is not aware of any violation by the Company of New York Stock Exchange corporate governance listing standards during 2008. Mr. Liu has executed a Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act and a Certification pursuant to 18 U.S.C. 1350, which are filed as Exhibits 31.1 and 32, respectively, to this Annual Report on Form 10-K.
 
COMPLIANCE WITH SECTION 16(a) OF EXCHANGE ACT
 
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the executive officers and directors of the Company and every person who is directly or indirectly the beneficial owner of more than 10% of any class of security of the Company to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Such persons also are required to furnish our company with copies of all Section 16(a) forms they file. Based solely on our review of copies of such forms received by us, we believe that during the fiscal year 2008, the executive officers and directors of the Company and every person who is directly or indirectly the beneficial owner of more than 10% of any class of security of the Company complied with the filing requirements of Section 16(a) of the Exchange Act, except the following individuals who did not timely file Form 4s: Tony Liu, Yanchun Li, Binsheng Li and Jun Min. Each of these individuals did not timely file one Form 4 disclosing one reportable transaction, which they later timely reported on Form 5s.
 
CODE OF ETHICS
 
We adopted a code of ethics that applies to our officers, employees and directors, including our Chief Executive Officer and Chief Financial Officer, and other persons who perform similar functions. Our Code of Ethics was amended on February 25, 2008 in connection with our listing on the New York Stock Exchange. A copy of our Code of Ethics is available on our website www.bioaobo.com and can be made available in print to any shareholder upon request at no charge by writing to our Chief Financial Officer, c/o American Oriental Bioengineering, Inc. at 330 Madison Avenue, 9th Floor, New York, NY 10017. Our Code of Ethics can be made available in print free of charge to any shareholders who requests it. Our Code of Ethics is intended to be a codification of the business and ethical principles which guide us, and to deter wrongdoing, to promote honest and ethical conduct, to avoid conflicts of interest, and to foster full, fair, accurate, timely and understandable disclosures, compliance with applicable governmental laws, rules and regulations, the prompt internal reporting of violations and accountability for adherence to this Code. Any waiver of the Code of Ethics will be promptly disclosed on our website at www.bioaobo.com and in a Current Report on 8-K.
 
 
The Company’s executive compensation program for the named executive officers (NEOs) is administered by the Compensation Committee of the Board of Directors.
 
Compensation Objectives
 
We believe that the compensation programs for the Company’s NEOs should reflect the Company’s performance and the value created for the Company’s stockholders. In addition, the compensation programs should support the short-term and long-term strategic goals and values of the Company, and should reward individual contributions to the Company’s success. Our compensation plans are consequently designed to link individual rewards with Company’s performance by applying objective, quantitative factors including the Company’s own business performance and general economic factors. We also rely upon subjective, qualitative factors such as technical expertise, leadership and management skills, when structuring executive compensation in a manner consistent with our compensation philosophy.
 
 
49

 
Process for Determining Compensation for Executives
 
The Compensation Committee makes independent decisions about all aspects of NEO compensation, and takes into account (i) recommendations from our CEO with respect to the compensation of NEOs other than himself, and (ii) information that our Human Resources department provides regarding compensation data and benchmarks for comparable positions and companies in different applicable geographical area.
 
The Compensation Committee regularly reviews the design and structure of the Company’s compensation programs to ensure that management’s interests are closely aligned with stockholders’ interests and that the compensation programs are designed to further the Company’s strategic priorities.
 
Elements of Compensation
 
Base Salary. Base salaries for the named executive officers are set forth in their respective employment agreements. Periodically, however, the Compensation Committee considers proposals from the Company’s management to approve increases to the base salaries for named executive officers other than our CEO. When considering whether to approve these adjustments, the Compensation Committee takes into account a number of factors, including:
 
 
·
the Company’s performance;
 
 
·
the individual’s current and historical performance and contribution to the Company;
 
 
·
and the individual’s role and unique skills.
 
We tried to set executives’ base salaries near the median of the range of salaries for executives in similar positions with similar responsibilities at comparable companies, in line with our compensation philosophy. Base salaries are reviewed annually, and may be increased to align salaries with market levels after taking into account the subjective evaluation described previously.
 
Annual Cash Incentive Bonuses. The Company has a cash incentive bonus plans for NEO. The plan is designed to promote executive decision making and achievement that supports the realization of key overall Company financial goals. For the year 2008, the participants in the Company’s cash incentives program consisted of each of the Company’s five named executive officers.
 
In 2008, executives had target bonus opportunities ranging from 0% to 75% of salary earnings, depending on position level and responsibility, with larger bonus opportunities provided to those with greater responsibility. The Compensation Committee establishes the guidelines under which the plan is administered, including financial performance goals and payout schedules. The goals reflect the Company’s performance using performance measures of net income.
 
The plan provides payouts based on different levels of achievement:
 
 
·
Thresholdthe minimum level of performance for which a bonus is paid and set at 90% of the Target level. No bonuses will be earned if the Threshold level of the Company’s performance is not achieved;
 
 
·
Minimum: 70% of bonus is paid for achievement of 90% to 99.9% of financial goals.
 
 
·
Target100% of bonus is paid for achievement of financial goals.
 
 
·
Maximumachievement at a superior level of performance for 300% payout of the Target bonus.
 
For achievement between Target and Maximum, bonus payouts are interpolated to reflect the level of results achieved.
 
Equity Incentive Compensation. We believe that long-term performance is achieved through an ownership culture participated in by our executive officers through the use of stock-based awards. Currently, we do not maintain any incentive compensation plans based on pre-defined performance criteria. The Compensation Committee has the general authority, however, to award equity incentive compensation, i.e. stock options, to our executive officers in such amounts and on such terms as the committee determines in its sole discretion. The Committee does not have a determined formula for determining the number of options available to be granted. The Compensation Committee will review each executive’s individual performance and his or her contribution to our strategic goals periodically. With the exception of stock options automatically granted at the end of each fiscal quarter in accordance with the terms of the employment agreement with our executive officers, our Compensation Committee grants equity incentive compensation at times when we do not have material non-public information to avoid timing issues and the appearance that such awards are made based on any such information.
 
The Compensation Committee is carefully monitoring our executive compensation programs. It is our general objective to provide our NEOs with total annual compensation near the median of the range of salaries for executives in similar positions with similar responsibilities at comparable companies. To accomplish this objective, we anticipate increasing levels of executive compensation over time. The Compensation Committee has reviewed the Compensation Discussion & Analysis (“CD & A”) prepared by management and recommended it for inclusion in this Annual Report on Form 10-K.
 
 
50

 
Summary Compensation Table
 
The following table sets forth all cash compensation paid or to be paid by the Company, as well as certain other compensation paid or accrued, for each of the last three years of our company to each named executive officer.
 
Name and Principal Position
 
Year
 
Salary
($) (1)
   
Bonus
($) (2)
   
Stock
Awards
($)
   
Option
Awards
($) (3)
   
Non-
Equity
Incentive
Plan
Compensation
($)
   
Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings ($)
   
All Other
Compensation
($)
   
Total
($)
 
Tony Liu, CEO and Chairman
 
2008
    200,000       40,267             538,000                         778,267  
    2007     200,000       53,253             1,488,000                         1,741,253  
    2006     150,000                   53,923                         203,923  
                                                                     
Yanchun Li, CFO, COO, Director
 
2008
    160,000       30,201             475,200                           665,401  
    2007     160,000       39,940             1,190,400                         1,390,340  
    2006     90,000                   32,355                         122,355  
                                                                     
Jun Min, VP, Director
 
2008
    120,000       30,201             356,400                         506,601  
    2007     120,000       39,940             892,800                         1,052,740  
    2006     70,000                   15,000                         85,000  
                                                                     
Binsheng Li, Chief Accounting officer, Director
 
2008
    80,000       20,134             293,600                         393,734  
    2007     80,000       26,626             595,200                         701,826  
    2006     57,000                   19,413                         76,413  
                                                                     
Wilfred Chow, SVP of Finance
 
2008
    190,000       40,267             327,000                         557,267  
    2007     160,000       53,253             744,000                         957,253  
    2006     100,000       26,666                                     126,666  
 

(1)
The amounts reported in this column represent base salaries paid to each of the named executive officers for 2008 as provided for in their respective employment agreements.
(2)
The named executive officers did not receive any discretionary bonuses, sign-on bonuses, or other annual bonus payments that are not contingent on the achievement of stipulated performance goals. Cash bonus payments that are contingent on achieving pre-established and communicated goals.
(3)
Option award amounts in this table relate to the accounting expense for options granted in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)), which requires the expensing of equity stock awards.
 
Employee Stock Option Plan
 
In March 2004, our board of directors formally adopted a Stock Option Plan (the “2004 Plan”). Under the 2004 Plan, we were authorized to grant non-qualified options to purchase up to 2,900,000 shares of our common stock to our employees, officers, directors and consultants. The 2004 Plan was administered directly by our Compensation Committee. Subject to the provisions of the 2004 Plan, the Compensation Committee determined who would receive stock options, the number of shares of common stock that may be covered by the option grants, the time and manner of exercise of options and exercise prices, as well as any other pertinent terms of the options. The Company replaced the 2004 Plan with a new Equity Incentive Plan that was adopted by the Board and approved by the Stockholders in 2006 (“2006 Plan”). The 2006 Plan provides a maximum of 5,000,000 shares for future grants but the Company is not intended to grant more than 1,000,000 shares in one calendar year. The Company will not grant any additional awards under the 2004 Plan. All Awards starting from 2007 would be granted under the 2006 Plan. Those individuals with awards outstanding under the 2004 Plan will continue to hold such awards in accordance with the terms of their respective grant agreements.
 
As of December 31, 2008, the Company granted an aggregate of 1,697,763 options under the 2006 Plan. For the year ended December 31, 2008, options to purchase a total of 413,763 shares of common stock were granted to the executive officers. In 2008, the Company granted the following options to the NEO’s pursuant to the 2006 Plan:
 
51

 
2008 Grants of plan-based awards table
 
Name
   
Grant
Date
   
Estimated Future
Payouts Under
Equity Incentive
Plan Awards
(Target) (#)(1)
   
Exercise or
Base Price
of Option
Awards
($ /Sh) (2)
   
Closing
Price on
Grant
Date
($ /Sh)
   
Grant Date
Fair Value
of Option
Awards
($ /Sh)
 
Tony Liu
   
              4/20/08
      111,850       8.35       8.35       538,000  
Yanchun Li
   
              4/20/08
      98,794       8.35       8.35       475,200  
Jun Min
   
              4/20/08
      74,096       8.35       8.35       356,400  
Binsheng Li
   
              4/20/08
      61,040       8.35       8.35       293,600  
Wilfred Chow
   
              4/20/08
      67,983       8.35       8.35       327,000  
 
 

(1)
Represents the number of stock options granted in 2008 under the Company’s 2006 Plan. These options vest and become exercisable ratably in five equal annual installments beginning one year after the grant date.
(2)
Represents the exercise price for the stock options granted, which was the five days average closing stock prices on the NYSE of the Company’s Common Stock preceding the grant date.
 
Employment Agreements
 
In April 20, 2008, we entered into employment agreements with Tony Liu, our Chairman and Chief Executive Officer, Yanchun Li, our Chief Financial Officer and Chief Operations Officer, Jun Min, our Vice President, and Binsheng Li, our Chief Accounting Officer, all of whom are also directors of the Company. We also entered into employment agreement with Wilfred Chow, our Senior Vice President of Finance. Each of the Employment Agreements were subsequently amended to reduce the number of options granted to the numbers included below in the description of each employment agreement.
 
Tony Liu’s employment agreement has a term of one year, effective as of April 20, 2008, and provides for an annual base salary of $200,000, subject to subsequent annual review by the Company’s Compensation Committee. The term of his agreement shall be automatically renewed for another year, unless a written notice is given by either party of an intention not to renew the agreement no later than 90 days prior to the expiration of the term. The agreement also provides for the grant of options to purchase 111,850 shares of common stock with an exercise price of $8.35 per share. The stock options are granted under the Company’s 2006 Equity Incentive Plan and will vest ratably over a five year period, subject to Mr. Liu’s continued employment with the Company on each vesting date. Mr. Liu is also entitled to an annual performance based bonus of up to US$40,000 based upon the Company’s performance. Such amount may be increased if the Company exceeds certain net income targets for the year, or may be decreased if the net income targets are not met. We can terminate Mr. Liu’s employment with cause or without cause pursuant to a decision by our board of directors. In the event Mr. Liu’s employment is terminated without cause, he will be eligible to receive monthly payments at his then applicable monthly base salary for the rest of his term from the date of termination of the employment.
 
Lily Li’s employment agreement has a term of one year, effective as of April 20, 2008, and provides for an annual base salary of $160,000, subject to subsequent annual review by the Company’s Compensation Committee. The term of her agreement shall be automatically renewed for another year, unless a written notice is given by either party of an intention not to renew the agreement no later than 90 days prior to the expiration of the term. The agreement also provides for the grant of options to purchase 98,794 shares of common stock with an exercise price of $8.35 per share. The stock options are granted under the Company’s 2006 Equity Incentive Plan and will vest ratably over a five year period, subject to Ms. Li’s continued employment with the Company on each vesting date. Ms. Li is also entitled to an annual performance based bonus of up to US$30,000 based upon the Company’s performance and such amount may be increased if the Company exceeds certain net income targets for the year, or may be decreased if the net income targets are not met. We can terminate Ms. Li’s employment with cause or without cause pursuant to a decision by our board of directors. In the event Ms. Li’s employment is terminated without cause, she will be eligible to receive monthly payments at her then applicable monthly base salary for the rest of her term from the date of termination of her employment.
 
Jun Min’s employment agreement has a term of one year, effective as of April 20, 2008, and provides for an annual base salary of $120,000, subject to subsequent annual review by our board of directors. The term of his agreement shall be automatically renewed for another year, unless a written notice is given by either party of an intention not to renew the agreement no later than 90 days prior to the expiration of the term. The agreement also provides for the grant of options to purchase 74,096 shares of common stock with an exercise price of $8.35 per share. The stock options are granted under the Company’s 2006 Equity Incentive Plan and will vest ratably over a five year period, subject to Mr. Min’s continued employment with the Company on each vesting date. Mr. Min is also entitled to an annual performance based bonus of up to US$30,000 based upon the Company’s performance and such amount may be increased if the Company exceeds certain net income targets for the year, or may be decreased if the net income targets are not met. We can terminate Mr. Min’s employment with cause or without cause pursuant to a decision by our Chief Executive Officer. In the event Mr. Min’s employment is terminated without cause, he will be eligible to receive monthly payments at his then applicable monthly base salary for the rest of his term from the date of termination of the employment.
 
 
52

 
Binsheng Li’s employment agreement has a term of one year, effective as of April 20, 2008, and provides for an annual base salary of $80,000, subject to subsequent annual review by our board of directors. The term of his agreement shall be automatically renewed for another year, unless a written notice is given by either party of an intention not to renew the agreement no later than 90 days prior to the expiration of the term. The agreement also provides for the grant of options to purchase 61,040 shares of common stock with an exercise price of $8.35 per share. The stock options are granted under the Company’s 2006 Equity Incentive Plan and will vest ratably over a five year period, subject to Mr. Li’s continued employment with the Company on each vesting date. Mr. Li is also entitled to an annual performance based bonus of up to US$20,000 based upon the Company’s performance and such amount may be increased if the Company exceeds certain net income targets for the year, or may be decreased if the net income targets are not met. We can terminate Mr. Li’s employment with cause or without cause pursuant to a decision by our Chief Executive Officer. In the event Mr. Li’s employment is terminated without cause, he will be eligible to receive monthly payments at his then applicable monthly base salary for the rest of his term from the date of termination of the employment.
Wilfred Chow’s employment agreement has a term of one year, effective as of April 20, 2008, and provides for an annual base salary of $190,000, subject to subsequent annual review by our board of directors. The term of his agreement shall be automatically renewed for another year, unless a written notice is given by either party of an intention not to renew the agreement no later than 90 days prior to the expiration of the term. The agreement also provides for the grant of options to purchase 67,983 shares of common stock with an exercise price of $8.35 per share. The stock options are granted under the Company’s 2006 Equity Incentive Plan and will vest ratably over a five year period, subject to Mr. Chow’s continued employment with the Company on each vesting date. Mr. Chow is also entitled to an annual performance based bonus of up to US$40,000 based upon the Company’s performance and such amount may be increased if the Company exceeds certain net income targets for the year, or may be decreased if the net income targets are not met. We can terminate Mr. Chow’s employment with cause or without cause pursuant to a decision by our Chief Executive Officer. In the event Mr. Chow’s employment is terminated without cause, he will be eligible to receive monthly payments at his then applicable monthly base salary for the rest of his term from the date of termination of the employment.
 
Potential Payments Upon Termination or Change in Control
 
Assuming the employment of our named executive officers were to be terminated without cause or for good reason, as of December 31, 2008, the following individuals would have been entitled to payments in the amounts set forth opposite to their name in the below table through April 20, 2009:
 
Cash Payments
     
Tony Liu
  $ 66,667  
Yanchun Li
    53,333  
JunMin
    40,000  
Binsheng Li
    26,667  
Wilfred Chow
    63,333  
 
2008 Outstanding Equity Awards at Year-end
 
   
Option Awards
   
Number of
Securities
Underlying
Unexercised
Options
(#)
   
Number of
Securities
Underlying
Unexercised
Options
(#)
   
Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)
   
Option
Exercise
Price
($)
 
Option
Expiration
Date
Name
 
Exercisable
   
Unexercisable
 
Tony Liu
    40,000       160,000       200,000     10.74    
4/20/2017
Tony Liu
          111,850       111,850     8.35    
4/20/2018
Yanchun Li
    32,000       128,000       160,000     10.74    
4/20/2017
Yanchun Li
          98,794       98,794     8.35    
4/20/2018
Jun Min
    24,000       96,000       120,000     10.74    
4/20/2017
Jun Min
          74,096       74,096     8.35    
4/20/2018
Binsheng Li
    16,000       64,000       80,000     10.74    
4/20/2017
Binsheng Li
          61,040       61,040     8.35    
4/20/2018
Wilfred Chow
    20,000       80,000       100,000     10.74    
4/20/2017
Wilfred Chow
          67,983       67,983     8.35    
4/20/2018
 
 
53

 
Option Exercises and Stock Vested During 2008
 
   
Option Awards
 
   
Number of
Shares Acquired on
Exercise (#)
   
Value Realized on
Exercise ($)
 
Tony Liu
           
Yanchun Li
           
Jun Min
           
Binsheng Li
           
Wilfred Chow
           
 
Compensation of Independent Directors for the 2008
 
On April 9, 2008, Compensation Committee of the Company, after the annual compensation review meeting, approved changes to the annual compensation provided to independent directors. The changes were made upon the ratification by the Board of Directors. The fee changes for annual retainers and the changes for annual equity awards become effective as of April 20, 2008. The changes in compensation for independent directors are as follows:
 
 
increased the annual retainer fee for each independent director from $40,000 to $50,000;
 
 
increased the annual stock award for each independent director from $60,000 to $65,000, and
 
 
additional annual stock award of $5,000 for Compensation Committee Chair and $8,000 for Audit Committee Chair.
 
The annual retainer is paid to the independent directors in monthly installments in arrears. Independent director shall be entitled to receive each year shares of common stock of the Company with an aggregate value range from $65,000 to $73,000 per annum, calculated based on the average closing price per share for the five (5) trading days preceding and including the date of the signing of each such independent director’s service agreement. The equity award to independent directors is awarded at the beginning of each year for service rendered for the preceding year. The Company reimburses its independent directors for reasonable travel expenses to attend Board and Committee meetings.
 
The following table sets forth all compensation paid or to be paid by AOB, as well as certain other compensation paid or accrued, for each of the independent directors for the year 2008.
 
Name
 
Fees Earned or
Paid in Cash
($)
   
Stock Awards
($)
 
Option Awards
($)
   
Non-Equity
Incentive Plan
Compensation
($)
   
Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings ($)
   
All Other
Compensation
($)
   
Total
($)
 
Cosimo J. Patti
  46,667       63,333  (1)                           110,000  
Xianmin Wang
  46,667       63,333  (1)                            110,000  
Eileen Brody
        115,000  (2)                           115,000  
Lawrence S Wizel
  46,667       71,333  (3)                           118,000  
Baiqing Zhang
  46,667       63,333  (1)                           110,000  
 

(1)
7,085 shares of common stock to be issued were outstanding for each of the independent directors as of January 1, 2009.
(2)
13,239 shares of common stock to be issued were outstanding as of January 1, 2009.
(3)
7,977 shares of common stock to be issued were outstanding as of January 1, 2009.
 
 
54

 
 
The following table sets forth certain information regarding beneficial ownership of common stock as of February 28, 2008 by each person known to us to own beneficially more than 5% of our common stock, each of our directors, each of our named executive officers; and all executive officers and directors as a group.
 
Name (1)
 
Title of Class
 
Amount and Nature of
Beneficial Owner (2)
 
Percent of Class
(3)
 
Tony Liu
 
Series A Preferred Stock
    1,000,000  (4)   100.00 %
Tony Liu
 
Common Stock
    14,437,648  (5)   18.45 %
Yanchun Li
 
Common Stock
    795,716  (6)   1.02 %
Jun Min
 
Common Stock
    933,494  (7)   1.19 %
Binsheng Li
 
Common Stock
    308,906  (8)   *  
Cosimo J. Patti
 
Common Stock
    16,213  (9)   *  
Xianmin Wang
 
Common Stock
    34,018  (10)   *  
Eileen Brody
 
Common Stock
    59,998  (11)   *  
Lawrence S. Wizel
 
Common Stock
    18,099  (12)   *  
Baiqing Zhang
 
Common Stock
    11,702  (13)   *  
Total Ownership of Common Stock by All Directors and Officers as a Group
        16,615,795     21.23 %
 


(1)
Unless otherwise indicated, the address for all named executive officers, directors and stockholders is c/o American Oriental Bioengineering, Inc., 25th Floor—Mid Section, Great China International Exchange Square, No. 1 Fuhua 1 Rd, Futian District, Shenzhen, 518034, People’s Republic of China.
(2)
The amount of beneficial ownership includes the number of shares of common stock and/or preferred stock, plus, in the case of each of the executive officer and directors and all officers and directors as a group, all shares issuable upon the exercise of the options held by them, which were exercisable as of December 31, 2008 or within 60 days thereafter. Pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, as amended, and the rules promulgated by the SEC, every person who has or shares the power to vote or to dispose of shares of common stock are deemed to be the “beneficial owner” of all the shares of common stock over which any such sole or shared power exists.
(3)
Based upon 78,249,264 shares outstanding as of February 28, 2009.
(4)
Through his common and preferred stock ownership, currently Mr. Liu has voting power equal to approximately 43.5% of our voting securities.
(5)
Includes 40,000 shares of common stock issuable upon exercise of options.
(6)
Includes 32,000 shares of common stock issuable upon exercise of options.
(7)
Includes 24,000 shares of common stock issuable upon exercise of options.
(8)
Includes 16,000 shares of common stock issuable upon exercise of options.
(9)
Includes 7,085 shares of common stock issuable for service rendered in 2008.
(10)
Includes 7,085 shares of common stock issuable for service rendered in 2008.
(11)
Includes 13,239 shares of common stock issuable for service rendered in 2008.
(12)
Includes 7,977 shares of common stock issuable for service rendered in 2008.
(13)
Includes 7,085 shares of common stock issuable for service rendered in 2008.
 
 
There were no transactions, since January 1, 2008, the beginning of the Company’s last year in which the Company was or is to be a participant and in which any related person had or will have a direct or indirect material interest. It is the Company’s policy that the Company will not enter into any related party transactions unless the Audit Committee or another independent body of the Board of Directors first reviews and approves the transactions.
 
 
55

 
Director Independence
 
A majority of the directors must be independent directors under Section 303A.01 of the listing standard of NYSE. Section 303A.02 of the NYSE listing standards provide that no director can qualify as independent unless the Board affirmatively determines that the director has no material relationship with the listed company. The Board has adopted the following standards in determining whether or not a director has a material relationship with the Company and these standards are:
 
 
No director who is an employee or a former employee of the Company can be independent until three years after termination of such employment.
 
 
No director who is, or in the past three years has been, affiliated with or employed by the Company’s present or former independent auditor can be independent until three years after the end of the affiliation, employment or auditing relationship.
 
 
No director can be independent if he or she is, or in the past three years has been, part of an interlocking directorship in which an executive officer of the Company serves on the compensation committee of another company that employs the director.
 
 
No director can be independent if he or she is receiving, or in the last three years has received, more than $120,000 during any 12-month period in direct compensation from the Company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).
 
 
Directors with immediate family members in the foregoing categories are subject to the same three-year restriction.
 
 
No director can be independent if he or she is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, AOB for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million, or 2% of such other company’s consolidated gross revenues.
 
Based on these independence standards and all of the relevant facts and circumstances, the Board determined that none of the following directors had any material relationship with the Company and, thus, are independent under Section 303A.02 of the listing standards of NYSE: Ms. Brody, and Messrs. Patti, Wang, Wizel and Zhang. In accordance with New York Stock Exchange rules a majority of our Board of Directors is independent.
 
 
Audit Fees
 
The aggregate fees for each of the last two fiscal years for professional services rendered by the principal accountant for our audits of our annual financial statements and interim reviews of our financial statements included in our fillings with Securities and Exchange Commission on Form 10-Ks and 10-Qs services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those years were approximately:
 
 
2008:
$1,581,498
Weinberg & Company, P.A.
       
 
2007:
$1,241,000
Weinberg & Company, P.A.
 
 
56

 
Audit Related Fees
 
The aggregate fees in each of the last two years for the assurance and related services provided by the principal accountant that are not reasonably related to the performance of the audit or review of the Company’s financial statements and are not reported in paragraph (1) were approximately:
 
 
2008:
$0
Weinberg & Company, P.A.
       
 
2007:
$0
Weinberg & Company, P.A.
 
We incurred these fees in connection with registration statements and financing transactions.
 
Tax Fees
 
The aggregate fees in each of the last two years for the professional services rendered by the principal accountant for tax compliance, tax advice and tax planning were approximately:
 
 
2008:
$4,500
Weinberg & Company, P.A.
       
 
2007:
$4,500
Weinberg & Company, P.A.
 
We incurred these fees due to the preparation of our tax returns.
 
All Other Fees
 
The aggregate fees in each of the last two fiscal years for the products and services provided by the principal accountant, other than the services reported in paragraph (1) through (3) were approximately:
 
 
2008:
$   85,811
Weinberg & Company, P.A.
       
 
2007:
$ 162,700
Weinberg & Company, P.A.
 
Audit Committee Approval
 
Our Audit Committee must pre-approve all audit and permissible non-audit services performed by the independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services.
 
All of the services described herein were approved by the Audit Committee pursuant to its pre-approval policies. None of the hours expended on the principal accountant’s engagement to audit the Company’s financial statements for the most recent fiscal year were attributed to work performed by persons other than the principal accountant’s full-time permanent employees.
 
 
57

 
 
 
Exhibit No
 
Description
2.1
 
Purchase Agreement, dated as of September 8, 2004, between American Oriental Bioengineering, Inc., the Government of Heilongjiang Province of China and Heilongjiang Songhuajiang Pharmaceutical Limited (incorporated by reference from the Report on Form 8-K, Commission File No. 000-29785, filed with the Commission on September 14, 2004).
     
2.2
 
Acquisition Agreement, dated September 6, 2007, by and between American Oriental Bioengineering, Inc. and Renson Holdings Limited for the purchase of all of the outstanding capital stock of Changchun Xinan Pharmaceutical Group Company Limited (incorporated by reference from the Report on Form 10-Q, Commission File No. 001-32569, filed with the Commission on November 5, 2007).
     
2.3
 
Acquisition Agreement, dated October 18, 2007, by and between American Oriental Bioengineering, Inc. and Renson Holdings Limited for the purchase of all of the outstanding capital stock of Guangxi Boke Pharmaceutical Limited (incorporated by reference from the Report on Form 10-Q, Commission File No. 001-32569, filed with the Commission on November 5, 2007).
     
3.1(a)
 
Amendment and Restatement of Articles of Incorporation of American Oriental Bioengineering, Inc. (incorporated by reference from the Registration Statement on Form SB-2 Commission File No. 333-124133, filed with the Commission on April 18, 2005).
     
3.1(b)
 
Certificate of Amendment to Amendment and Restatement of Articles of Incorporation of American Oriental Bioengineering, Inc. (incorporated by reference from the Registration Statement on Form S-3 Commission File No. 333-131229, filed with the Commission on January 23, 2006).
     
3.2
 
Amended and Restated Bylaws of American Oriental Bioengineering, Inc. (incorporated by reference from the Report on Form 10-Q, Commission File No. 001-32569, filed with the Commission on August 11, 2008).
     
4.1
 
Form of Warrant (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on December 1, 2005).
     
4.2
 
American Oriental Bioengineering, Inc. 2003 Stock Option Plan (incorporated by reference from the Report on Form 10-KSB, Commission File No. 000-29785, filed with the Commission on April 15, 2004).
     
4.3
 
Indenture, dated as of July 15, 2008, by and between Wells Fargo Bank, National Association, as Trustee and American Oriental Bioengineering, Inc. (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on July 15, 2008).
     
4.4
 
Registration Rights Agreement, dated as of July 15, 2008, by and among the investors specified therein and American Oriental Bioengineering, Inc. (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on July 15, 2008).
     
10.1
 
Stock and Warrant Purchase Agreement, dated as of November 28, 2005, by and among American Oriental Bioengineering, Inc. and the signatory purchasers named therein (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on December 1, 2005).
     
10.2
 
Form of Registration Rights Agreement by and among American Oriental Bioengineering, Inc. and the signatories thereto (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on December 1, 2005).
     
10.3
 
Purchase Agreement, dated September 8, 2004, by and between American Oriental Bioengineering, Inc. and the Government of Heilongjiang Province of China and Heilongjiang Songhuajiang Pharmaceutical Limited (incorporated by reference from the Current Report on Form 8-K, Commission File No. 000-29785, filed with the Commission on September 14, 2004).
     
10.4
 
Purchase Agreement, dated as of August 18, 2002, by and between American Oriental Bioengineering, Inc. and Tony Liu (incorporated by reference from the Schedule 14C Commission File No. 000-29785, filed with the Commission on October 15, 2002).
     
10.5
 
Subscription Agreement, dated as of November 23, 2004, between American Oriental Bioengineering, Inc. and the Subscribers (incorporated by reference from the Registration Statement on Form SB-2, Commission File No. 333-124133, filed with the Commission on April 18, 2005).
 
 
58

 
 10.6(a)  
Consulting Agreement, dated June 28, 2004, by and between American Oriental Bioengineering, Inc. and Bai Chao (incorporated by reference from the Registration Statement on Form S-8, Commission File No. 333-117276, filed with the Commission on July 9, 2004).
     
10.6(b)
 
Consulting Agreement, dated June 28, 2004, by and between American Oriental Bioengineering, Inc. and Kou Yumin (incorporated by reference from the Registration Statement on Form S-8, Commission File No. 333-117276, filed with the Commission on July 9, 2004).
     
10.6(c)
 
Consulting Agreement, dated June 28, 2004, by and between American Oriental Bioengineering, Inc. and Xiangli Men (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-117276, filed with the Commission on July 9, 2004).
     
10.6(d)
 
Consulting Agreement, dated June 28, 2004, by and between American Oriental Bioengineering, Inc. and Linda Welsh (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-117276, filed with the Commission on July 9, 2004).
     
10.6(e)
 
Consulting Agreement, dated June 28, 2004, by and between American Oriental Bioengineering, Inc. and Dr. Jie Zhu (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-117276, filed with the Commission on July 9, 2004).
     
10.6(f)
 
Consulting Agreement, dated June 28, 2004, by and between American Oriental Bioengineering, Inc. and Brian Corday (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-117276, filed with the Commission on July 9, 2004).
     
10.6(g)
 
Consulting Agreement, dated October 1, 2003, by and between American Oriental Bioengineering, Inc. and Haishan Wang (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-109832, filed with the Commission on October 10, 2003).
     
10.6(h)
 
Consulting Agreement, dated October 1, 2003, by and between American Oriental Bioengineering, Inc. and Xiangli Men (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-109832, filed with the Commission on October 10, 2003).
     
10.6(i)
 
Consulting Agreement, dated October 1, 2003, by and between American Oriental Bioengineering, Inc. and Lau Chak Wong (incorporated by reference from the Registration Statement on Form S-8 Commission File No. 333-109832, filed with the Commission on October 10, 2003).
     
10.7(a)
 
Independent Director Agreement, dated July 1, 2006, by and between American Oriental Bioengineering, Inc. and Cosimo J. Patti (incorporated by reference to the Quarterly Report on Form 10-Q, filed with the Commission on August 14, 2006).
     
10.7(b)
 
Independent Director Agreement, dated July 1, 2006, by and between American Oriental Bioengineering, Inc. and Xianmin Wang (incorporated by reference to the Quarterly Report on Form 10-Q, filed with the Commission on August 14, 2006).
     
10.7(c)
 
Independent Director Agreement, dated July 1, 2006, by and between American Oriental Bioengineering, Inc. and Eileen B. Brody (incorporated by reference to the Quarterly Report on Form 10-Q, filed with the Commission on August 14, 2006).
     
10.7(d)
 
Independent Director Agreement, dated August 21, 2006, by and between American Oriental Bioengineering, Inc. and Lawrence S. Wizel, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 13, 2007).
     
10.7(e)
 
Independent Director Agreement, dated December 15, 2006, by and between American Oriental Bioengineering, Inc. and Baiqing Zhang, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 13, 2007).
     
10.8
 
Securities Purchase Agreement, dated as of July 9, 2008, by and among the investors specified therein and American Oriental Bioengineering, Inc. (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on July 15, 2008).
     
10.9
 
Form of Prepaid Forward Share Repurchase Contract Confirmation, dated as of July 15, 2009 (incorporated by reference from the Current Report on Form 8-K, Commission File No. 001-32569, filed with the Commission on July 15, 2008).
     
10.10(a)
 
Employment Agreement, dated April 20, 2008, by and between American Oriental Bioengineering, Inc. and Tony Liu, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 9, 2009).
     
10.10(b)
 
Employment Agreement, dated April 20, 2008, by and between American Oriental Bioengineering, Inc. and Yanchun Li, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 9, 2009).
 
 
59

 
10.10(c)
 
Employment Agreement, dated April 20, 2008, by and between American Oriental Bioengineering, Inc. and Jun Min, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 9, 2009).
     
10.10(d)
 
Employment Agreement, dated April 20, 2008, by and between American Oriental Bioengineering, Inc. and Binsheng Li, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 9, 2009).
     
10.10(e)
 
Employment Agreement, dated April 20, 2008, by and between American Oriental Bioengineering, Inc. and Wilfred Chow, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 9, 2009).
     
14
 
Amended and Restated Code of Ethics of American Oriental Bioengineering, Inc., dated November 9, 2006, (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 13, 2007).
     
21
 
Subsidiaries of the Registrant, (incorporated by reference to the Annual Report on Form 10-K,  (incorporated by reference to the Annual Report on Form 10-K, filed with the Commission on March 9, 2009).
     
31.1
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
     
31.2
 
Certification of Acting Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
     
32
 
Certification of Chief Executive Officer and Acting Chief Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002), filed herewith.
 
 
60

 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
Date: November 16, 2009
By:
/s/ Tony Liu
 
By:
Tony Liu
 
Title:
Chief Executive Officer and Director
 
Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following person on behalf of the Registrant and in the capacities and on the dates indicated.
 
SIGNATURE
 
TITLE
 
DATE
         
/s/ Tony Liu
 
Chief Executive Officer and Chairman of the Board of Directors
 
November 16, 2009
Tony Liu
 
 
 
 
         
         
/s/ Yanchun Li
 
Chief Financial Officer, Chief Operating Officer, Secretary and Director
 
November 16, 2009
Yanchun Li
 
 
 
 
         
         
/s/ Jun Min
 
Vice President and Director
 
November 16, 2009
Jun Min
 
 
 
 
         
         
/s/ Binsheng Li
 
Chief Accounting Officer and Director
 
November 16, 2009
Binsheng Li
 
 
 
 
         
         
/s/ Cosimo J. Patti
 
Independent Director
 
November 16, 2009
Cosimo J. Patti
 
 
 
 
         
         
/s/ Xianmin Wang
 
Independent Director
 
November 16, 2009
Xianmin Wang
 
 
 
 
         
         
/s/ Eileen Brody
 
Independent Director
 
November 16, 2009
Eileen Brody
 
 
 
 
         
         
/s/ Lawrence S. Wizel
 
Independent Director
 
November 16, 2009
Lawrence S. Wizel
 
 
 
 
         
         
/s/ Baiqing Zhang
 
Independent Director
 
November 16, 2009
Baiqing Zhang
 
 
 
 
 
 
61

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
 
CONTENTS
 
     
PAGE
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
     
PAGE
3-4
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2008 AND 2007
     
PAGE
5
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
     
PAGE
6-7
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
     
PAGE
8-9
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
     
PAGE
10-36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
 
 
F-1

 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Shareholders of
American Oriental Bioengineering, Inc.:
 
We have audited the accompanying consolidated balance sheets of American Oriental Bioengineering, Inc. and Subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2008.  We have also audited the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organization of the Treadway Commission.  As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Nuo Hua Investment Company Ltd., which was acquired October 18, 2008, and Guangxi HuiKe Pharmaceutical Research and Development Co., ltd., which was acquired October 20, 2008, and whose combined financial statements constitute 11% and 10% of net and total assets, respectively, and 2% of revenues and (25%) of net income of the consolidated financial statements as of and for the year ended December 31, 2008. Accordingly, our audit did not include the internal control over financial reporting at Nuo Hua Investment Company Ltd. and GuangXi HuiKe Pharmaceutical Research and Development Co., Ltd..  The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting.  Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  An audit of the consolidated financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinions.
 
 A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive an principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with  generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be detected on a timely basis.   Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Oriental Bioengineering, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
 As more fully described in Note 4 to the consolidated financial statements, errors were discovered by management during 2009 relating to the accounting for stock options, deferred taxes with respect to the acquisition of two subsidiaries and deferred taxes with respect to the foreign currency translation gain as of and for the years ended December 31, 2008 and 2007.  Accordingly, the consolidated balance sheets as of December 31, 2008 and 2007 and the related statements of income and comprehensive income for the years ended December 31, 2008 and 2007 and changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2008 have been restated to reflect corrections to previously reported amounts.
 
 
/s/  Weinberg & Company, P.A.
Boca Raton, Florida
 
February 27, 2009, except for Note 4, which is as of November 13, 2009
 
 
F-2

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
ASSETS
 
   
DECEMBER 31,
 
   
2008
   
2007
 
   
(RESTATED)
   
(RESTATED)
 
CURRENT ASSETS
           
Cash and cash equivalents
  $ 70,636,510     $ 166,410,075  
Accounts receivable, net
    36,982,167       16,494,619  
Inventories, net
    13,042,123       12,264,536  
Advances to suppliers and prepaid expenses
    3,593,979       4,309,352  
Notes receivable
    708,076       2,259,616  
Refundable deposit
    6,396,996       3,479,262  
Deferred tax assets
    347,216       15,297  
Other current assets
    744,903       1,654,856  
Total Current Assets
    132,451,970       206,887,613  
                 
LONG-TERM ASSETS
               
Property, plant and equipment, net
    98,154,443       48,496,760  
Land use rights, net
    148,988,870       46,310,240  
Deposit for long-term assets
    6,347,174        
Construction in progress
    25,385,835       755,614  
Other intangible assets, net
    23,690,440       26,972,166  
Goodwill
    33,164,121       27,187,663  
Investments in and advances to equity investments
    54,963,064       242,551  
Deferred tax assets
    1,313,832       1,498,481  
Unamortized financing cost
    4,215,983        
Total Long-Term Assets
    396,223,762       151,463,475  
                 
TOTAL ASSETS
  $ 528,675,732     $ 358,351,088  
 
See accompanying notes to the consolidated financial statements
 
 
F-3

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
   
DECEMBER 31,
 
   
2008
   
2007
 
   
(RESTATED)
   
(RESTATED)
 
CURRENT LIABILITIES
           
             
Accounts payable
  $ 12,287,887     $ 3,436,352  
Notes payables
    3,262,877       72,254  
Other payables and accrued expenses
    19,766,652       7,786,157  
Taxes payable
    420,671       2,843,719  
Short-term bank loans
    7,140,148       6,289,222  
Current portion of long-term bank loans
    58,659       2,374,565  
Other liabilities
    2,253,440       3,548,776  
Deferred tax liabilities
    178,931        
Total Current Liabilities
    45,369,265       26,351,045  
                 
LONG-TERM LIABILITIES
               
                 
Long-term bank loans, net of current portion
    804,521       1,263,483  
Long-term notes payable
    269,908       286,365  
Deferred tax liabilities
    17,635,511       16,671,624  
Convertible notes
    115,000,000        
Total Long-Term Liabilities
    133,709,940       18,221,472  
TOTAL LIABILITIES
    179,079,205       44,572,517  
                 
                 
COMMITMENTS
               
                 
MINORITY INTERESTS
    652,081        
                 
SHAREHOLDERS’ EQUITY
               
                 
Preferred stock, $0.001 par value; 2,000,000 shares authorized; 1,000,000 shares issued and outstanding at December 31, 2008 and December 31, 2007, respectively
    1,000       1,000  
Common stock, $0.001 par value; 150,000,000 shares authorized; 78,249,264 and 77,991,935 shares issued and outstanding at December 31, 2008 and December 31, 2007, respectively
    78,249       77,992  
Common stock to be issued
    376,335       1,611,333  
Prepaid forward repurchase contract
    (29,998,616 )      
Additional paid-in capital
    197,046,688       193,474,941  
Retained earnings (the restricted portion of retained earnings is $19,924,918 and $15,910,685 at December 31, 2008 and December 31, 2007, respectively)
    149,752,604       102,692,989  
Accumulated other comprehensive income
    31,688,186       15,920,316  
Total Shareholders’ Equity
    348,944,446       313,778,571  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
  $ 528,675,732     $ 358,351,088  
 
See accompanying notes to the consolidated financial statements
 
 
F-4

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
 
   
YEAR ENDED DECEMBER 31,
 
   
2008
   
2007
   
2006
 
   
(RESTATED)
   
(RESTATED)
       
                   
REVENUES
  $ 264,643,058     $ 160,482,383     $ 110,182,092  
COST OF GOODS SOLD
    91,031,274       49,364,486       38,318,223  
GROSS PROFIT
    173,611,784       111,117,897       71,863,869  
Selling and marketing
    39,774,330       20,669,303       8,876,829  
Advertising
    34,102,538       22,865,903       15,174,125  
General and administrative
    19,603,947       13,832,110       10,446,740  
Depreciation and amortization
    4,383,215       1,989,425       988,488  
Purchased in-process research and development
    12,255,248              
Total operating expenses
    110,119,278       59,356,741       35,486,182  
EQUITY IN EARNINGS (LOSS) FROM UNCONSOLIDATED ENTITIES
    (1,132,986 )     23,711       (3,811 )
INTEREST (EXPENSE), NET
    (2,571,015 )     617,524       574,172  
OTHER EXPENSE, NET
    (65,843 )     (525,065 )     (329,987 )
MINORITY INTERESTS
    (27,575 )            
INCOME BEFORE INCOME TAXES
    59,695,087       51,877,326       36,618,061  
INCOME TAXES
    12,635,472       8,011,248       7,416,915  
NET INCOME
    47,059,615       43,866,078       29,201,146  
OTHER COMPREHENSIVE INCOME
                       
Foreign currency translation gain, net of tax
    15,767,870       11,623,761       2,867,276  
OTHER COMPREHENSIVE INCOME, NET OF TAX
    15,767,870       11,623,761       2, 867,276  
COMPREHENSIVE INCOME
  $ 62,827,485     $ 55,489,839     $ 32,068,422  
NET INCOME PER COMMON SHARE
                       
BASIC
  $ 0.62     $ 0.63     $ 0.47  
DILUTED
  $ 0.61     $ 0.61     $ 0.46  
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
                       
BASIC
    76,504,035       69,870,775       62,679,996  
DILUTED
    82,254,185       71,364,244       62,913,961  
 
See accompanying notes to the consolidated financial statements
 
F-5

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
 
 
   
Preferred Stock
   
Common Stock
                                     
   
Shares
   
Stated
Value
   
Shares
   
Par
Value
   
Stock To
Be Issued
   
Prepaid
forward
repurchase
contract
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income
   
Total
 
BALANCE AT JANUARY 1, 2006
    1,000,000     $ 1,000       57,109,188     $ 57,109     $ 141,044     $     $ 59,491,393     $ 29,625,765     $ 1,429,279     $ 90,745,590  
                                                                                 
Common stock and warrants issued in private placement, net
                5,526,600       5,527                   26,522,153                   26,527,680  
Common stock to be issued for director services
                            87,598                               87,598  
Common stock to be issued for warrant exercise
                            370,427                               370,427  
Common stock issued for consulting services
                30,000       30                   142,170                   142,200  
Common stock issued for acquisition
                1,200,000       1,200                   5,638,800                   5,640,000  
Stock option granted to executives
                                        138,046                   138,046  
Exercise of warrants
                364,581       364                   1,928,121                   1,928,485  
Finance expenses related to private placement
                                        (1,552,723 )                 (1,552,723 )
Foreign currency translation gain (Restated)
                                                    2,867,276       2,867,276  
Net income
                                              29,201,146             29,201,146  
                                                                                 
BALANCE AT DECEMBER 31, 2006 (Restated)
    1,000,000     $ 1,000       64,230,369     $ 64,230     $ 599,069     $     $ 92,307,960     $ 58,826,911     $ 4,296,555     $ 156,095,725  
                                                                                 
Common stock and warrants issued in secondary offering, net
                9,275,000       9,275                     72,975,083                   72,984,358  
Common stock issued for director services
                48,379       49       (228,642 )           228,593                    
Common stock issued for warrant exercises
                            (370,427 )                             (370,427 )
Common stock to be issued for director services
                            285,333                               285,333  
Common stock to be issued for warrant exercises
                            1,326,000                               1,326,000  
Common stock issued for consulting services
                20,000       20                   259,980                   260,000  
Stock options granted to executives (Restated)
                                        777,795                   777,795  
Exercise of warrants
                4,318,918       4,319                   26,576,191                   26,580,510  
Exercise of option
                99,269       99                   198,439                   198,538  
Contribution from shareholder
                                        150,900                   150,900  
Foreign currency translation gain (Restated)
                                                    11,623,761       11,623,761  
Net income (Restated)
                                              43,866,078             43,866,078  
 
 
F-6

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
CONTINUED
 
   
Preferred Stock
   
Common Stock
                                     
   
Shares
   
Stated
Value
   
Shares
   
Par
Value
   
Stock To
Be Issued
   
Prepaid
forward
repurchase
contract
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income
   
Total
 
                                                                                 
BALANCE AT DECEMBER 31, 2007 (Restated)
    1,000,000     $ 1,000       77,991,935     $ 77,992     $ 1,611,333     $     $ 193,474,941     $ 102,692,989     $ 15,920,316     $ 313,778,571  
                                                                                 
Common stock issued for director services
                26,581       26       (285,333 )           285,307                    
Common stock to be issued for director services
                            376,335                               376,335  
Common stock issued for consulting services
                26,748       27                   259,973                   260,000  
Stock options granted to executives (Restated)
                                        1,700,671                   1,700,671  
Prepaid forward repurchase contract
                                            (29,998,616 )                             (29,998,616 )
Exercise of warrants
                204,000       204       (1,326,000 )           1,325,796                    
Foreign currency translation gain (Restated)
                                                    15,767,870       15,767,870  
Net income (Restated)
                                              47,059,615             47,059,615  
                                                                                 
BALANCE AT DECEMBER 31, 2008 (Restated)
    1,000,000     $ 1,000       78,249,264     $ 78,249     $ 376,335     $ (29,998,616 )   $ 197,046,688     $ 149,752,604     $ 31,688,186     $ 348,944,446  
 
See accompanying notes to the consolidated financial statements
 
 
F-7

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
 
   
YEAR ENDED DECEMBER 31,
 
   
2008
   
2007
   
2006
 
   
(Restated)
   
(Restated)
   
(Restated)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
                 
                   
Net income
  $ 47,059,615     $ 43,866,078     $ 29,201,146  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    9,919,809       4,627,607       2,479,955  
Amortization of deferred insurance cost
    425,466                  
Loss on disposal of property, plant and equipment
    29,890       427       124,015  
Amortization of deferred consulting expenses
    200,500       394,100       728,220  
Purchased in-process research and development
    12,255,248              
Provision (reversal) for doubtful accounts and slow moving inventories
    (200,683 )     (194,363 )     548,753  
Deferred taxes
    1,205,733       153,934       (32,210 )
Common stock to be issued for services
    68,000       285,333       87,598  
Stock based compensation expense
    1,700,671       777,795       138,046  
Equity (income) loss of unconsolidated entity
    1,580,344       (23,711 )     3,811  
Independent director stock compensation
    376,335             —   
Minority interests
    27,575              
Acquisition from Nuohua investment income
    (448,697 )            
                         
Changes in operating assets and liabilities, net of effects of acquisitions:
                       
(Increase) Decrease In:
                       
Accounts receivable
    (16,093,721 )     (4,142,308 )     (2,814,800 )
Notes receivable
    1,551,540       978,545       (2,640,593 )
Inventories
    745,267       433,341       (3,814,766 )
Advances to suppliers and prepaid expenses
    939,249       (2,205,730 )     1,824,318  
Other current assets
    1,185,707       (2,755,757 )     121,761  
Increase (Decrease) In:
                       
Accounts payable
    4,854,620       628,638       (1,310,363 )
Other payables and accrued expenses
    11,927,197       2,856,936       1,471,912  
Taxes payable
    (2,427,886 )     428,879       725,671  
Customer deposits
          (29,738 )     550,461  
Other liabilities
    (2,071,912 )     (715,474 )     1,619,012  
Net cash provided by operating activities
    74,809,867       45,364,532       29,011,947  
                         
CASH FLOWS FROM INVESTING ACTIVITIES:
                       
                         
Purchases of construction in progress
    (24,574,369 )     (2,478,601 )     (2,010,869 )
Purchases of property, plant and equipment
    (48,561,170 )     (1,507,017 )     (2,326,932 )
Purchase of land use rights and other intangible assets
    (99,546,611 )                
Purchases of subsidiary, net of cash acquired
    (53,055,492 )     (65,872,747 )     (22,060,687 )
Refundable deposit
    (2,917,734 )            
Deposit for long-term assets
    (6,347,174 )            
Investments in and advances to equity investments
    (22,379,659 )            
Proceeds from sales of marketable securities
                2,768  
Proceeds from disposal of property, plant and equipment
    8,116       12,663       9,156  
                         
Net cash used in investing activities
    (257,374,093 )     (69,845,702 )     (26,386,564 )
 
 
F-8

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
 
   
YEAR ENDED DECEMBER 31,
 
   
2008
   
2007
   
2006
 
   
(Restated)
   
(Restated)
   
(Restated)
 
CASH FLOWS FROM FINANCING ACTIVITIES
                 
Proceeds from short-term bank loans
    9,480,315       6,740,860       4,732,971  
Repayment of short-term bank loans
    (8,834,575 )     (10,750,915 )     (4,489,926 )
Proceeds from long-term bank loans
                973,960  
Repayment of long-term bank loans
                (653,836 )
Repayment of short-term notes payable
    (57,510 )           (1,664,587 )
Repayments of capital lease and notes payable
          (26,118 )     (13,935 )
Cash proceeds from sales of common stock, net
          72,984,358       24,974,955  
Proceeds from exercise of warrants
          27,536,083       2,298,912  
Proceeds from exercise of option
          198,538        
Contribution from shareholder
          150,900        
Net proceeds from convertible notes
    110,358,550              
Prepaid forward repurchase contract
    (29,998,616 )            
Net cash provided by financing activities
    80,948,164       96,833,706       26,158,514  
                         
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
   
(101,616,062
)     72,352,536       28,782,897  
Effect of exchange rate changes on cash
    5,842,497       6,273,120       1,468,473  
Cash and cash equivalents, beginning of year
    166,410,075       87,784,419       57,532,049  
CASH AND CASH EQUIVALENTS, END OF YEAR 
  $ 70,636,510     $ 166,410,075     $ 87,784,419  
                         
SUPPLEMENTARY CASH FLOW INFORMATION
                       
Interest paid
  $ 778,013     $ 855,715     $ 571,892  
Income taxes paid
  $ 14,909,132     $ 8,381,205     $ 6,573,840  
 
Also see Note 21.
See accompanying notes to the consolidated financial statements

 
F-9

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
NOTE 1 - PRINCIPAL ACTIVITIES AND ORGANIZATION
 
American Oriental Bioengineering Inc. (“AOB”) is a fully integrated pharmaceutical company dedicated to improving health through the development, manufacture, commercialization and distribution of a broad range of pharmaceutical and healthcare products in China. AOB and its subsidiaries are collectively referred to herein as the “Company,” “we,” “us,” “our” and “ourselves,” unless the context indicates otherwise. The following list contains the particulars of its operating subsidiaries and major affiliate companies:
 
Name of Subsidiary
 
Principal activities
 
Acquired
 
Percentage of
ownership
December 31,
2008
Harbin Three Happiness Bioengineering Co., Ltd. (“Three Happiness”)
 
Manufacture and commercialize a board range of branded pharmaceutical and nutraceutical products
 
Jun 2002
 
100%
             
Heilongjiang Songhuajiang Pharmaceutical Co., Ltd. (“HSPL”)
 
Manufacture and commercialize an anti-viral injection powder, a prescription pharmaceutical product
 
Sept 2004
 
100%
             
Guangxi Lingfeng Pharmaceutical Co., Ltd. (“GLP”)
 
Manufacture and commercialize a series of pharmaceutical products that focus on women’s health
 
Apr 2006
 
100%
             
Heilongjiang Qitai Pharmaceutical Co.,Ltd. (“HQPL”)
 
Wholesale of pharmaceutical and nutraceutical products
 
Jul 2006
 
100%
             
Changchun Xinan Pharmaceutical Co.Ltd., (“CCXA”)
 
Manufacture and distribute a broad range of generic pharmaceutical products
 
Sept 2007
 
100%
             
Guangxi Boke Pharmaceutical Co., Ltd. (“Boke”)
 
Manufacture and commercialize pharmaceutical products that alleviate nasal congestion and provide sinus relief
 
Oct 2007
 
100%
             
China Aoxing Pharmaceutical Company, Inc. (”CAXG”)
 
Manufacture and commercialize pain management pharmaceutical products
 
Mar 2008
 
38%
             
Nuo Hua Investment Co., Ltd. (“Nuo Hua”)
 
Wholesale and retail of pharmaceutical and nutraceutical products
 
Oct 2008
 
100%
             
GuangXi HuiKe Research and Development Co., Ltd. (“GHK”)
 
Pharmaceutical research and products development
 
Oct 2008
 
100%
 
Also see Note 12 for acquisitions.
 
NOTE 2 - BASIS OF PRESENTATION
 
Basis of Consolidation
 
The consolidated financial statements include the accounts of American Oriental Bioengineering, Inc. and its wholly owned subsidiaries. All of the Company’s subsidiaries are included in the consolidated financial statements. All significant inter-company accounts and transactions have been eliminated in consolidation.
 
Use of Estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Management makes these estimates using the best information available at the time the estimates are made; however actual results when ultimately realized could differ from those estimates.
 
 
F-10

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Revenue Recognition
 
Revenues represent the invoiced value of goods sold recognized upon the shipment of goods to customers. Revenues are recognized when all of the following criteria are met:
 
 
Persuasive evidence of an arrangement exists,
 
 
Delivery has occurred or services have been rendered,
 
 
The seller’s price to the buyer is fixed or determinable, and
 
 
Collectability is reasonably assured.
 
Selling and Marketing Expenses
 
Selling and marketing expenses include the costs of selling merchandise, including preparing the merchandise for sale, such as picking, packing, warehousing and order charges. All shipping and handling are expensed as incurred and outbound freight is not billed to customers. Shipping and handling expenses included in selling expenses were $3,501,453, $2,796,100 and $1,921,318 for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Advertising Costs
 
The Company expenses advertising costs as incurred or the first time advertising takes place. Point of sale materials are accounted for as inventory and charged to expense as utilized. Advertising costs were $34,102,538, $22,865,903 and $15,174,125 for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Research and Development
 
Research and development costs are expensed as incurred. Engineers and technical staff are involved in the production of our products as well as on-going research, with no segregation of the portion of their salaries relating to research and development from the portion of their salaries relating to production. The total salaries are included in cost of goods sold. Research and development expense for the years ended December 31, 2008, 2007 and 2006 is $1,528,992, $870,219 and $742,705, respectively. The increased investment in research and development demonstrates the Company’s focus on knowledge-based products.
 
Purchased In-Process Research and Development
 
In a business combination, assets acquired to be used in R&D activities are separately identifiable assets and each one is allocated a portion of the cost of the acquired company based on its fair value. The value assigned to acquisition related in-process technology was determined by identifying those acquired specific in-process research and development projects that would be continued and for which (a) technological feasibility had not been established at the acquisition date, (b) there was no alternative future use, and (c) the fair value was not determinable with reasonable reliability. In-process research and development is that did not meet the criteria above were charged to expense as of the date of the combination. The Company recorded a charge for in-process research and development of $12.2 million related to the acquisition of GHK.
 
Retirement Benefits
 
Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to expense as incurred. The retirement benefits expense for 2008, 2007 and 2006 is $457,432, $237,363 and $43,506, respectively and is included in general and administrative expenses.
 
Foreign Currency Translation
 
The accompanying consolidated financial statements are presented in United States dollars. The functional currency of the Company’ subsidiaries operate in PRC is the Chinese Renminbi (RMB). Capital accounts of the consolidated financial statements are translated into United States dollars from RMB at their historical exchange rates when the capital transactions occurred. Assets and liabilities are translated at the exchange rates as of balance sheet date. Income and expenditures are translated at the average exchange rate of the year.
 
   
2008
   
2007
   
2006
 
Year end RMB : US$ exchange rate
    6.8542       7.3141       7.8175  
Average yearly RMB : US$ exchange rate
    7.0842       7.5658       7.9439  
 

F-11

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.
 
Comprehensive Income
 
Comprehensive income is defined to include changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. Comprehensive income includes net income and the foreign currency translation gain.
 
Stock-Based Compensation (Restated)
 
The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R in the first quarter of 2006, at which time the Company began recognizing an expense for unvested share-based compensation that has been issued or will be issued after that date. The Company adopted SFAS No. 123R on a prospective basis.
 
The Company estimates fair value of restricted stock based on the number of shares granted and the quoted price of the Company’s common stock on the date of grant. The fair value of stock options is estimated using the Black-Scholes model. The Company’s expected volatility assumption is based on the historical volatility of Company’s stock. The expected life assumption is primarily based on historical exercise patterns and post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
 
Stock compensation expense recognized is based on awards expected to vest, and there were no estimated forfeitures as the current options outstanding were only issued to founders and senior executives of the Company, which have very low turnover. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates.
 
The fair value of the stock based compensation expense for year ended December 31, 2008, 2007 and 2006 was $1,700,671, $777,795 and $138,046, respectively.
 
Income Taxes
 
The Company accounts for income tax using an asset and liability approach and allows for recognition of deferred tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will expire before either the Company is able to realize their benefits, or that future realization is uncertain. The Company had adopted FIN 48 January 1, 2007. See Note 16
 
Segmental Reporting
 
Prior to the acquisition of Nuo Hua and the consolidation of its business in October 2008, the Company operated in one significant business segment: manufacturing and commercialization of pharmaceutical and nutraceutical products. Since October 2008, the Company has two operating segments based on its major lines of businesses: manufacturing and distribution. Each operating segment derives its revenues from the sale of products or services, respectively and each is the responsibility of a group of senior management of the Company who has knowledge of product and service specific operational risks and opportunities. The Company’s chief operating decision maker reviews and evaluates two sets of financial information deciding how to allocate resources and in assessing performance.
 
For the years ended December 31, 2008, 2007 and 2006 the Company’s manufacturing and distribution revenue, are as follows:
 
   
Year Ended December 31,
 
   
2008
   
2007
   
2006
 
Revenue from pharmaceutical products
  $ 224,904,348     $ 127,823,297     $ 79,367,161  
Revenue from nutraceutical products
    34,266,739       32,659,086       30,814,931  
Total manufacturing revenue
    259,171,087       160,482,383       110,182,092  
Distribution revenue
    5,471,971              
Total sales revenue
  $ 264,643,058     $ 160,482,383     $ 110,182,092  
 
The Company has recorded $5,471,971 distribution revenue from Nuo Hua since its acquisition on October 18, 2008. The Company had no distribution revenue for the years ended December 31, 2007 and 2006.
 

F-12

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
For the years ended December 31, 2008, 2007 and 2006 the Company’s segments are as follows:
 
   
Year Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(Restated)
   
(Restated)
       
Operating income from pharmaceutical products
  $ 49,874,480     $ 37,706,161     $ 24,190,975  
Operating income from nutraceutical products
    13,542,261       14,054,995       12,186,712  
Total manufacturing operating income
    63,416,741       51,761,156       36,377,687  
Distribution operating income
    75,765              
Total operating income
  $ 63,492,506     $ 51,761,156     $ 36,377,687  
 
The Company’s manufacturing operating income from manufacturing segment included the purchased in-process research and development amounting to $12,255,248.
 
At December 31, 2008 and 2007 total assets for the manufacturing and distribution segments are as follows:
 
   
December 31,
 
   
2008
   
2007
 
   
(Restated)
   
(Restated)
 
Manufacturing
  $ 316,767,049     $ 321,042,121  
Distribution
    52,445,008        
Corporate
    159,463,675       37,308,967  
Total assets
  $ 528,675,732     $ 358,351,088  
 
Cash and Cash Equivalents
 
The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. The majority of the Company’s cash as of December 31, 2008 is in our current working capital account, among which, $39,589,261 was the US Dollar equivalent in Renminbi (“RMB”) held in China and $31,047,249 was outside China in US Dollars and HK Dollars. Included in the cash balance as of December 31, 2008 was $2,575,741 restricted cash for the issuance of bank acceptance notes.
 
Accounts Receivable
 
Trade receivables are recognized and carried at the original invoice amount less allowance for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off as incurred. The allowance for doubtful accounts was $226,330 and $302,270 as of December 31, 2008 and 2007, respectively.
 
Inventories
 
Inventories consisting of raw materials, work-in-progress and finished goods are stated at the lower of weighted average cost or market value. Finished goods are comprised of direct materials, direct labor and an appropriate proportion of overhead.
 
Fair Value of Financial Instruments
 
The Company’s financial instruments include cash and cash equivalents, accounts receivable, advances to suppliers, notes receivable, other current assets, taxes payable, accounts payable, accrued expenses, debt, customer deposits and other payables. Management has estimated that the carrying amount approximates their fair value due to their short-term nature or long-term debt interest rates approximate the current market rates.
 
Construction In Progress
 
Construction in progress represents direct costs of construction or acquisition and design fees incurred. Capitalization of these costs ceases and the construction in progress is transferred to property, plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. No depreciation is provided until it is completed and ready for intended use.
 
Land Use Rights
 
According to the law of China, the government owns all the land in China. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. Land use rights are being amortized using the straight-line method over the lease term of 40 to 50 years.
 
 
F-13

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
Property, Plant and Equipment
 
Property, plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of the property, plant and equipment are as follows:
 
Buildings
               40 years
Machinery and equipment
               10 years
Motor vehicles
               5 years
Office equipment
               5 years
Other equipment
               5 years
Leasehold improvements
               10 years
 
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to the statement of income as incurred, whereas significant renewals and betterments are capitalized.
 
Other Intangible Assets
 
Other intangible assets include product licenses, trademarks, patents and proprietary technology. The cost of the product licenses are amortized over their licensed period of 2 to 12 years; the cost of trademarks are amortized over their registered period of 2 to 10 years; the cost of patents are amortized over their protection period of 7 to 20 years and the cost of proprietary technology is amortized over its protection period of 10 years.
 
Goodwill
 
Goodwill and other intangible assets are accounted for in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”. Under SFAS 142, goodwill, including any goodwill included in the carrying value of investments accounted for using the equity method of accounting, and certain other intangible assets deemed to have indefinite useful lives are not amortized. Rather, goodwill and such indefinite-lived intangible assets are assessed for impairment at least annually based on comparisons of their respective fair values to their carrying values. Finite-lived intangible assets are amortized over their respective useful lives and, along with other long-lived assets, are evaluated for impairment periodically whenever events or changes in circumstances indicate that their related carrying amounts may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.
 
In evaluating long-lived assets for recoverability, including finite-lived intangibles and property and equipment, the Company uses its best estimate of future cash flows expected to result from the use of the asset and eventual disposition in accordance with SFAS No.144. To the extent that estimated future, undiscounted cash inflows attributable to the asset, less estimated future, undiscounted cash outflows, are less than the carrying amount, an impairment loss is recognized in an amount equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal, whether through sale or abandonment, are reported at the lower of carrying value or fair value less costs to sell.
 
There were no impairment losses recognized for the periods presented.
 
Economic and Political Risks
 
The Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.
 
The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
 
 
F-14

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
New Accounting Pronouncements
 
In December 2007, the FASB issued SFAS No. 141 (R), Business Combinations. SFAS No. 141 (R) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No. 141 (R) is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. SFAS 141 (R) will significantly affect the accounting for future business combinations and we will determine the accounting as new combinations occur.
 
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. This Statement establishes accounting and reporting standards that require the ownership interests in subsidiaries’ non-parent owners be clearly presented in the equity section of the balance sheet; requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; requires that changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently; requires that when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value and the gain or loss on the deconsolidation of the subsidiary be measured using the fair value of any noncontrolling equity; requires that entities provide disclosures that clearly identify the interests of the parent and the interests of the noncontrolling owners. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after December 15, 2008. We are aware that our accounting for minority interest will change and we are considering those effects now but believe the effects will only be a reclassification of minority interest from mezzanine equity to our shareholders’ equity section in the balance sheet. The Company has not determined the impact, if any, SFAS No. 160 will have on its financial statements.
 
In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133. FAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide disclosures about (a) how and why derivative instruments are used, (b) how derivative instruments and related hedged items are accounted for under FAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and its related interpretations, and (c) how derivative instruments and related hedged items affect the entity’s financial position, financial performance, and cash flows. FAS No. 161 is effective January 1, 2009. We are currently evaluating the impact of adopting this statement.

NOTE 4 – RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS

During the review of its third quarter September 30, 2009 operating results, the Company identified isolated historical accounting errors in: (i) the calculation of stock based compensation, (ii) the recognition of deferred tax liabilities of certain acquired assets and (iii) the provision of deferred tax liabilities on undistributed earnings. The accounting errors have resulted in the misstatement of certain balance sheet and  income statement items and the cumulative net earnings since 2006. The Company has no evidence that the errors resulted from any fraud or intentional misconduct. The Company undertook a review to determine the total amount of the errors and the accounting periods in which the errors occurred. Although the impact of each individual error identified or in aggregate was not material, considering the effects of prior year misstatements when quantifying misstatements in current year financial statements, the Company chose to restate its previously reported financial statements.

The restatement corrects three historical accounting errors identified:

(i)           The Company identified historical accounting errors in stock-based compensation expense for years ended December 31, 2008 and 2007. The errors were identified after the Company re-examined the calculation of expected volatility. The Company used monthly price observations to derive the standard deviation of expected monthly returns but failed to annualize the standard deviation as required by the Black Scholes Model. The Company have understated the expected volatility and thus understated the fair value of option being granted. The impact is the understatement of stock-based compensation expenses being amortized in subsequent periods. The errors also led to an inflated number of options being granted when the grants were approved based on the total estimated fair value instead of the quantity of options.

The Company determined that the aggregate stock-based compensation expense error related to the periods discussed above totaled $1.3 million. To correct these errors, the Company has recorded additional non-cash stock-based compensation expense of $0.8 million in 2008, $0.5 million in 2007. The Company has also cancelled 723,493 options granted in 2008 based the revised options fair value. The cumulative effect of the stock-based compensation adjustments on the consolidated balance sheets for the years ended 2008 and 2007 resulted in an increase in additional paid-in capital offset by a corresponding change in retained earning which resulted in no net effect on shareholders’ equity.


F-15

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
(ii)           The Company identified errors in the recognition of deferred tax liabilities of certain acquired assets and the corresponding goodwill for years ended December 31, 2007 and 2006. The errors were identified when the Company reviewed and re-evaluated applicable tax laws at the time of acquisitions.  The Company acquired 100% of Guangxi Lingfeng Pharmaceutical Co., Ltd. (“GLP”) and Guangxi Boke Pharmaceutical Co., Ltd. (“Boke”) in 2006 and 2007, respectively. The acquisitions were accounted under business combination The purchase prices was allocated to assets and liabilities to the extend of their fair value and the excess was accounted for as goodwill. The Company also provided deferred tax for the  fair value adjustments.

GLP and Boke measured the deferred tax related to fair value adjustments at its preferential tax rate at the acquisition date of 15%.  The Company subsequently determined that according to “Cai Shui [2001] 202”issued in 2001, the preferential tax rate of 15% would expire in year 2010. The Company should have been using the then enacted statutory tax rate of 30%, instead of 15%, in measuring its deferred tax for anticipated reversal post 2010. Furthermore, when new Corporate Income Tax Law was enacted in March 2007, the companies’ deferred tax should have been re-measured at the new enacted statutory corporate tax rate of 25%.  This rate change was not recorded by the companies.

The Company determined that the aggregate errors related to the initial recording of the deferred tax at acquisition totaled approximately $4.0 million which was corrected with the off-setting entry  recorded to Goodwill in May 2006 and in October 2007. The Company also corrected the subsequent change in tax rate by reducing the deferred tax of approximately $1.0 million with the off-setting entry to income tax expenses in 2007. The related translation impact was recorded to Other Comprehensive Income accordingly.  The adjustment affected certain applicable financial  statements as of and for the years ended December 31, 2008, 2007 and 2006.

(iii)           The Company identified errors in the recording of a deferred tax liability on its foreign subsidiaries’ post-2007 undistributed earnings. The errors were identified after the Company re-examined applicable tax laws and accounting standards. As the Company has asserted permanent reinvestment of its foreign subsidiaries’ undistributed earnings, no deferred tax liability should be recorded for any outside basis differences and related translation adjustments.

The Company determined that the aggregate error related to this issue totaled approximately $3.2 million. To correct this error, the Company wrote-off the deferred tax liability with the off-setting entry to Other Comprehensive Income in 2008. The error has no impact to revenue or cash and cash equivalents but impacted the consolidated balance sheet  and changes in shareholders' equity as of and for the year ended December 31, 2008.
 
The Company has restated certain applicable financial statements as of and for the years ended December 31, 2008, 2007 and 2006. The following discloses each line item on the Company’s consolidated financial statements as originally reported in the Company’s annual report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on March 9, 2009, the increase (decrease) in each line item on the Company’s consolidated financial statements as a result of the restatement and each line item on the Company’s consolidated financial statements as restated.
 
 
F-16

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
CONSOLIDATED BALANCE SHEETS
 
                                                       
      As of December 31, 2008       As of December 31, 2007       As of December 31, 2006  
   
Previously
       
 
   
Previously
   
 
   
 
   
Previously
   
 
   
 
 
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
 
                                                       
Deferred tax assets
  $ -     $ -     $ -     $ -     $ 15,297     $ 15,297     $ -     $ -     $ -  
Goodwill
    28,543,226       4,620,895       33,164,121       22,566,768       4,620,895       27,187,663       1,933,100       3,194,295       5,127,395  
Total assets
    524,054,837       4,620,895       528,675,732       353,714,896       4,636,192       358,351,088       185,273,946       3,194,295       188,468,241  
Deferred tax liability - current
    846,026       (667,095 )     178,931       109,733       (109,733 )     -       -       -       -  
Deferred tax liability - non current
    16,083,768       1,551,743       17,635,511       12,621,180       4,050,444       16,671,624       4,580,698       3,275,812       7,856,510  
Total liabilities
    178,194,557       884,648       179,079,205       40,631,806       3,940,711       44,572,517       29,096,704       3,275,812       32,372,516  
Additional paid-in capital
    195,741,544       1,305,144       197,046,688       193,007,987       466,954       193,474,941       92,307,960       -       92,307,960  
Retained earnings
    149,923,681       (171,077 )     149,752,604       102,117,792       575,197       102,692,989       58,826,911       -       58,826,911  
Accumulated other comprehensive income
    29,086,006       2,602,180       31,688,186       16,266,986       (346,670 )     15,920,316       4,378,072       (81,517 )     4,296,555  
Total  equity
    345,860,280       3,736,247       349,596,527       313,083,090       695,481       313,778,571       156,177,242       (81,517     156,095,725  
Total liabilities and shareholders’ equity
  $ 524,054,837     $ 4,620,895     $ 528,675,732     $ 353,714,896     $ 4,636,192     $ 358,351,088     $ 185,273,946     $ 3,194,295     $ 188,468,241  

 
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

      Year Ended December 31, 2008       Year Ended December 31, 2007       Year Ended December 31, 2006  
   
Previously
       
 
   
Previously
       
 
   
Previously
   
 
   
 
 
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
 
                                                       
General and administrative
  $ 18,765,757     $ 838,190     $ 19,603,947     $ 13,365,156     $ 466,954     $ 13,832,110     $ 10,446,740     $ -     $ 10,446,740  
Income from operations
    64,330,696       (838,190 )     63,492,506       52,228,110       (466,954 )     51,761,156       36,377,687       -       36,377,687  
Income before income tax
    60,533,277       (838,190 )     59,695,087       52,344,280       (466,954 )     51,877,326       36,618,061       -       36,618,061  
Income tax
    12,727,388       (91,916 )     12,635,472       9,053,399       (1,042,151 )     8,011,248       7,416,915       -       7,416,915  
Net income
    47,805,889       (746,274 )     47,059,615       43,290,881       575,197       43,866,078       29,201,146       -       29,201,146  
Foreign currency translation gain
    12,819,020       2,948,850       15,767,870       10,105,577       1,518,184       11,623,761       2,506,474       360,802       2,867,276  
Comprehensive income
    60,624,909       2,202,576       62,827,485       53,396,458       2,093,381       55,489,839       31,707,620       360,802       32,068,422  
 Basic EPS
    0.62       -       0.62       0.62       -       0.63       0.47       -       0.47  
 Diluted EPS
  $ 0.61     $ -     $ 0.61     $ 0.61     $ -     $ 0.61     $ 0.46     $ -     $ 0.46  
 
 
F-17

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
CONSOLIDATED STATEMENTS OF CASH FLOWS


      Year Ended December 31, 2008       Year Ended December 31, 2007       Year Ended December 31, 2006  
   
Previously
       
 
   
Previously
       
 
   
Previously
   
 
   
 
 
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
 
                                                       
Net income
  $ 47,805,889     $ (746,274 )   $ 47,059,615     $ 43,290,881     $ 575,197     $ 43,866,078     $ 29,201,146     $ -     $ 29,201,146  
Deferred tax
    4,246,499       (3,040,766 )     1,205,733       930,932       (776,998 )     153,934       49,307       (81,517 )     (32,210 )
Stock option compensation expense
    862,481       838,190       1,700,671       310,841       466,954       777,795       138,046       -       138,046  
Net cash provided by operating activities
    77,758,717       (2,948,850 )     74,809,867       45,099,379       265,153       45,364,532       29,093,464       (81,517 )     29,011,947  
Effect of exchange rate change on cash
    2,893,647       2,948,850       5,842,497       6,538,273       (265,153 )     6,273,120       1,386,956       81,517       1,468,473  
Cash and cash equivalents, end of year
  $ 70,636,510     $ -     $ 70,636,510     $ 166,410,075     $ -     $ 166,410,075     $ 87,784,419     $ -     $ 87,784,419  

 
   
Three Months Ended March 31, 2008
   
Three Months Ended June 30, 2008
   
Three Months Ended September 30, 2008
 
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
 
                                                 
General and administrative
 
$
3,912,683
   
$
202,705
   
$
4,115,388
   
$
5,253,274
   
$
176,351
   
$
5,429,625
   
$
4,467,638
   
$
223,155
   
$
4,690,793
 
Income from operations
   
11,977,020
     
(202,705
)
   
11,774,315
     
18,677,700
     
(176,351
)
   
18,501,349
     
21,846,863
     
(223,155
)
   
21,623,708
 
Income before income tax
   
11,892,077
     
(202,705
)
   
11,689,372
     
17,751,306
     
(176,351
)
   
17,574,955
     
20,845,253
     
(223,155
)
   
20,622,098
 
Income tax
   
2,469,948
     
(22,299
)
   
2,447,649
     
3,891,614
     
(23,009
)
   
3,868,605
     
4,362,334
     
(23,289
)
   
4,339,045
 
Net income
   
9,422,129
     
(180,406
)
   
9,241,723
     
13,859,692
     
(153,342
)
   
13,706,350
     
16,482,919
     
(199,866
)
   
16,283,053
 
Foreign currency translation gain
   
6,934,434
     
2,148,769
     
9,083,203
     
5,154,761
     
859,027
     
6,013,788
     
729,272
     
(82,867
)
   
646,405
 
Comprehensive income
   
16,356,563
     
1,968,363
     
18,324,926
     
19,014,453
     
705,685
     
19,720,138
     
17,212,191
     
(282,733
)
   
16,929,458
 
Basic EPS
   
0.12
     
-
     
0.12
     
0.18
     
-
     
0.18
     
0.22
     
-
     
0.22
 
Diluted EPS
 
$
0.12
   
$
-
   
$
0.12
   
$
0.18
   
$
-
   
$
0.18
   
$
0.21
   
$
-
   
$
0.21
 
 
 
F-18

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
NOTE 5 - EARNINGS PER SHARE
 
Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding, excluding common shares to be delivered under a prepaid forward repurchase contract (3,712,700 shares), during the period. Diluted earnings per share is computed 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 potential common shares had been issued and if the additional common shares were dilutive.
 
The following is a reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per share available to common shareholders.
 
   
Year Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(Restated)
   
(Restated)
       
Numerator:
                 
Net income
  $ 47,059,615     $ 43,866,078     $ 29,201,146  
Interest expense on convertible securities, net of taxes
    2,635,417              
Amortization of  financing costs, net of taxes
    425,466              
Net income, as adjusted
  $ 50,120,498     $ 43,866,078     $ 29,201,146  
                         
Denominator:
                       
Weighted average shares outstanding - Basic
    76,504,035       69,870,775       62,679,996  
Effect of dilutive instruments:
                       
Stock options
          54,295       56,111  
Convertible notes
    5,749,763              
Warrants
    387       1,439,174       177,854  
Weighted average shares outstanding - Diluted
    82,254,185       71,364,244       62,913,961  
 
The calculation of diluted earnings per share for the year December 31, 2008 excludes the potential exercise of options to purchase approximately 193,900 common shares, because their effect would be anti-dilutive.
 
As more fully discussed in Notes 16, the Company had certain convertible notes outstanding during the years presented. The aggregate number of shares of common stock that could be issued in the future to settle these notes is deemed outstanding for the purposes of the calculation of diluted earnings per share. This approach, referred to as the if-converted method, requires that such shares be deemed outstanding regardless of whether the notes are then contractually convertible into the Company’s common stock. For this if-converted calculation, the interest expense (net of tax) attributable to these notes is added back to Net Income, reflecting the assumption that the notes have been converted.
 
NOTE 6 - INVENTORIES
 
Inventories are summarized as follows:
 
   
December 31,
 
   
2008
   
2007
 
Raw materials
  $ 5,569,981     $ 7,509,497  
Work in progress
    2,350,291       2,685,053  
Finished goods
    5,289,280       2,307,413  
      13,209,552       12,501,963  
Less: provision for slow moving inventories
    (167,429 )     (237,427 )
Inventories, net
  $ 13,042,123     $ 12,264,536  
 
NOTE 7 - NOTES RECEIVABLE
 
Notes receivable are bank acceptance notes collected from customers. All the notes do not bear interest and are to be received within one year.
 
 
F-19

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
NOTE 8 - LAND USE RIGHTS
 
Land use rights consist of the following:
 
   
December 31,
 
   
2008
   
2007
 
Cost of land use rights
  $ 152,297,695     $ 48,177,647  
Less: Accumulated amortization
    (3,308,825 )     (1,867,407 )
Land use rights, net
  $ 148,988,870     $ 46,310,240  
 
As of December 31, 2008, the net book value of land use rights pledged as collateral was $21,170,021. See Note 14.
 
Amortization expense for the years ended December 31, 2008, 2007 and 2006 was $1,357,929, $835,562 and $585,243, respectively.
 
Amortization expense for the next five years and thereafter is as follows:
 
2009
  $ 2,947,091  
2010
  $ 2,947,091  
2011
  $ 2,947,091  
2012
  $ 2,947,091  
2013
  $ 2,947,091  
Thereafter
  $ 134,253,415  
Total
  $ 148,988,870  

NOTE 9 - CONSTRUCTION IN PROGRESS
 
Construction in progress as of December 31, 2008 and 2007 was $25,385,835 and $755,614, respectively. During 2008, the Company acquired land use rights located close to its operating subsidiaries and started construction projects for the expansion of manufacturing facilities.
 
 
F-20

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
NOTE 10 - PROPERTY, PLANT AND EQUIPMENT
 
Property, plant and equipment consist of the following:
 
   
December 31,
 
   
2008
   
2007
 
At cost:
           
Buildings
  $ 91,261,579     $ 41,017,380  
Machinery and equipment
    20,665,315       17,949,890  
Motor vehicles
    1,568,059       1,320,091  
Office equipment
    1,543,300       1,137,140  
Other equipment
    482,097       446,326  
Leasehold improvements
    29,150       108,348  
      115,549,500       61,979,175  
Less : Accumulated depreciation
               
Buildings
    (4,732,906 )     (3,305,219 )
Machinery and equipment
    (10,782,285 )     (8,774,745 )
Motor vehicles
    (998,535 )     (694,256 )
Office equipment
    (771,630 )     (510,926 )
Other equipment
    (91,078 )     (118,528 )
Leasehold improvements
    (18,623 )     (78,741 )
      (17,395,057 )     (13,482,415 )
Property, plant and equipment, net
  $ 98,154,443     $ 48,496,760  
 
In 2008, we invested and purchased buildings in Beijing Economic-Technological Development Area for $47,545,960.
 
As of December 31, 2008, the net book value of property, plant and equipment pledged as collateral for bank loans was $19,650,294. See Note 14.
 
Depreciation expense for the years ended December 31, 2008, 2007 and 2006 was $3,396,747, $2,470,923 and $1,796,691, respectively.
 

NOTE 11 - OTHER INTANGIBLE ASSETS
 
Other intangible assets include product licenses, trademarks, patents, proprietary technology and software. The cost of the product licenses are amortized over their estimated useful lives of 10 to 12 years; the cost of trademarks are amortized over their registered useful lives of 4 to 10 years; the cost of patents are amortized over their protection period of 7 to 8 years; the cost of proprietary technology are amortized over their protection period of 10 years and the cost of software are amortized over their estimated useful life of 10 years. Other intangible assets are summarized as follows:
 
   
December 31,
 
   
2008
   
2007
 
At cost:
           
Product licenses
  $ 15,485,939     $ 15,742,705  
Trademarks
    10,558,660       9,894,747  
Patents
    4,796,179       3,264,102  
Proprietary technology
    281,664       263,954  
Software
    73,640        
      31,196,082       29,165,508  
Less: Accumulated amortization
    (7,505,642 )     (2,193,342 )
Other intangible assets, net
  $ 23,690,440     $ 26,972,166  
 
Amortization expense for the years ended December 31, 2008, 2007 and 2006 was $5,165,133, $1,351,288 and $94,413, respectively.
 

F-21

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
Amortization expense for the next five years and thereafter is as follows:
 
2009
  $ 5,168,020  
2010
  $ 5,168,020  
2011
  $ 5,058,598  
2012
  $ 3,516,430  
2013
  $ 1,117,567  
Thereafter
  $ 3,661,805  
Total
  $ 23,690,440  
 
 
NOTE 12 - ACQUISITIONS
 
2008 Acquisitions
 
1. Nuo Hua Acquisition
 
On October 18, 2008, the Company acquired from the Nuo Hua Investment Company Limited (“Nuo Hua”) shareholders all of the issued and outstanding shares of capital stock of Nuo Hua. Nuo Hua owns 55% equity of Yushuntang Pharmaceutical Co., Ltd. in Jilin province, and 30% equity of a wholesale and distribution company in Shandong province, (“Nuo Hua Affiliate”). Nuo Hua, through its subsidiary and affiliated company, distributes pharmaceutical products through sales network covering major urban and rural areas in China.
 
The acquisition cost was $39,500,000 in cash and the amount was paid in full as of December 31, 2008.
 
The accompanying consolidated financial statements include the following allocation of the acquisition cost to the net assets acquired based on their respective fair values.
 
Cash
  $ 5,129  
Long term investment
    38,399,147  
Fixed assets
    26,133  
Total assets purchased
    38,430,409  
Net assets acquired
  $ 38,430,409  
Total consideration paid
    39,500,000  
Goodwill
    1,069,591  
 
If the final valuation, which is expected to be completed within 12 months from the closing of the acquisition, derives different amounts from our estimate, we will adjust these amounts to goodwill.
 
2. GHK Acquisition
 
On October 20, 2008, the Company acquired from the GuangXi HuiKe Pharmaceutical Research and Development Co., Ltd. (“GHK”) shareholders all of the issued and outstanding shares of capital stock of GHK. GHK is engaged in pharmaceutical research and product development leading to SFDA approval and expedient product launches in China. The Company provides research and development through innovative technology, raw material selection, extraction and production of pharmaceutical products.
 
The acquisition cost was $13,605,844 (including $5,844 in transaction cost) in cash and the amount was paid in full as of December 31, 2008. Certain assets acquired from GHK qualify for recognition as intangible assets apart from goodwill, a portion of the purchase price allocation, $12,255,248 million, representing in-process research and development was charged to expense as of the date of the acquisition because it did not meet one of the following criteria (a) technological feasibility had not been established at the acquisition date, (b) there was no alternative future use, and (c) the fair value was not determinable with reasonable reliability.
 
 
F-22

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
The accompanying consolidated financial statements include the following allocation of the acquisition cost to the net assets acquired and liabilities assumed based on their respective fair values.
 
IPR&D
  $ 12,255,248  
Fixed assets
    492,129  
Cash
    38,441  
Other receivables and prepayments
    14,238  
Total assets purchased
    12,800,056  
Other payables and accrued expenses
    33,836  
Total liabilities assumed
    33,836  
Net assets acquired
    12,766,220  
Total consideration paid
    13,605,844  
Goodwill
  $ 839,624  
 
The amount of the purchase price allocated to the acquired in-process research and development represents the estimated value based on risk-adjusted cash flows related to in-process projects that have not yet reached technological feasibility and have no alternative future uses as of the date of the acquisition. The primary basis for determining the technological feasibility of these projects is obtaining regulatory approval to market the underlying products.
 
The value assigned to the acquired IPR&D was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projections used to value the acquired IPR&D was based on estimates of relevant market sizes and growth factors and the nature and expected timing of new product introductions by us and our competitors. The resulting net cash flows from such projects were based on our estimates of cost of sales, operating expenses, and income taxes from such projects.
 
The rate of 10 percent utilized to discount the net cash flows to their present value was based on estimated cost of capital plus a risk premium. Due to the nature of the forecasts and the risks associated with the developmental projects, appropriate risk-adjusted discount rates were used for the IPR&D projects. The discount rates are based on the stage of completion and uncertainties surrounding the successful development of the purchased in-process technology projects.
 
GHK was working on seven R&D project at the time of acquisition. The purchased in-process technology of GHK relates to research and development projects in both pharmaceutical and nutraceutical product families. The Company continues to evaluate certain of these projects for their feasibility and alignment with the Company’s core strategic objectives.
 
If the final valuation, which is expected to be completed within 12 months from the closing of the acquisition, derives different amounts from our estimate, we will adjust these amounts
 
The results of operations for Nuo Hua and GHK are included in the consolidated results of operations commencing October 18, 2008 and October 20, 2008, respectively.
 
The following unaudited pro forma combined condensed statements of income for the year ended December 31, 2008 and 2007 have been prepared as if the acquisitions of Nuo Hua and GHK occurred on January 1, 2008 and 2007. The statements are based on accounting for the business acquisitions under purchase accounting. The pro forma information may not be indicative of the results that actually would have occurred if the acquisition had been in effect from and on the dates indicated or which may be obtained in the future.
 
   
Unaudited
Pro Forma Combined (Restated)
Year Ended December 31,
 
   
2008
   
2007
 
Revenues
  $ 322,081,293     $ 218,444,959  
Income from Operations
    63,521,268       52,127,117  
Net Income
    47,691,945       44,488,627  
Net Income Per Share
               
Basic
  $ 0.62     $ 0.64  
Diluted
  $ 0.62     $ 0.62  
Weighted Average number of shares outstanding
               
Basic
    76,504,035       69,870,775  
Diluted
    82,254,185       71,364,244  
 

F-23

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
 2007 Acquisitions
 
1. Boke Acquisition (Restated)
 
On October 18, 2007, the Company acquired from Guangxi Boke Pharmaceutical Limited (“Boke”) shareholders all of the issued and outstanding shares of capital stock of Boke. Boke is a pharmaceutical company located in the city of Nanning in Guangxi Province of the PRC and it manufactures and distributes plant-based pharmaceutical, nutraceutical and personal care products, marketed primarily in China.
 
The acquisition cost was $36,966,471 (including $466,741 in transaction cost) in cash and the amount was paid in full as of December 31, 2007.
 
The accompanying consolidated financial statements include the following allocation of the acquisition cost to the net assets acquired and liabilities assumed based on their respective fair values.
 
Land use right
  $ 4,772,779  
Other intangible assets
    17,441,676  
Fixed assets
    4,018,429  
Cash
    491,381  
Accounts receivable
    1,116,711  
Inventories
    877,974  
Other receivables and prepayments
    1,779,502  
Total assets purchased
    30,498,452  
Other payables and accrued expenses
    1,124,639  
Deferred taxes payable
    4,757,319  
Total liabilities assumed
    5,881,958  
Net assets acquired
    24,616,494  
Total consideration paid
    36,966,471  
Goodwill
  $ 12,349,977  
 
2. CCXA Acquisition
 
On September 5, 2007, the Company acquired from Changchun Xinan Pharmaceutical Group Company Limited (“CCXA”) shareholders all of the issued and outstanding shares of capital stock of CCXA. CCXA is a pharmaceutical company specializing in manufacturing and distribution of plant-based medicines and is based in Changchun, Jilin Province, China. CCXA’s products cover both the prescription and OTC markets.
 
The acquisition cost was $29,398,358 in cash (including $898,358 of transaction costs) and the amount was paid in full as of December 31, 2007.
 
The accompanying consolidated financial statements include the following allocation of the acquisition cost to the net assets acquired and liabilities assumed based on their respective fair values.
 
Land use right
  $ 6,836,912  
Other intangible assets
    9,688,027  
Fixed assets
    9,051,130  
Cash
    700  
Accounts receivable
    345,657  
Inventories
    690,109  
Other receivables and prepayments
    55,640  
Other current assets
    41,643  
Total assets purchased
    26,709,818  
Other payables and accrued expenses
    195,475  
Long term bank loans
    2,639,039  
Deferred taxes payable
    3,977,058  
Total liabilities assumed
    6,811,572  
Net assets acquired
    19,898,246  
Total consideration paid
    29,398,358  
Goodwill
  $ 9,500,112  
 

F-24

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
The results of operations for Boke and CCXA are included in the consolidated results of operations commencing October 19, 2007 and September 6, 2007, respectively.
 
The following unaudited pro forma combined condensed statements of income for the year ended December 31, 2007 and 2006 have been prepared as if the acquisitions of Boke and CCXA had occurred on January 1, 2007 and 2006. The statements are based on accounting for the business acquisition under purchase accounting. The pro forma information may not be indicative of the results that actually would have occurred if the acquisition had been in effect from and on the dates indicated or which may be obtained in the future.
 
   
Unaudited
Pro Forma Combined (Restated)
Year Ended December 31,
 
   
2007
   
2006
 
Revenues
  $ 175,561,278     $ 130,789,447  
Income from Operations
    53,765,665       40,094,533  
Net Income
    45,296,764       32,040,287  
Net Income Per Share
               
Basic
  $ 0.65     $ 0.51  
Diluted
  $ 0.63     $ 0.51  
Weighted Average number of shares outstanding
               
Basic
    69,870,775       62,679,996  
Diluted
    71,364,244       62,913,961  
 
NOTE 13 - INVESTMENTS AND ADVANCES IN UNCONSOLIDATED ENTITIES
 
Long-term investments and advances include our equity investment in CAXG, Nuo Hua Affiliate and Hezhou Jinji Color Printing Co Ltd. (“Jinji”). CAXG is a China-based pharmaceutical company specializing in research, development, manufacturing and distribution of narcotic and pain-management products in China. Nuo Hua Affiliate maintains a significant presence in pharmaceutical wholesale and retail distribution in China. Jinji is a color printing company focusing on the printing of external packaging materials.
 
The Company owns 38% equity interest in CAXG through an $18 million direct investment of its common stock in April 2008. The cost of investment in excess of our estimate of the underlying equity in net assets at the time of the investments was $1,369,799. The Company owns 30% equity interest in Nuo Hua Affiliate through the acquisition of Nuo Hua in October 2008 and the Company owns 40% equity interest in Jinji through the acquisition of GLP in April 2006. Long-term investments are accounted for using the equity accounting method.
 
The following table summarizes the long-term investments and advances as of December 31, 2008 and 2007:
 
   
December 31, 2008
   
December 31, 2007
 
Cost of investments:
           
CAXG
  $ 18,000,000     $  
Nuo Hua Affiliate
    32,999,023        
Jinji
    86,067       86,067  
Share of equity income (loss):
               
CAXG
    (1,580,344 )      
Nuo Hua Affiliate
    773,415        
Jinji
    42,303       28,672  
Advances:
               
CAXG
    4,520,209        
Jinji
    122,391       127,812  
Long-term investment and advances
  $ 54,963,064     $ 242,551  
 
Included in the advance to CAXG is a RMB30 million, or approximately US$4.3 million, convertible promissory note. The note bears interest at a rate of 8% payable quarterly in arrears and matures in one year. CAXG may elect to make the quarterly loan payments in cash or to convert the payments into shares of its common stock. The Company also has the option to receive payment in shares of CAXG’s common stock if CAXG is either unable to repay the loan in cash or consents to the conversion of its payment obligations into shares of its common stock.
 
 
F-25

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
NOTE 14 - DEBT
 
Short-term bank loans are obtained from local banks with interest rates 7.47% per annum. All the short-term bank loans are repayable within one year and are secured by property, plant and equipment and land use rights owned by the Company. See Notes 7 and 9.
 
Short-term loans are summarized as follows:
 
No.
 
Due Date
 
Interest Rate
Per Annum
   
December 31,
2008
 
1.  
March 14, 2009
    7.470 %   $ 729,480  
2.  
March 28, 2009
    8.541 %     428,934  
3.  
April 16, 2009
    7.470 %     1,458,959  
4.  
May 9, 2009
    7.470 %     729,480  
5.  
May 22, 2009
    7.470 %     729,480  
6.  
August 11, 2009
    7.470 %     875,376  
7.  
August 14, 2009
    7.470 %     1,458,959  
8.  
September 9, 2009
    7.470 %     729,480  
                $ 7,140,148  
                     
No.
 
Due Date
 
Interest Rate
Per Annum
   
December 31,
2007
 
1.  
March 30, 2008
    6.438 %   $ 683,611  
2.  
April 19, 2008
    6.482 %     1,367,222  
3.  
May 8, 2008
    6.570 %     683,611  
4.  
June 3, 2008
    6.570 %     683,611  
5.  
September 20, 2008
    7.290 %     820,333  
6.  
September 5, 2008
    7.020 %     1,367,222  
7.  
October 11, 2008
    7.290 %     683,612  
                $ 6,289,222  
 
Long-term loans include a mortgage loan that bears 4.25% interest per annum and is repayable over 15 years. The principal amount of long-term loans is not payable until the end of the term. Long-term loans are summarized as follows:

   
December 31,
2008
   
December 31,
2007
 
Loan from HSBC, due December 31, 2021, bearing a 4.250% interest rate per annum, secured by the office in CNT Tower.
  $ 863,180     $ 911,807  
Loan from Jilin Bank Changchun Heping Branch, due March 28, 2009, bearing an 8.541% interest rate per annum, secured by building.
          401,963  
Loan from Jilin Bank Changchun Heping Branch, due November 1, 2008, bearing an 8.190% interest rate per annum, secured by building.
          1,367,222  
Loan from Jilin Bank Changchun Heping Branch, due June 18, 2008, bearing a 7.839% interest rate per annum, secured by building.
          957,056  
Total long-term loan
    863,180       3,638,048  
Less: current portion of long-term loan
    58,659       2,374,565  
Long-term portion
  $ 804,521     $ 1,263,483  
 
 
F-26

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
The repayment schedule is as below:
 
No.
   
Due Date
 
Interest Rate
Per Annum
   
December 31,
2008
 
  1.  
December 31, 2009
    4.250 %   $ 58,659  
                       
Current portion of long-term loans
            58,659  
                       
  2.  
December 31, 2010
    4.250 %     60,141  
  3.  
December 31, 2011
    4.250 %     61,663  
  4.  
December 31, 2012
    4.250 %     63,220  
  5.  
December 31, 2013
    4.250 %     64,821  
  6.  
December 31, 2014
    4.250 %     66,460  
     
Thereafter (Due December 31, 2021)
    4.250 %     488,216  
Long-term portion
            804,521  
                  $ 863,180  
 
Current notes payable was $3,262,877 as of December 31, 2008 with an annual interest rate of 1.98% and is repayable on demand. The long-term notes payable was $269,908 as of December 31, 2008 with an annual interest rate of 11.73%. Long-term notes payable will be fully repaid by January 2010.
 
Interest expense for all outstanding debt was $1,244,411, $855,715 and $571,892 for the years ended December 31, 2008, 2007 and 2006 respectively.
 
 
NOTE 15 - DEPOSIT FOR LONG-TERM ASSETS
 
Deposits for long term assets are refundable deposits to acquire land use rights located in the PRC. The long-lived assets to be acquired will be for use in the expansion of some of the Company's current manufacturing facilities and are not intended for resale by the Company. The deposits will be reclassified to the respective accounts under the long lived assets upon the transfers of legal title.
 

NOTE 16 - CONVERTIBLE NOTES AND PREPAID FORWARD CONTRACT
 
On July 15, 2008, the Company closed a private offering and issued $115 million aggregate principal amount of 5.00% Convertible Senior Notes due 2015 (the “Notes”). The Notes were sold to qualified institutional buyers in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. The net proceeds from the sale of the Notes was approximately $110.0 million, after deducting the placement agents’ commission and estimated offering expenses payable by the Company.
 
The following is a brief summary of certain terms of this offering.
 
 
Total offering is $115,000,000 aggregate principal amount of 5.00% Convertible Senior Notes due on July 15, 2015.
 
 
Interest at 5.00% per year, payable semiannually in arrears in cash.
 
 
The notes are convertible, at the option of the holder, at any time prior to the close of business on the second business day preceding the maturity date based on an initial conversion rate of 107.6195 shares per $1,000 principal amount of notes, which represents an initial conversion price of approximately $9.29 per share. (See blow)
 
 
The conversion rate is subject to certain adjustments. In particular, holders who convert their notes in connection with certain fundamental changes may be entitled to a make whole premium in the form of additional shares of our common stock.
 
 
The initial conversion rate may be adjusted on January 15, 2009 if the volume weighted average price (“VWAP”) of our common stock for each of the 30 consecutive trading days ending on January 15, 2009 is less than $8.08 per share, then the conversion rate will be increased as a one-time purchase price adjustment such that the conversion price as adjusted would represent the greater of (1) 115.0% of such arithmetic average of the daily VWAP and (2) $8.08. (See below)
 
 
Holders may require the Company to purchase all or a portion of their notes on July 15, 2013 for cash at a price equal to 100% of the principal amount of the notes to be purchased, plus accrued and unpaid interest, if any, to, but excluding, the purchase date.

F-27

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
 
If a fundamental change occurs, holders will have the right to require the Company to purchase for cash all or any portion of their notes. The fundamental change purchase price will be 100% of the principal amount of the notes to be purchased plus accrued and unpaid interest, if any, to, but excluding, the fundamental change purchase date.
 
 
The notes will be direct unsecured, unsubordinated obligations and will rank equal in right of payment to all of the Company’s existing and future unsecured and unsubordinated indebtedness. The notes will be effectively subordinated to all of the Company’s existing and future secured indebtedness.
 
Convertible notes issuance costs incurred by the Company that were directly attributable to the issuance of convertible notes were deferred and are charged to the consolidated statements of income using the straight-line method over the term of the convertible notes, the results of which approximate the effective interest rate method.
 
The Company has determined that the conversion feature embedded in the Convertible Notes is not required to be bifurcated and accounted for as a derivative pursuant to SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”, since the embedded conversion feature is indexed to the Company’s own stock and would be classified in shareholders’ equity if it was a free-standing instrument. Further, since the conversion price of the Convertible Notes exceeded the market price of the Company’s ordinary shares on the date of issuance of Convertible Notes, no portion of the proceeds from the issuance was accounted for as attributable to the conversion feature.
 
Subsequent to year end, as the VWAP of our common stock for each of the 30 consecutive trading days ending on January 15, 2009 was $6.02 per share and 115% of the VWAP is $6.9183, the initial conversion price of $9.29 per share was adjusted to $8.08 on January 15, 2009.
 
 
NOTE 17 - PREPAID FORWARD SHARES REPURCHASE TRANSACTION
 
In connection with the offering of the Notes, the Company entered into a prepaid forward shares repurchase contract with an affiliate of the lead placement agent (“Merrill affiliate”). Pursuant to the prepaid forward shares repurchase contract, the Company paid approximately $30 million to the Merrill affiliate to fund the purchase of 3.7 million shares of common stock for settlement at or about maturity of the notes. The forward shares purchase transaction was also intended to reduce the potential dilution of our common stock that would result from the conversion of the Convertible Notes into shares of our common stock.
 
The company accounted for the forward shares purchase transaction pursuant to guidance in EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” Accordingly, the $30.0 million cost of the forward stock purchase transaction was recorded as a reduction to additional paid in capital in the Balance Sheet as of December 31, 2008 and will not recognize subsequent changes in fair value.
 
The Company is potentially subject to significant concentration of credit risk with respect to the prepaid forward repurchase contract. The fact that Merrill affiliate has merged with Bank of America reduced the bankruptcy and default risk. We will closely monitor the third depositary and may request early settlement of the contract prior to the maturity of the convertible notes.
 
 
F-28

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
NOTE 18 - SHAREHOLDERS’ EQUITY
 
Preferred Stock
 
The Company had 1,000,000 shares of Series A preferred stock (“Series A”) issued and outstanding. Pursuant to the terms of the Series A, the holder holds aggregate voting power equal to 25% of the combined voting power of our common stock and preferred stock. The percentage of voting power represented by the Series A cannot be diluted by the issuance of additional shares of common stock. The Series A has a liquidation preference equal to its initial issue price that will be paid to the holders of the Series A upon liquidation, dissolution or winding up and prior to any distributions being made to holders of our common stock.
 
Common Stock
 
A. Issuance of Common Stock
 
The Company entered into two consulting agreements during 2008 and issued 26,748 shares of common stock as part of the consulting fees. The Company recorded a total of deferred consulting expenses of $260,000, based on the market value of the common stock at the date of grants, which has been and will be amortized over a one-year service period. Of the total value, $236,000 was amortized through December 31, 2008.
 
B. Stock Options (Restated)
 
As part of the 2008 Compensation review and analysis, on April 9, 2008 the Compensation Committee of the Board of Directors of the Company approved grant of stock options to the Company’s principal executive officer, principal financial officer and certain other executives. Stock options for 413,763 shares of common stock at a per share exercise price of $8.35 were granted under the Company’s 2006 Equity Incentive Plan (the “2006 Plan”) and will vest ratably over a five year period. The Company valued the stock options at $1,990,200. The value of the options was estimated using the Black Scholes Model with an expected volatility of 56.9%, expected life of 6.5 years and risk-free interest rate of 2.93 %.
 
On May 23, 2008, the Company granted stock options for 100,000 shares of common stock at a per share exercise price of $11.20 to a Company’s senior member of the management under the 2006 Plan and will vest ratably over a five year period. The Company valued the stock options at $665,000. The value of the options was estimated using the Black Scholes Model with an expected volatility of 58.4%, expected life of 6.5 years and risk-free interest rate of 3.45 %. This granted stock options was subsequently cancelled in November 2008.
 
On November 25, 2008, the Company granted stock options for 314,500 shares of common stock at a per share exercise price of $4.95 to a group of senior management under the 2006 Plan and will vest ratably over a five year period. The Company valued the stock options at $1,050,430. The value of the options was estimated using the Black Scholes Model with an expected volatility of 64.8%, expected life of 6.5 years and risk-free interest rate of 2.41 %.
 
The Company recorded total stock option compensation expenses $1,700,671 for 2008. Of the total value of the old and new option grants, $8,257,234 has not yet been recognized and will be amortized over the requisite service periods.
 
The following table summarizes the stock option activities of the Company:
 
   
Activity
   
Weighted Average
Exercise Price
 
Outstanding as of January 1, 2008
    974,500     $ 10.03  
Granted
    828,263     $ 7.40  
Exercised
        $  
Cancelled
    (105,000 )   $ 11.07  
Outstanding as of December 31, 2008 (Restated)
    1,697,763     $ 8.68  
 
 The following table summarizes information about stock options outstanding as of December 31, 2008:

     
Options Outstanding
   
Options Exercisable
 
Range of Exercise Prices
   
Number of
Shares
(Restated)
   
Weighted
Average
Exercise
Price
   
Weighted Average
Remaining
Contractual Life
(in years)
   
Number of
Shares
   
Weighted
Average
Exercise
Price
 
  $8.54-$10.74       969,500     $ 10.04       4       193,900     $ 10.04  
  $4.95-$8.35       728,263     $ 6.88       5              
          1,697,763                       193,900          
 

F-29

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
All the options granted have exercise price equal to the market price and they have no intrinsic value at the grant date. The weighted average fair value per share of the 1,697,763 options issued under the Plan is $8.68 per share. As of December 31, 2008, the Company has 193,900 outstanding vested stock options, with an exercise price above the average market price, are excluded from the Company’s diluted computation.
 
C. Common Stock to be Issued
 
For the year ended December 31, 2008, the Company recorded general and administrative expenses $376,332, respectively, for the stock compensation in connection with the services rendered by the Company’s independent directors. A total of 42,472 shares of common stock are issuable to independent directors as of December 31, 2008.
 
NOTE 19 - COMMITMENTS
 
As of December 31, 2008, the Company entered into unconditional capital commitments for the purchase of land use rights and construction of manufacturing facilities in the PRC for $7,666,839 within one year and $11,734,773 after one year.
 
As of December 31, 2008, the Company has no material unconditional purchase commitments for raw materials, packing materials and advertising.
 
NOTE 20 - INCOME TAX
 
(a) Corporation Income Tax (“CIT”)
 
The Company has not recorded a provision for U.S. federal income tax for the year ended December 31, 2008 due to the net operating loss carry forward in the United States. Net operating loss carry forward in the United States as of December 31, 2008 was $11,737,378 and it will expire in year 2024 and will end in 2027.
 
On March 16, 2007, the National People’s Congress of China approved the new Corporate Income Tax Law of the People’s Republic of China (the “New CIT Law”), which is effective from January 1, 2008.
 
Prior to January 1, 2008, CIT rate applicable to our subsidiaries in the PRC range from 0% to 33%. GLP is entitled to a full exemption from CIT in year 2006 and 2007. Three Happiness, on the other hand, enjoys a favorable tax rate of 15% as it is located in a special economic development zone and is considered a high technology company by the Chinese government. Boke also enjoys a favorable tax rate of 15% as it is located in a Western province of China. HSPL, HQPL and CCXA do not qualify for any tax concession and have a 33% tax rate.
 
After January 1, 2008, under the new CIT Law, the corporate income tax rate applicable to most companies is 25% instead of the old tax rate of 33%. The new CIT Law also provides certain tax concession to selective eligible companies based on their location and enterprise status. GLP and Boke enjoy a favorable tax rate of 15% as they are located in the Western province of China. Three Happiness, HSPL and CCXA were granted high-tech enterprise status and also enjoy a favorable tax rate of 15% from 2008 to 2010. High-tech enterprise status is renewable and re-application should be done prior to the tax preferences expire. HQPL, Nuo Hua and GHK do not qualify for any tax concession and they have a 25% tax rate.
 
 
F-30

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
 
 
The Company’s tax expense differs from the “expected” tax expense as follows:
 
   
Year Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(Restated)
   
(Restated)
       
Computed “expected” expense
  $ 15,133,319     $ 11,339,030     $ 8,165,851  
Favorable tax rate effect
    (8,424,544 )     (2,270,741 )     (769,608 )
Permanent differences
    5,926,697       (1,057,041 )     20,672  
Income tax expense
  $ 12,635,472     $ 8,011,248     $ 7,416,915  
 
The provisions for income taxes for the year ended December 31, 2008, 2007 and 2006 are summarized as follows:
 
   
Year Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(Restated)
   
(Restated)
       
Current
  $ 12,469,511     $ 8,840,665     $ 7,908,963  
Deferred
    165,961       (829,417 )     (492,048 )
Total
  $ 12,635,472     $ 8,011,248     $ 7,416,915  
 
The tax effects of temporary differences that give rise to the Company’s net deferred tax liabilities as of December 31, 2008 and 2007 are as follows:
 
   
Year Ended December 31,
 
   
2008
   
2007
 
   
(Restated)
   
(Restated)
 
Deferred tax assets
           
Current
           
Bad debts
  $ 9,651     $  
Other costs
    337,565       15,297  
Total current deferred tax assets
    347,216       15,297  
Non-current
               
Bad debts
    216,094       211,551  
Amortization
    164,313       98,239  
Other costs
    858,636       801,840  
Stock provision
    32,083       289,511  
Depreciation
    42,706       97,340  
Total non-current deferred tax assets
    1,313,832       1,498,481  
Total deferred tax assets
  $ 1,661,048     $ 1,513,778  
Deferred tax liabilities
               
Current
               
Over accrual of welfare
  $ (114,842 )   $  
Boke acquisition
    -        
CCXA acquisition -
    45,704          
Other
    (109,793 )        
Total current deferred tax liabilities
    (178,931 )     -  
Non-current
               
Over accrual of welfare
    (18,283 )     (146,154 )
Amortization
    (291,034 )     (208,519 )
Depreciation
    (130,803 )     (51,976 )
Government grant
    (1,019,319 )     (887,633 )
GLP acquisition
    (6,362,131 )     (6,049,506 )
CCXA acquisition
    (4,429,843 )     (4,340,893 )
Boke acquisition
    (5,334,072 )     (4,889,663 )
Other
    (50,026 )     (97,280 )
Total non-current deferred tax liabilities
    (17,635,511 )     (16,671,624 )
Total deferred tax liabilities
    (17,814,442 )     (16,671,624 )
Net deferred tax liabilities
  $
(16,153,394
)   $
(15,157,846
)
 
F-31

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
 
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 ,” (“FIN 48”), on January 1, 2007. The Company did not have any material unrecognized tax benefits and there was no effect on its financial condition or results of operations as a result of implementing FIN 48.
 
(b) Value Added Tax (“VAT”)
 
Enterprises or individuals who sell commodities, engage in repair and maintenance or import or export goods in the PRC are subject to a value added tax in accordance with the PRC laws. The value added tax standard rate is 17% of the gross sales price. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on the sales of the finished products.
 
The VAT payable balance of $6,262,715 and $3,722,621 at December 31, 2008 and 2007 respectively are included in Other Payables and Accrued Expenses in the accompanying consolidated balance sheets.
 
(c) Tax Holiday (Restated)
 
Income before income tax expense was $59.7 million, $51.9 million and $36.6 million for 2008, 2007 and 2006 and was mainly attributed to subsidiaries with operations in China. Income tax related to China income for 2008 was $12.7 million. The combined unaudited pro forma effects of the income tax expense exemption and reduction available to us are as follows:
 
   
Year Ended December 31,
(Unaudited)
 
   
2008
   
2007
 
   
(Restated)
   
(Restated)
 
Tax holiday effect
  $ 8,424,544     $ 2,270,741  
Basic net income per share exclude tax holiday effect
  $ 0.51     $ 0.60  
 
NOTE 21 - NON-CASH TRANSACTIONS
 
2008
 
Issued 26,748 shares of common stock valued at $260,000 for consulting services.
 
2007
 
Assets of $2,126,189 were transferred from construction in progress to property, plant and equipment at completion.
 
Issued 20,000 shares of common stock valued at $260,000 for investment banking services.
 
2006
 
Assets of $3,836,919 were transferred from construction in progress to property, plant and equipment at completion.
 
Issued 30,000 shares of common stock valued at $142,200 for consulting services.
 
Issued 1,200,000 shares of common stock valued at $5,640,000 as part of the consideration for the acquisition of GLP.
 
 
F-32

 
AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
NOTE 22 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
 
The tables below list the quarterly financial information.
 
   
Quarters Ended (Restated)
 
   
31-Mar
   
30-Jun
   
30-Sep
   
31-Dec
 
Year Ended December 31, 2008
                       
REVENUES
  $ 38,768,598     $ 59,010,005     $ 70,593,949     $ 96,270,506  
GROSS PROFIT
  $ 26,290,962     $ 40,081,558     $ 47,191,542     $ 60,047,722  
NET INCOME
  $ 9,241,723     $ 13,706,350     $ 16,283,053     $ 7,828,489  
Basic net income per common share
  $ 0.12     $ 0.18     $ 0.22     $ 0.10  
Diluted net income per common share
  $ 0.12     $ 0.18     $ 0.21     $ 0.10  
                                 
Year Ended December 31, 2007
                               
REVENUES
  $ 25,722,577     $ 33,913,234     $ 43,514,049     $ 57,332,523  
GROSS PROFIT
  $ 17,704,317     $ 23,702,749     $ 30,680,797     $ 39,030,034  
NET INCOME
  $ 6,446,267     $ 9,573,210     $ 11,742,459     $ 16,104,142  
Basic net income per common share
  $ 0.10     $ 0.15     $ 0.16     $ 0.22  
Diluted net income per common share
  $ 0.10     $ 0.15     $ 0.16     $ 0.20  
 
The Company has restated certain applicable financial statements as of and for the years ended December 31, 2008 and 2007 and 2006 as discussed in Note 4.
 
The unaudited interim financial statements for the year ended 2006 are not disclosed separately as the overall impact of the restatement to the periods is not significant.  The following tables present the effects of the restatement on the Company’s unaudited interim financial statements for 2008 and 2007.

 
F-33

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006
CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
As of March 31, 2007
   
As of June 30, 2007
   
As of September 30, 2007
 
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
 
Deferred tax assets
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
Goodwill
    1,933,100       3,194,295       5,127,395       1,933,100       3,194,295       5,127,395       11,467,270       3,194,295       14,661,565  
Total assets
    192,369,644       3,194,295       195,563,939       207,584,474       3,194,295       210,778,769       317,455,282       3,194,295       320,649,577  
Deferred tax liability - current
    -       -       -       -       -       -       -       -       -  
Deferred tax liability - non current
    4,614,058       3,308,228       7,922,286       4,656,198       3,358,601       8,014,799       8,882,761       3,406,494       12,289,255  
Total liabilities
    25,879,369       3,308,228       29,187,597       28,370,763       3,358,601       31,729,364       47,240,993       3,406,494       50,647,487  
Additional paid-in capital
    95,265,594       -       95,265,594       97,082,545       98,340       97,180,885       172,963,877       264,249       173,228,126  
Retained earnings
    65,273,178       -       65,273,178       74,944,728       (98,340 )     74,846,388       86,853,096       (264,249 )     86,588,847  
Accumulated other comprehensive income
    5,588,219       (113,933 )     5,474,286       7,779,627       (164,306 )     7,615,321       10,124,324       (212,199 )     9,912,125  
Total equity
    166,490,275       (113,933 )     166,376,342       179,213,711       (164,306 )     179,049,405       270,214,289       (212,199 )     270,002,090  
Total liabilities and shareholders’ equity
  $ 192,369,644     $ 3,194,295     $ 195,563,939     $ 207,584,474     $ 3,194,295     $ 210,778,769     $ 317,455,282     $ 3,194,295     $ 320,649,577  
 
 
   
As of March 31, 2008
   
As of June 30, 2008
   
As of September 30, 2008
 
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
 
                                                       
Deferred tax assets
  $ -     $ 27,882     $ 27,882     $ -     $ 40,703     $ 40,703     $ 529,813     $ -     $ 529,813  
Goodwill
    22,566,767       4,620,895       27,187,662       22,566,768       4,620,895       27,187,663       22,566,768       4,620,895       27,187,663  
Total assets
    370,700,557       4,648,777       375,349,334       396,552,073       4,661,598       401,213,671       503,907,426       4,620,895       508,528,321  
Deferred tax liability - current
    232,572       (232,572 )     -       358,529       (358,529 )     -       680,544       (533,606 )     146,938  
Deferred tax liability - non current
    15,480,108       2,014,800       17,494,908       16,713,352       1,271,543       17,984,895       16,390,430       1,465,495       17,85 5,925  
Total liabilities
    40,845,533       1,782,228       42,627,761       47,281,615       913,014       48,194,629       167,078,962       931,889       168,010,851  
Additional paid-in capital
    194,754,211       669,659       195,423,870       195,253,082       846,010       196,099,092       195,500,513       1,069,165       196,569,678  
Retained earnings
    111,539,921       394,791       111,934,712       125,399,613       241,449       125,641,062       141,882,532       41,583       141,924,115  
Accumulated other comprehensive income
    23,201,420       1,802,099       25,003,519       28,356,182       2,661,125       31,017,307       29,085,454       2,578,258       31,663,712  
Total equity
    329,855,024       2,866,549       332,721,573       349,270,458       3,748,584       353,019,042       336,828,464       3,689,006       340,517,470  
Total liabilities and shareholders’ equity
  $ 370,700,557     $ 4,648,777     $ 375,349,334     $ 396,552,073     $ 4,661,598     $ 401,213,671     $ 503,907,426     $ 4,620,895     $ 508,528,321  
 
F-34

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

   
Three Months Ended March 31, 2007
   
Three Months Ended June 30, 2007
   
Three Mmonths Ended September 30, 2007
 
    Previously
Reported
    Adjustments      As Restated     Previously
Reported
      Adjustments      As Restated    
Previously
Reported
     
Adjustments
     
As Restated
 
 
 
 
         
 
   
 
         
 
   
 
   
 
 
General and administrative
  $ 2,933,066     $ -     $ 2,933,066     $ 2,557,805     $ 98,340     $ 2,656,145     $ 3,742,363     $ 165,909     $ 3,908,272  
Income from operations
    7,912,527       -       7,912,527       11,504,308       (98,340 )     11,405,968       13,981,641       (165,909 )     13,815,732  
Income before income tax
    7,969,370       -       7,969,370       11,608,196       (95,161 )     11,513,035       14,329,815       (201,167 )     14,128,648  
Income tax
    1,523,103       -       1,523,103       1,939,825       -       1,939,825       2,386,189       -       2,386,189  
Net income
    6,446,267       -       6,446,267       9,668,371       (95,161 )     9,573,210       11,943,626       (201,167 )     11,742,459  
Foreign currency translation gain
    810,798       366,933       1,177,731       1,468,243       672,792       2,141,035       1,992,992       303,812       2,296,804  
Comprehensive income
    7,257,065       366,933       7,623,998       11,136,614       577,631       11,714,245       13,936,618       102,645       14,039,263  
Basic EPS
    0.10       -       0.10       0.15       -       0.15       0.16       -       0.16  
Diluted EPS
  $ 0.10     $ -     $ 0.10     $ 0.15     $ -     $ 0.15       0.16     $ -     $ 0.16  
 
   
Three Months Ended March 31, 2008
   
Three Mmonths Ended June 30, 2008
   
Three Months Ended September 30, 2008
 
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
   
Previously
Reported
   
Adjustments
   
As Restated
 
                                                 
General and administrative
 
$
3,912,683
   
$
202,705
   
$
4,115,388
   
$
5,253,274
   
$
176,351
   
$
5,429,625
   
$
4,467,638
   
$
223,155
   
$
4,690,793
 
Income from operations
   
11,977,020
     
(202,705
)
   
11,774,315
     
18,677,700
     
(176,351
)
   
18,501,349
     
21,846,863
     
(223,155
)
   
21,623,708
 
Income before income tax
   
11,892,077
     
(202,705
)
   
11,689,372
     
17,751,306
     
(176,351
)
   
17,574,955
     
20,845,253
     
(223,155
)
   
20,622,098
 
Income tax
   
2,469,948
     
(22,299
)
   
2,447,649
     
3,891,614
     
(23,009
)
   
3,868,605
     
4,362,334
     
(23,289
)
   
4,339,045
 
Net income
   
9,422,129
     
(180,406
)
   
9,241,723
     
13,859,692
     
(153,342
)
   
13,706,350
     
16,482,919
     
(199,866
)
   
16,283,053
 
Foreign currency translation gain
   
6,934,434
     
2,148,769
     
9,083,203
     
5,154,761
     
859,027
     
6,013,788
     
729,272
     
(82,867
)
   
646,405
 
Comprehensive income
   
16,356,563
     
1,968,363
     
18,324,926
     
19,014,453
     
705,685
     
19,720,138
     
17,212,191
     
(282,733
)
   
16,929,458
 
Basic EPS
   
0.12
     
-
     
0.12
     
0.18
     
-
     
0.18
     
0.22
     
-
     
0.22
 
Diluted EPS
 
$
0.12
   
$
-
   
$
0.12
   
$
0.18
   
$
-
   
$
0.18
   
$
0.21
   
$
-
   
$
0.21
 
 
F-35

AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
AS OF DECEMBER 31, 2008, 2007 AND 2006

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
      Three Months Ended March 31, 2007       Six Months Ended June 30, 2007       Nine Months Ended September 30, 2007  
   
Previously
           
Previously
       
 
   
Previously
   
 
   
 
 
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
 
                                                       
Net income
  $ 6,446,267     $ -     $ 6,446,267     $ 16,117,817     $ (95,161 )   $ 16,019,477     $ 28,026,185     $ (296,328 )   $ 27,761,936  
Deferred tax
    172,782       32,416       205,198       192,865       82,789       275,654       245,609       130,682       376,291  
Stock option compensation expense
            -       -       65,340       98,340       163,680       175,720       264,249       439,969  
Net cash provided by operating activities
    4,534,617       32,416       4,567,033       16,007,441       85,968       16,093,409       26,989,761       98,603       27,088,364  
Effect of exchange rate change on cash
    677,937       (32,416 )     645,521       2,039,014       (85,968 )     1,953,046       3,394,762       (98,603 )     3,296,159  
Cash and cash equivalents, end of period
  $ 93,442,093     $ -     $ 93,442,093     $ 108,449,801     $ -     $ 108,449,801     $ 170,624,005     $ -     $ 170,624,005  
 
 
 
      Three Months Ended March 31, 2008       Six Months Ended June 30, 2008       Nine Months Ended September 30, 2008  
   
Previously
   
 
       
Previously
       
 
   
Previously
       
 
 
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
   
Reported
   
Adjustments
   
As Restated
 
                                                       
Net income
  $ 9,422,129     $ (180,406 )   $ 9,241,723     $ 23,281,820     $ (333,748 )   $ 22,948,073     $ 39,764,740     $ (533,614 )   $ 39,231,126  
Deferred tax
    2,744,506       (2,171,068 )     573,438       714,100       206,135       920,235       705,006       192,883       897,889  
Stock option compensation expense
    135,121       202,705       337,826       374,019       379,056       753,075       621,450       602,211       1,223,661  
Net cash provided by operating activities
    10,676,287       (2,148,769 )     8,527,518       28,374,749       251,443       28,626,192       48,569,653       261,480       48,831,133  
Effect of exchange rate change on cash
    2,314,557       2,148,769       4,463,326       8,187,869       (251,443 )     7,936,426       8,644,302       (261,480 )     8,382,822  
Cash and cash equivalents, end of period
  $ 159,031,217     $ -     $ 159,031,217     $ 144,473,275     $ -     $ 144,473,275     $ 219,727,043     $ -     $ 219,727,043  
 
 
 
F-36

 
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Exhibit 31.1
 

CERTIFICATION

I, Tony Liu, the Chairman and Chief Executive Officer (Principal Executive Officer) of American Oriental Bioengineering, Inc. certify that:

1.
I have reviewed this Quarterly Report on Form 10-K/A of American Oriental Bioengineering, Inc. for the period ended December 31, 2008;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 
a.
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b.
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c.
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d.
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 
a.
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 16, 2009

/s/ Tony Liu                                     
Tony Liu
Chairman and Chief Executive Officer
(Principal Executive Officer)
EX-31.2 4 aob_10ka-ex3102.htm CERTIFICATION aob_10ka-ex3102.htm
Exhibit 31.2
CERTIFICATION

I, Yanchun Li, Chief Financial Officer (Principal Financial Officer) of American Oriental Bioengineering, Inc. certify that:

1.
I have reviewed this Quarterly Report on Form 10-K/A of American Oriental Bioengineering, Inc. for the period ended December 31, 2008;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a.
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b.
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c.
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d.
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
 
a.
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: November 16, 2009

/s/ Yanchun Li                              
Yanchun Li
Chief Financial Officer
(Principal Financial Officer)
EX-32.1 5 aob_10ka-ex3201.htm CERTIFICATION aob_10ka-ex3201.htm
Exhibit 32.1
Certification
Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906 of
the Sarbanes - Oxley Act of 2002

In connection with the Quarterly Report on Form 10-K/A of American Oriental Bioengineering, Inc. (the “Company”) for the quarter ended December 31, 2008, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned officer of the Company certifies, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the undersigned officers’ knowledge:

 
i.
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 
ii.
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Tony Liu                                          
Tony Liu
Chairman and Chief Executive Officer
(Principal Executive Officer)
November 16, 2009
 
 
 
 
/s/ Yanchun Li                                     
Yanchun Li
Chief Financial Officer
(Principal Financial Officer)
November 16, 2009


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