10KSB 1 v108922_10ksb.htm Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-KSB


For the fiscal year ended December 31, 2007

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _____________________ to ______________

Commission file number 001-33537

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.

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

Delaware
20-2903562
(State or other jurisdiction
of incorporation)
(IRS Employer Identification No.)

No. 2, Jing You Road, Kunming National Economy & Technology Developing District, People’s Republic of China 650217
(Address of principal executive offices) (Zip Code)

 
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $0.0001 par value
 
American Stock Exchange

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
None.
 
Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. o

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 No o
 
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S−B contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10−KSB or any amendment to this Form 10−KSB.     o

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

Issuer’s revenues for its most recent fiscal year: $19,973,918

The aggregate market value of the registrant's issued and outstanding shares of common stock held by non-affiliates of the registrant as of June 29, 2007 (based on the price at which the registrant’s common stock was last sold on such date) was approximately $23,141,920.

The number of shares outstanding of the issuer’s common equity as of March 24, 2008 was 19,679,400.

DOCUMENTS INCORPORATED BY REFERENCE: The information required by Part III of Form 10-KSB is incorporated by reference from the registrant's definitive proxy statement on Schedule 14A that will be filed no later than the end of the 120-day period following the registrant's fiscal year end, or, if the registrant's definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-KSB/A, not later than the end of the 120-day period.

Transitional Small Business Disclosure Format: Yes No x
 

 
TABLE OF CONTENTS

       
PAGE
PART I
 
 
 
 
         
ITEM 1.
 
DESCRIPTION OF BUSINESS
 
1
ITEM 2.
 
DESCRIPTION OF PROPERTY
 
 26
ITEM 3.
 
LEGAL PROCEEDINGS
 
 26
ITEM 4.
 
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
26
 
 
 
   
PART II
 
 
   
 
 
 
 
 
ITEM 5.
 
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
 
 26
ITEM 6.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 
 29
ITEM 7.
 
FINANCIAL STATEMENTS
 
 37
ITEM 8.
 
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
 38
ITEM 8A.
 
CONTROLS AND PROCEDURES
 
38
ITEM 8B.
 
OTHER INFORMATION
 
 39
         
PART III
 
 
   
 
 
 
   
ITEM 9.
 
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSON AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
 
 39
ITEM 10.
 
EXECUTIVE COMPENSATION
 
 40
ITEM 11.
 
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
 40
ITEM 12.
 
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
 40
ITEM 13.
 
EXHIBITS
 
 40
ITEM 14.
 
PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
 41
 
 
 
 
 
SIGNATURES
 
 
 
 42
 


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

 
·
our reliance on one product for over 90% of our revenues;
 
·
our reliance on one supplier for Sanchi, a scarce plant that is the primary ingredient in almost all of our products;
 
·
our ability to develop and market new products;
 
·
our increasing employee advances;
 
·
our ability to establish and maintain a strong brand;
 
·
continued maintenance of certificates, permits and licenses required to conduct business in China;
 
·
protection of our intellectual property rights;
 
·
market acceptance of our products;
 
·
changes in the laws of the PRC that affect our operations;
 
·
any recurrence of severe acute respiratory syndrome or avian flu;
 
·
our ability to obtain all necessary government certifications and/or licenses to conduct our business;
 
·
development of a public trading market for our securities;
 
·
cost of complying with current and future governmental regulations and the impact of any changes in the regulations on our operations; and
 
·
other factors referenced in this report, including, without limitation, under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis or Plan of Operation,” and “Description of Business.”
 
The risks included above are not exhaustive. Other sections of this report may include additional factors that could adversely impact our business and operating results. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and we cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward looking statements.
 
You should not rely upon forward-looking statements as predictions of future events. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assume responsibility for the accuracy and completeness of the forward-looking statements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.
 
You should read this report, and the documents that we reference in this report and have filed as exhibits to this report with the Securities and Exchange Commission, completely and with the understanding that our actual future results, levels of activity, performance and achievements may materially differ from what we expect. We qualify all of our forward-looking statements by these cautionary statements.
 

 
PART I

ITEM 1.
DESCRIPTION OF BUSINESS

Unless the context otherwise requires, the terms “Shenghuo,” the “Company,” “we,” “us,” or “our” as used throughout this report refer to China Shenghuo Pharmaceutical Holdings, Inc., our 93.75%-owned subsidiary Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. (“Shenghuo China”) and the three foreign owned subsidiaries of Shenghuo China that are organized under the laws of the People's Republic of China (“PRC” or “China”).
 
Overview

We are primarily engaged in the research, development, manufacture, and marketing of pharmaceutical, nutritional supplement and cosmetic products. Almost all of our products are derived from the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow plant that only grows in a few geographic locations on Earth, one of which is Yunnan Province in southwest China, where we are located. The main root of Panax notoginseng are cylindrical shaped and are most commonly one to six centimeters long and one to four centimeters in diameter. Panax notoginseng saponins (PNS), the active ingredients in Panax notoginseng, are extracted from the plant using high-tech equipment and in accord with Good Manufacturing Practice (GMP) standards. Our main product, Xuesaitong Soft Capsules, accounted for approximately 90% of our sales for the year ended December 31, 2007.

Since our establishment, we have focused primarily on the development of products to serve three major markets—cardiovascular and cerebrovascular disease, peptic ulcer disease and health products. Our goal has been to focus on the development of pharmaceutical products and over the counters products based on traditional Chinese medicines designed to address these areas.

Recent Events

Initial Public Offering

In June 2007, we completed an initial public offering consisting of 460,000 shares of our common stock. Our sale of common stock, which was sold indirectly by us to the public at a price of $3.50 per share for aggregate gross proceeds of $1,610,000. We received an aggregate of $1,094,381 of net proceeds from the offering, after deduction of underwriter’s fees and other expenses of $515,619. Upon the closing of the offering, we sold to the underwriter warrants to purchase up to 40,000 shares of our common stock. The warrants are exercisable at a per share price of $4.20 and expire if unexercised after five years.

Market Focus

Since our establishment, we have focused primarily on the development of products to serve three major markets—cardiovascular and cerebrovascular disease, peptic ulcer disease and health products. Our goal has been to focus on the development of pharmaceutical products and over the counters products based on traditional Chinese medicines designed to address these areas.

 
·
Cardiovascular and Cerebrovascular Disease. Hyperlipemia, which is high circulating blood levels of fats such as cholesterol and triglycerides, has ranked high on the list of modern health diseases. The primary effect of hyperlipemia is the development of cardiovascular and cerebrovascular diseases, including heart attacks and strokes.

 
·
Peptic Ulcer Disease. A peptic ulcer is an erosion of the lining of the stomach or the upper part of the small intestine. The causative factors may include excess stomach acid, excess pepsin, Helicobacter Pylori infection, poor health and eating habits, and psychological stress. There is no radical cure for peptic ulcers, which may eventually lead to gastric hemorrhage, gastric perforation and even cancer. People of all ages can be affected by peptic ulcers, but they are most prevalent in persons between the ages of 45 and 55, with incidences in men being slightly higher than in women.

 
·
Health and Food Products. The health products industry, which consists of non-prescription traditional Chinese medicines and supplements, has grown as a result of quality improvements in products and the introduction of new products to the market in China. Over the past two decades, there has been a growth of health product sales in Chinese urban areas. The Chinese Ministry of Health has approved several uses for health products and a substantial number of the products on the market are designed to aid in immunoregulation, blood fat regulation and fatigue resistance. In addition, China's market for cosmetics product is one of the largest in Asia and within the top ten in the world.

1

 
Products

We are primarily engaged in the research, development, manufacture, and marketing of pharmaceutical, nutritional supplement and cosmetic products. Almost all of our products are derived from the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow plant that only grows in a few geographic locations on Earth, one of which is Yunnan Province in southwest China, where we are located. The main root of Panax notoginseng are cylindrical shaped and are most commonly one to six centimeters long and one to four centimeters in diameter. Panax notoginseng saponins (PNS), the active ingredients in Panax notoginseng, are extracted from the plant using high-tech equipment and in accord with Good Manufacturing Practice (GMP) standards.

Pharmaceutical Products

Our pharmaceutical products are marketed under the Lixuwang brand name. The following is a list of our approved pharmaceutical products and their intended uses.

Product Name
 
Intended Use
     
Xuesaitong Soft Capsules
 
 
Designed to invigorate the circulation of blood and improve microcirculation. Used for the treatment of symptoms of cardiovascular and cerebrovascular disease, such as angina pectoris, strangulation, squeezing and crushing of chest, acute and chronic peripheral vascular-metabolic disorders, brain occlusion, occlusion of retina central vein, acute and chronic cerebral vascular-metabolic disorders caused by arteriosclerosis. This product accounted for approximately 90% of our sales for the year ended December 31, 2007. The reason for the change in percentage is that the sale of our OTC drugs has been increasing.
     
Qiye Shen’an Tablets
 
 
Designed to help relieve headache, insomnia, and palpitation. Designed to invigorate the circulation of blood, improve microcirculation and improve liver functionality.
     
Banlangen Tablets
 
Designed for the treatment of parotitis, pharyngitis, mastitis, swollen and sore throat due to cold and influenza.
     
Bergenini Tablets
 
Designed to help relieve cough and phlegm due to bronchial ailments.
     
Huangtengsu Tablets (film tablets)
 
 
Designed to treat the symptoms of dysentery, enteritis, respiratory tract infections, uncomplicated urethral, surgery infections and conjunctivitis.
     
Danshen Tablets
 
Designed to regulate blood circulation and treat the symptoms of blood stasis. Designed to treat the symptoms of coronary arteriosclerosis, angina pectoris and hyperlipemia.
     
Triperygium hypoglaucum Hutch Tablet
 
An immunosuppressant. Designed to treat the symptoms of rheumatoid arthritis.
     
Huangtengsu Soft Capsules
 
Designed to treat symptoms of dysentery, enteritis, respiratory tract infections, surgery infections and conjunctivitis
 
2


We have the following additional drugs that are currently in late-stage clinical trials for prescription use:

 
·
Wei Dingkang Soft Capsules are a type of traditional Chinese medicine designed to treat peptic ulcer disease by inhibiting bacterial growth, relieving stomach muscle spasms, and reducing inflammation of the intestinal lining. The product is designed to be effective for upset stomach, vomiting, pain and degradation of the stomach lining. The product has been approved by the State Food and Drug Administration (SFDA) for clinical testing. Phase two clinical trials were completed in July 2007, and phase three clinical trials have commenced. We anticipate obtaining production approval by the end of 2008. We are also applying to the Yunnan Provincial Development and Reform Committee and Yunnan Agriculture Bureau to begin a pilot cultivation project to produce approximately 72 tons per year of daemonorops margaritae palms, which is the primary ingredient used to produce Wei Dingkang Soft capsules, on approximately 3.35 square kilometers of land.

 
·
Dencichine Hemostat is designed to be a non-toxic product that addresses a range of anti-hemorrhagic applications, such as stopping bleeding without causing clotting. We anticipate receiving governmental approval for the production and marketing of the product in 2011. Assuming required governmental approvals are obtained in a timely fashion, we anticipate that production and marketing of the product will begin no sooner than 2012. Dencichine Hemostat is a drug requiring extensive technology testing by the national SFDA, and neurotoxicity testing is required to be done, which may take a significant amount of time. In addition, clinical testing and audit processes are out of our control, so we must allow for additional time.

 
·
Other drugs that we have in the clinical testing application process are Levofloxacin Hydrochloride Soft Capsules, which is designed for antibiotic applications, and Brufen Soft Capsules, which are intended to treat fever and headache caused by influenza, colds and acute pharyngitis. Levofloxacin Hydrochloride Soft Capsules have received State Food and Drug Administration (SFDA) approval for clinical testing, which has entered the first phase. We expect to receive approval no later than 2009. Brufen Soft Capsules are being tested and appraised for production approval, which we hope to receive shortly.
 
Health and Food Products

We offer a wide array of over the counter supplements as well as vitamin capsules and pills. The following are some of our non-prescription products and their intended uses. We have received government approval and currently market each of the supplements listed below.


Product Name
 
Intended Use
     
Banlangen Grains
 
Health product designed to treat swollen and sore throat due to cold and influenza.
     
Gegenqinlian Tablets
 
Health product designed to reduce stomach discomfort and treat diarrhea.
     
Huangtensu Soft Capsules
 
 
Designed to treat symptoms of dysentery, enteritis, respiratory tract infections, surgery infections and conjunctivitis.
     
Luotongding Tablets
 
Health product designed to reduce visceral pain, headache, and cramping.
     
Paracetamol Caffeine and Aspirin Powders
 
Health product designed to treat headaches, migraines and fevers caused by influenza and cold.
     
Siji Sanhuang Tablets
 
 
Health product designed to relieve inflammation and alleviate fever, commonly in connection with pharyngitis.
     
Sulfadiazine Silver Ointment
 
Health product designed to assist in the prevention of infections related to burns.
     
Tianqi Tongjing Capsules
 
Health product designed to treat dysmenorrhea and emmeniopathy caused by colds.
 
3

 
Product Name
 
Intended Use
     
Vitamin AD Soft Capsules
 
Health product designed to treat deficiencies of vitamin A and D.
     
Vitamin C Tablets
 
Health product designed to treat deficiencies of vitamin C.
     
Vitamin B6 Tablets
 
Health product designed to treat deficiencies of vitamin B6.
     
Vitamin E Soft Capsules
 
Health product designed to treat deficiencies of Vitamin E.
     
Yinhuang Capsules
 
Health product designed to relieve inflammation and sore of throat.
     
Lycopene Soft Capsules
 
Food product designed to treat side effects of and act as a general deterrent to certain carcinogens.
     
Oil of Purple Perilla Soft Capsules
 
Food product designed to treat effects of chough, asthma and astriction.
     
Rhizoma Aspidii and Chinese Wampi leaf Grains
 
Designed to treat effects of fever, aversion, headache, cough with excessive sputum.
     
Soya Lecithin Soft Capsules
 
Food product designed to treat effects of high blood fat, hypertension and other diseases of cardiovascular and cerebrovascular systems.
     
Spirulina Soft Capsules
 
Food product designed to normalize stomach and intestinal functions.

We also intend to introduce and market the following non-prescription supplements, as indicated in the table below. Our anticipated timelines for introduction and marketing of our new drugs depend, in large part, on government approval. Our anticipated timelines, as set forth below, are based on our experience in the approval process and our communications with the SFDA. However, there is no assurance that such approvals will be obtained, at all, or the anticipated timelines will be met. The SFDA issues certificates of medicine production approval that include the names, specifications, approval numbers and other information about the approved medicines. According to the law of the Drug Administration of the People’s Republic of China, a drug-manufacturing factory must acquire both the certificate of medicine production permit and medicine production approval, before the drug-manufacturing factory has the necessary qualifications to manufacture, market and sell the medicine.

In the table below, the “Application Submission Date” column indicates the month and year in which we submitted a formal registration application to the State Food and Drug Supervision Administration for the product we have researched and developed. That is, we have applied to the State Food and Drug Supervision Administration for a production approval, which we must obtain prior to the production and sale of each of our products. The “Anticipated Approval Date” indicates the date by which we anticipate obtaining the production approval for manufacturing the products from the State Food and Drug Supervision Administration. There is no assurance that we will obtain approval by the Anticipated Approval Date, if at all. We would only be allowed to engage in production and marketing of a product after obtaining the corresponding production approval.
 
4


Anticipated
Product Name
 
Intended Use
 
Application
Submission
Date
 
Anticipated
Approval
Date
             
Fructus Ligustri Lucidi and Radix Astragali Soft Capsules
 
 
Designed to treat symptoms of weakness due to prolonged illness, radiation and chemical therapy. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
September 2005
 
 
June 2008
 
Ginseng and Pilose Antler Soft Capsules
 
 
Designed to treat effects of weakness due to deficiency of the kidney and heart, palpitation, and soreness and weakness of waist and knees. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
March 2006
 
September 2008
Li Xu Wang Shu Tong Soft Capsules
 
 
Designed to reduce blood viscosity and improve blood circulation. This product is currently being tested and appraised for production approval, which we hope to receive shortly.
 
 
February 2006
 
March 2008
Long Xue Jie Soft Capsules
 
 
Designed to promote blood circulation and treat effects of blood stasis, relieve pain, induce astringent and help promote tissue regeneration. Designed to treat effects of trauma with blood-stasis syndrome and painful swelling, amenorrhea due to blood stasis, and wound bleeding. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
September 2005
 
 
June 2008
 
Qi Ju Di Huang Soft Capsules
 
 
Designed to treat effects of weakness of the kidney and liver, dizziness, drumming in the ears, dryness in eyes, photophobia, and blurred vision. This product is currently being tested and appraised for production approval which we hope to will receive shortly.
 
 
January 2006
 
 
October 2008
 
Radix Polygoni Multiflori Capsules
 
 
Designed to treat effects of weakness of the kidney and liver, fatigue, and dizziness due to blood deficiencies. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
January 2006
 
 
December 2008
 
Tranquilization Soft Capsules
 
 
Designed to enrich the blood and treat effects of dizziness, palpitation, insomnia, and poor memory. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
March 2006
 
 
December 2008
 
Xue Zhi Kang Soft Capsules
 
 
Designed to promote blood circulation and to treat effects of blood stasis, weakness of the spleen and poor digestion. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
August 2005
 
May 2008
Yan Lu Ru Kang Soft Capsules
 
 
Designed to treat the symptoms of galactophore hyperplasia diseases, hysteromyoma and functionality uterus bleeding. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
April 2005
 
December 2008
 
5

 
Anticipated
Product Name
 
Intended Use
 
Application
Submission
Date
 
Anticipated
Approval
Date
             
Zhi Bi Tuo Soft Capsules
 
 
Designed to affect the spleen to improve digestion, reduce phlegm, invigorate the blood and improve blood stasis. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
December 2005
 
 
September 2008
 
Zhu Zi Gan Tai Soft Capsules
 
 
Designed to be used for distending pain in the chest caused by deficiency of the spleen, fatigue, and hepatitis B virus. This product is currently being tested and appraised for production approval which we hope to receive shortly.
 
 
January 2006
 
October 2008
Cosmetic Products

We also offer an expanding line of cosmetic products including lotions, creams and other cosmetic items. We have conducted extensive research and have specifically formulated our cosmetic products to meet the cosmetic and skincare needs of our female consumers. Our “12Ways™ Chinese Traditional Medicine Beauty Salon Series” is a line of over 100 cosmetic products that includes facial masks and creams, skin and eye creams, and shampoos. Our line of products has acquired production approval to be sold only in China. Each of our cosmetic skincare products contains natural ingredients including herbal anti-irritants and anti-oxidants, as well as Sanchi. Our comprehensive line of skincare includes a mixture of basic products (e.g., creams and gels), treatment products (e.g., firming treatments), specialty helpers (e.g., masks), and beauty supplements. The use of supplements is an important element of skincare, nurturing the skin’s health using vital nutrients. Our cosmetic line combines the strength of several skincare methods to achieve healthy skin and beauty.

In September 2007, we expanded the geographic region in which our 12Ways products were sold from our native Yunnan province to a number of cities and provinces outside our local region. We have opened a number of retail specialty counters to offer our cosmetic products at pharmacies throughout Eastern China, and we hope to eventually expand our retail presence across China. As of December 31, 2007, we have opened approximately 106 retail specialty counters in Beijing, Shanghai, Hangzhou, Dongwan, Shengzhen, and Shaoguang. We believe that this retail counter strategy will allow us to increase our brand recognition, as well as sell and market our newest cosmetics products developed using our experience in traditional Chinese medicine.

Our line of cosmetic products includes the following food products and health supplements.

Product Name
 
Intended Use
     
Jasmine Tea
 
 
Food product designed to help and promote healthy skin affected by acne.
 
Rose Tea
 
 
Food product designed to help promote healthy skin and complexion
 
SHEN HUO Beauty Soft Capsules
 
 
Health supplement designed to help with balancing water in the body.
 
SHEN HUO Brighten Soft Capsules
 
 
Health supplement designed to help promote healthy skin affected by spotting.
 
SHEN HUO Immaculacy Soft Capsules
 
 
Health supplement designed to help promote healthy skin affected by acne.
 
12ways Yunnan Bamboo Anti-Acne Cream
 
 
Health supplement designed to help promote healthy skin affected by acne.
 
12 Ways DanShen Spot Fade Light Cream
 
Health supplement designed to lighten skin discoloration.
 
6

 
Product Name
 
Intended Use
     
12 Ways Eye care series
 
 
Health supplement designed to improve the appearance of fine lines, dark circle, and puffiness
 
12 Ways Sunscreen Series
 
 
Sunscreen product
 
12 Ways Panax Notoginseng Moisturizer Series
 
 
Moisturizer
 
12 Ways Snow Poria Whiten Series
 
Health supplement designed to lighten and whiten the skin

Growth Strategies

We believe that our business has opportunities for growth through the following growth strategies:
 
 
·
New Product Development. We have traditionally focused on research and development of products serving the cardiovascular and cerebrovascular disease, peptic ulcer disease and health products markets. We intend to devote additional resources to research and development and to continue to evaluate and develop additional product candidates to expand our pipeline where we perceive an unmet need and commercial potential, and to improve existing products to enhance their efficacy.

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

 
·
Domestic Growth (China). We intend to grow our internal marketing and sales function and increase our relationships with other national distributors to expand the distribution and presence of our non-prescription brands and cosmetics. In expanding market share of our products, we intend to take advantage of our large manufacturing scale and reasonable cost control mechanisms, and our strong sales network. In addition, our goal is to establish our products as a preferred choice for prescription drugs in major hospitals. We believe that establishing a strong reputation with major hospitals may open the market for smaller, community and rural hospitals because patients from large hospitals also receive services from smaller hospitals. We also anticipate that the inclusion of Xuesaitong Soft Capsules on China’s National Medical Insurance List in 2005 should result in increased growth for that product over the next several years. We hope to add other prescription drugs, some of which are now in late-stage clinical trial, into this channel over the next few years.

 
·
International Growth. In addition to China, we have sold our products in Asian countries such as Indonesia, Thailand and Kyrgystan. We hope to expand sales into other countries where our products could be affordable treatment options.

 
·
Growth of Cosmetics Market Share. We intend to focus on the expansion of our cosmetics product line and devote additional marketing and sales resources. We hope that our cosmetics products will account for a larger percentage of our revenue in the future.

Research and Development

As of December 31, 2007, we employed 48 technicians, including 10 senior researchers, 16 mid-level researchers, and 22 junior analysts. The technicians’ specializations include medicine, pharmacology, chemistry, biology, and medicine production equipment.
 
7

 
In an attempt to capitalize on the natural resource of Sanchi in Yunnan Province and to develop a strong medical industry in the Yunnan Province, we have recently established an enterprise technology center – Kunming Beisheng Science and Technology Development Company – in cooperation with the Shijia Research Center of Beijing University. This collaboration combines the natural resources of Yunnan Province and the working conditions of our company with technical information and expertise of Beijing University. The project is designed to develop new techniques of extraction, purification and quality control while developing natural medicines native to Yunnan Province. The objectives are as follows: modernizing Chinese medicine development techniques; improving technological skill and processing techniques; industrialization of Chinese herbal medicine; creation of intellectual property rights; and deepening research into high-end Yunnan Province medicine. Pursuant to the joint establishment agreement that we entered into with Shijia Research Center, the project will have a duration of ten years from the date of completion of the industrial and commercial registration with the State Department of Industrial and Commercial Supervision Administration and receipt of an Enterprise Legal Person Business License. The business scope of the project includes development and technology transfer of bulk pharmaceuticals, prepared Chinese medicine, chemicals, biologicals, health food, and medical cosmetic products; importation of scientific instruments and medical technology, and communication with foreign and domestic research centers.

After signing the agreement with the Shijia Research Center, we completed the industrial and commercial registration of Kunming Beisheng Science and Technology Development Company, or the Development Company. The Development Company could not engage in enterprise activities, such as production and marketing, until it completed its industrial and commercial registration with the State Department of Industrial and Commercial Supervision Administration and obtained an Enterprise Legal Person Business License. Currently, we have obtained the appropriate Enterprise Legal Person Business License, which was approved by the Industrial and Commercial Administration of Kunming City, Yunnan Province in December 2006. Thus, the Development Company’s industrial and commercial registration process has been completed and the Development Company is now our subsidiary. We own 70% of the shares of the Development Company and the chairman of the board and legal representative is Mr. Lan Gui Hua. The remaining 30% of the shares are owned by the Shijia Research Center. The Development Company operates according to the regulations of our agreement with the Shijia Research Center.

Marketing and Sales

As of December 31, 2007, our marketing team maintains sales offices or agents in approximately 20 provinces throughout China. The sales network covers approximately 186 cities and is staffed by approximately 400 sales representatives.

We also use a distribution system comprised of independent regional distributors. In a typical distribution contract, a distributor will be provided with certain sales targets for a particular period according to a set retail price. If the distributor completes the sales task within the prescribed period, the agent distributor will be given greater economic incentives and future distribution opportunities. If the distributor fails to complete the sales task within the prescribed period, we will cancel our contract with the distributor and sign with other competent distributors. We also sign reselling contracts with franchise drug companies for the distribution of our products. The franchise drug company, as a reseller, resells our products to local hospitals, drug stores, and other channel distributors. In addition, we sell our products directly to hospitals and retail drug stores.

Approximately 15% of sales of Xuesaitong Soft Capsules are sold to hospitals directly while approximately 85% of sales are made to distributors. Our three largest customers accounted for approximately 21.6%, 32.1%, and 21.7% of our sales for the years ended December 31, 2007, 2006, and 2005, respectively.

We establish selling offices in many cities in China, and the selling offices manage sales representatives according to our internal management rules and sales policy. Because the main product “Xuesaitong” capsule is sold to distributors and hospitals located in the various cities of China and because China has thousands of distributors and hospitals, in order to increase market share, we employ a large number of sales representatives to expand into new markets and gain new customers.

In order to encourage sales representatives to increase sales, we make cash employee advances to sales representatives. We accomplish this by having the selling offices sign advance agreements with sales representatives to determine the conditions of the advances, specifying the amounts and the term. According to our sales policy, sales representatives earn sales commissions from us based on the sale amount and the amount of collection of trade receivables, less expenses paid by sales representatives. The remaining amount is the net profit of the sales representatives. However, the sales representatives still have the obligation of paying off employee advances. We believe the sales representatives are able to expand in to new markets and obtain new customers if they have advanced funds for their travel, meals, and other incidental expenses that arise over the time they perform their functions as sales representatives. When we makes advances to sales representatives, we require that our selling offices sign advance agreements with sales representatives to arrange the specific purpose of the advance, the amount of the advance, and the term of the advance. Our finance department records the detail of advances and checks the remaining balance with sales representatives every month. We also supervise the repayment of the advances. For sales representatives who do not have good credit, we require them to use real property as collateral when receiving advances from us. Additionally, for sales representatives who refuse to pay off the advances, we attempt to collect on the advances and decrease the risk of bad debt as much as possible by withholding sales commissions, prosecuting delinquent sales representatives, and by other valid means of collection. On January 1, 2007, we added punitive measures for overdue advances to the advance agreement.
 
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Net current and long-term employee advances were approximately $10.66 million at December 31, 2007 and $3.13 million as of December 31, 2006, and increase of $7.53 million, or 240.6%. The increase was due to us advancing more money to sales representatives to encourage them to expand their markets and increase sales. The large increase was due to us advancing more money to sales representatives to encourage them to expand their markets and increase sales. As of December 31, 2007, the gross amount of employee advances was $13.26 million and as of December 31, 2006 it was $4.56 million, an increase of $8.70 million in that year period. As of December 31, 2007, the gross amount of employee advances aged over one year was $2.2 million. Beginning September 2006, we began to employ more sales representatives, and, as a result, we made more advances to sales representatives in an attempt to encourage and assist sales representatives to expand into new selling markets and gain new customers. This contributed as well to the increase in employee advances. Because of the increase in the balance of employee advances, we, in compliance with its established policy to reserve an allowance for specific percentages of its aged receivables, accrued a larger allowance for the increased employee advances in order to consistently apply our established allowance policy.

Prices for our products are fixed and determinable. Each time products are purchased a specific price is agreed upon, a contract is signed and we and the customer are legally bound and neither can change the price. Prices for products are normally derived from our standard price lists, however, larger, more established customers are given quantity discounts. There are no instances in which payment for products sold is contingent on re-sales to or otherwise used by end-user patients. We do not allow returns on our products sold.

Production

We manufacture and package our products at our factory located in Kunming, China. The factory, which was built in 2000, is approximately 161,460 square feet and includes a clean area that occupies approximately 86,110 square feet. Our clean area in the production facilities includes approximately 52,500 square feet of Class 10,000 certified and 2,350 square feet of Class 100,000 certified. The cleanliness classification is based on the number of dust particles and bacteria per cubic meter, so lower numbers indicate a higher cleanliness class. According to the Regulation for Quality Control of Drug Production issued by the SFDA, oral preparations of traditional Chinese medicines must be produced in a Class 300,000 or lower environment. Our production facilities use equipment imported from the U.S. and are designed to meet American standards, so our Class 10,000 and Class 100,000 certified areas are cleaner than the Chinese national standard. The production facilities have more than 600 machines and supporting parts for pharmaceutical production from domestic and foreign suppliers. The factory has a total of 28 complete production lines for semi-finished and finished hard capsules, tablets, granules, powder, electuary, and emulsifier. The key facilities are two soft capsule production lines obtained from GIC Company, an Italian producer of industrial machinery, and an automatic packaging production line purchased from Klockner Haensel GmbH, a German company. In addition, all of our precision testing machines are supplied by Sharp Document Systems, U.S.A. Our production facilities were certified to be in compliance with Good Manufacturing Practice (GMP) standards in August 2002 and February 2004. In May 2004 and October 2005, we received the GMP certifications, which is renewed through July 18, 2012, for the production of health food products and supplements, including soft capsules, hard capsules, tablets and granule productions. We also received an additional GMP certification for production of pharmaceutical ointment products.
 
We utilize a complex process in extracting active components from the Sanchi plant, purifying the components and manufacturing our products. A typical manufacturing process begins by us obtaining the Sanchi plant from our supplier, washed clean, divided into main root, branch root and rhizome. The branch root known as “Sanchi Jintiao” and rhizome is known as “Sanchi Jiankou.” The Sanchi Jiankou is the portion of the Sanchi that contains the active ingredient, Panax Notoginseng Saponins. The Sanchi Jiankou is then sent to heavy pulverizing machinery to crush it into a specified powder size. The Sanchi Jiankou powder then undergoes a complex extracting process in which the powder is mixed with extracting solvents and the resulting solution is percolated and filter processed. The solution is concentrated by vacuum equipment while the extracting solvent is recollected and the active ingredient condensate is collected. The active ingredient condensate is then separated and purified through a chromatographic column, and the Sanchi polysaccharides and Sanchi saponins are collected separately. The solutions of Sanchi saponins and Sanchi polysaccharides are then separately purified by second chromatographic column to remove pigments and other useless compounds and obtain the pure saponins and polysaccharides, respectively. The Sanchi saponins and Sanchi polysaccharides are then separately dried by a spray-dryer, the resulting powders are weighed and packaged into separate contamination resistant plastic bags, which undergo quality control inspections and are stored in a warehouse for use in our line of products. Production of each product varies depending on the ingredients and form of the product, but production usually includes mixing of the Sanchi powder and the delivery agent, such as oil for soft capsules, and the ingredients are then processed using advanced pressing, drying, polishing and blister packaging equipment.
 
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Quality Control

Our production facilities are designed and maintained with a view towards conforming with good practice standards. To comply with GMP operational requirements, we have implemented a quality assurance plan setting forth our quality assurance procedures. Our Quality Control department is responsible for maintaining quality standards throughout the production process. Quality Control executes the following functions:

 
·
setting internal controls and regulations for semi-finished and finished products;
 
 
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implementing sampling systems and sample files;
 
 
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maintaining quality of equipment, instruments, reagents, test solutions, volumetric solutions, culture media and laboratory animals;
 
 
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auditing production records to ensure delivery of quality products;
 
 
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monitoring the number of dust particles and microbes in the clean areas;
 
 
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evaluating stability of raw materials, semi-finished products and finished products in order to generate accurate statistics on storage duration and shelf life;
 
 
·
articulating the responsibilities of Quality Control staff; and
 
 
·
on-site evaluation of supplier quality control systems.

Competition

The pharmaceutical industry both within China and globally is intensely competitive and is characterized by rapid and significant technological progress, and our operating environment is increasingly competitive. Our competitors, both domestic and international, include large pharmaceutical companies, universities, and public and private research institutions that currently engage in or may engage in efforts related to the discovery and development of new pharmaceuticals. Many of these entities have substantially greater research and development capabilities and financial, scientific, manufacturing, marketing and sales resources than we do, as well as more experience in research and development, clinical trials, regulatory matters, manufacturing, marketing and sales.

Competition in the manufacture and sale of medical products for cardiovascular and cerebrovascular disease in China is also intense. There are a large number of companies that are licensed to manufacture and sell these type of medical products in China. Western drugs such as lovastatins and nitroglycerine have more than half of the market share of medications used to treat cardiovascular and cerebrovascular disease in China, with Chinese traditional medicines make up the next largest part of the market. On the whole, Chinese patent medicine still generally has many problems such as complex and unclear ingredients, inconsistent quality, slow action and ineffectiveness. Therefore, new Chinese medicines tend not to stay on the market for very long.

There are also many Chinese traditional medicines available to treat peptic ulcers. While they are inexpensive and readily available, they are not as effective as western medicines. In China, peptic ulcers are usually treated with western medicines such as H2 blockers (e.g., Zantac), proton pump inhibitors (e.g., Nexium) and bismuth (e.g., Pepto-Bismol). In addition, amoxicillin and other antibiotics are now commonly used in conjunction to treat peptic ulcers.

The market for health and cosmetic products in China is also highly competitive. Both industries have a high number of competitors, some of which overlap, and many of which have a longer operating history and higher visibility, name recognition and financial resources than we do. Our competitors include manufacturers and marketers of personal care and nutritional products, pharmaceutical companies and other organizations.

Intellectual Property

We rely on a combination of trademark, copyright and trade secret protection laws in China, as well as confidentiality procedures and contractual provisions to protect our intellectual property. Our primary product, Xue Saitong Soft Capsules, first received patent protection and production and new medicine certification in 1999 and the protections continue until April 25, 2012. We also have protections for our technology methods of using Sanchi to help stop bleeding and combination methods, production and function of the medicine to treat intestinal disease. Xue Saitong Soft Capsules receive protections from the SFDA, which will not issue additional drug permits other than those already issued during the protection period. We have eight registered trademarks and have applied for registration of another two trademarks in China. Other than the foregoing, we do not have any measures to prevent any infringement of our intellectual property rights.
 
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Seasonality

Sales in the first quarter are usually lower due to people traveling and taking vacations during the traditional Chinese New Year and Chinese Spring Festival holidays. Sales in the fourth quarter are usually higher.

Government Regulations of Pharmaceuticals

The testing, approval, manufacturing, labeling, advertising and marketing, post-approval safety reporting, and export of our products or product candidates are extensively regulated by governmental authorities in the PRC and other countries. Our principal sales market is presently in China. We are subject to the Drug Administration Law of China, which governs the licensing, manufacturing, marketing and distribution of pharmaceutical products in China and sets penalties for violations of the law. Additionally, we are subject to various regulations and permit systems by the Chinese government.

The application and approval procedure in China for a newly developed drug product has numerous steps. New drug applicants prepare the documentation of pharmacological study, toxicity study and pharmacokinetics and drug metabolism (PKDM) study and new drug samples. Documentation and samples are then submitted to provincial food and drug administration (“provincial FDA”). The provincial FDA sends its officials to the applicant to check the applicant’s research and development facilities and to arrange new drug examination committee meeting for approval deliberations. This process usually takes three months. After the documentation and samples being approved by the provincial FDA, the provincial FDA will submit the approved documentation and samples to SFDA. SFDA examines the documentation and tests the samples and arranges new drug examination committee meeting for approval deliberations. If the application is approved by SFDA, SFDA will issue a clinical trial license to the applicant for clinical trials. The clinical trial license approval typically takes one year. The applicant completes the clinical trial process and prepares documentation and files submitted to SFDA for new drug approval. The clinical trial process usually takes one year or two depending on the category and class of the new drug. SFDA examines the documentation and gives final approval for the new drug and issues the new drug license to the applicant. This process usually takes eight months. The whole process for new drug approval usually takes three to four years.

Insurance Catalogue

Pursuant to the Decision of the State Council on the Establishment of the State Basic Medical Insurance System for Urban Employees and the Implementation Measures for the Administration of the Scope of Medical Insurance Coverage for Pharmaceuticals for Urban Employees, the Ministry of Labor and Social Security in China established the Insurance Catalogue. The Insurance Catalogue is divided into Parts A and B. The medicines included in Part A are designated by the Chinese governmental authorities for general application. Local governmental authorities may not adjust the content of medicines in Part A. Although the medicines included in Part B are designated by Chinese governmental authorities in the first instance, provincial level authorities may make limited changes to the medicines included in Part B, resulting in some regional variations in the medicines included in Part B from region to region.
 
Patients purchasing medicines included in Part A are entitled to reimbursement of the costs of such medicines from the social medical fund in accordance with relevant regulations in China. Patients purchasing medicines included in Part B are required to pay a predetermined proportion of the costs of such medicines.

The medicines included in the Insurance Catalogue are selected by the Chinese government authorities based on various factors including treatment requirements, frequency of use, effectiveness and price. Medicines included in the Insurance Catalogue are subject to price control by the Chinese government. The Insurance Catalogue is revised every two years. In connection with each revision, the relevant provincial drug authority collects proposals from relevant enterprises before organizing a comprehensive appraisal. The SFDA then makes the final decision on any revisions based on the preliminary opinion suggested by the provincial drug administration. Other than completing a normal application process, we have no role in the selection of products for inclusion in the Insurance Catalog. We do not pay any fee in order to be listed.
 
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In 2005, our primary product, Xuesaitong Soft Capsules was listed in Part B of the Insurance Catalogue. Xuesaitong Soft Capsules represented approximately 90% of our sales for the year ended December 31, 2007. Removal of the product from the Insurance Catalogue would adversely affect our total revenue.

We are seeking to have other products listed in the Insurance Catalogue. At present, Xuesaitong Soft Capsules and Sulfadiazine Silver Ointment have already been listed in the Insurance Catalogue. The China Society and Labor Security Department plans to update the Insurance Catalogue every two years, but since 2000, the catalog has only been updated once. It is expected to be updated again after 2007 and we hope to receive approval for listing of our Huangtensu Soft Capsules based on its medicinal attributes and sales, but there is no guarantee that this product will be approved for listing.

Price Controls

Drugs that are listed in the Insurance Catalogue and whose production or trading will constitute monopolies are commonly subject to price control by the Chinese government. The maximum prices of such medicine products are published by the state and provincial administration authorities from time to time. The prices of other medicines that are not subject to price control are determined by the pharmaceutical manufacturers, subject, in certain cases, to providing notice to the provincial pricing authorities. Our primary product, Xuesaitong Soft Capsules, is subject to retail and wholesale price controls.

The price of Xuesaitong Soft Capsules is determined by The National Development and Reform Commission of the PRC. The original price, as approved by the government, was 45 RMB (U.S. $5.63) per box of 24 capsules. As of December 31, 2007, its maximum price has been adjusted to 44.2 RMB (U.S. $5.53) per box of 24 capsules. We have submitted an application to The National Development and Reform Commission of the PRC requesting that the Xuesaitong Soft Capsules be placed into the category of drugs with good quality and low price that benefits from price protection, which, if approved, would exempt our product from price reductions.

Employees

As of December 31, 2007, we had 540 full-time, salaried employees and 471 of these employees receive labor insurance. These employees are organized into a union under the labor laws of China and can bargain collectively with us. In addition, we employ over 400 sales representatives who are paid on a commission basis. These representatives are not part of the union. We maintain good relations with our employees.

We are required to contribute a portion of our employees’ total salaries to the Chinese government’s social insurance funds, including medical insurance, unemployment insurance and job injuries insurance, and a housing assistance fund, in accordance with relevant regulations. In the last three years, we contributed approximately $147,434, $115,744 and $99,700 for the years ended December 31, 2007, 2006 and 2005, respectively. We expect the amount of our contribution to the government’s social insurance funds to increase in the future as we expand our workforce and operations.

Additional Information

We are subject to the information and periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and in accordance with the Exchange Act, we file annual, quarterly and special reports, and other information with the Securities and Exchange Commission. These periodic reports and other information are available for inspection and copying at the regional offices, public reference facilities and website of the Securities and Exchange Commission referred to below.

Statements contained in this report about the contents of any contract or any other document that is filed as an exhibit are not necessarily complete, and we refer you to the full text of the contract or other document filed as an exhibit. A copy of annual, quarterly and special reports and related exhibits and schedules may be inspected without charge at the Public Reference Room maintained by the Securities and Exchange Commission at 100 F Street, N.E., Washington, D.C. 20549, and copies of such reports may be obtained from the Securities and Exchange Commission upon payment of the prescribed fee. Information regarding the operation of the Public Reference Room may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains a web site that contains reports, proxy and information statements, and other information regarding registrants that file electronically with the SEC. The address of the site is www.sec.gov.
 
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Any investment in our common stock involves a high degree of risk. Investors should carefully consider the risks described below and all of the information contained in this report before deciding whether to purchase our common stock. Our business, financial condition or results of operations could be materially adversely affected by these risks if any of them actually occur. The trading price of our common stock could decline due to any of these risks, and an investor may lose all or part of his investment. Some of these factors have affected our financial condition and operating results in the past or are currently affecting our company. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face as described below and elsewhere in this report. With respect to this discussion, the terms “Shenghuo,” the “Company,” “we,” “us,” or “our” refer to China Shenghuo Pharmaceutical Holdings, Inc., our 93.75%-owned subsidiary Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. (“Shenghuo China”) and the three foreign owned subsidiaries of Shenghuo China that are organized under the laws of the People’s Republic of China (“PRC” or “China”).
 
RISKS RELATED TO OUR OPERATIONS

Our Current Business Is Primarily Based On A Single Product, Which Currently Accounts For More Than 90% Of Our Revenues, And We May Not Be Able To Generate Significant Revenue If This Product Fails.
 
Approximately 90% of our sales for the years ended December 31, 2007 comes from a single product, Xuesaitong Soft Capsules, and our business may fail if this product fails. If we experience difficulties or obstacles in the manufacture and sale of the Xuesaitong Soft Capsules, or if our licenses and government approvals are revoked to sell the product, then we may not be able to generate significant revenues, our business may fail and you would lose all or part of your investment in our company.

We Rely On A Few Suppliers For Sanchi, The Primary Ingredient in Most of Our Products, And Any Disruption With Our Suppliers Could Delay Product Shipments And Have a Material Adverse Impact on Our Business Operations And Profitability.

Due to the limited availability of Sanchi, we currently rely on a small number of suppliers as our source for Sanchi, the primary raw material that is needed for us to produce our products. We believe that there are few alternative suppliers available to supply the Sanchi plant, and should any of our current suppliers terminate their business arrangements with us or increase their prices of materials supplied, it would delay product shipments and adversely affect our business operations and profitability. In addition, if the suppliers refused to sell Sanchi, or increased the sales prices of Sanchi, this would also have a material adverse impact on our results of operations.

If Our Primary Product Is Replaced By Other Medicines Or Is Removed From China’s Insurance Catalogue In The Future, Our Revenue Will Suffer Substantially.

Under Chinese regulations, patients purchasing medicines listed by China’s state and/or provincial governments in the Insurance Catalogue may be reimbursed, in part or in whole, by a social medicine fund. Accordingly, pharmaceutical distributors prefer to engage in the distribution of medicines listed in the Insurance Catalogue. Since 2005, the main product, Xuesaitong Soft Capsules, that we manufacture and sell is listed in the Insurance Catalogue. The content of the Insurance Catalogue is subject to change by the Ministry of Labor and Social Security of China, and new medicines may be added to the Insurance Catalogue by provincial level authorities as part of their limited ability to change certain medicines listed in the Insurance Catalogue. Xuesaitong Soft Capsules accounted for approximately 90% of our sales for the year ended December 31, 2007, and if this product is replaced by other medicines or removed from the Insurance Catalogue in the future, our total revenue will suffer substantially.

We May Need To Raise Additional Capital To Fund Our Operations And Failure To Raise Additional Capital May Force Us To Delay, Reduce, Or Eliminate Our Product Development Programs.

Due to the large funds required for research and development and the subsequent marketing of products, the pharmaceutical industry is very capital intensive. The industry is characterized by large receivable turnovers, which could mean that we will need more working capital if our revenues increase. We have traditionally been committed to research and development and it is possible that we will need to raise additional capital within the foreseeable future. Additional capital may be needed for the development of new products or product lines, advances to employees, financing of general and administrative expenses, licensing or acquisition of additional technologies, and marketing of new or existing products. There are no assurances that we will be able to raise the appropriate amount of capital needed for our future operations. Failure to obtain funding when needed may force us to delay, reduce, or eliminate our product development programs.
 
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We Make Cash Employee Advances To Our Sales Representatives, And If We Are Not Able To Collect On These Advances In A Timely Manner, Or At All, Then It Will Decrease The Amount Of Working Capital That We Have Available To Effectively Operate Our Business.

We have experienced a significant growth in the amount of outstanding employee advances, and if we are unable to collect such advances in a timely manner, or at all, it will reduce our available cash and restrict out ability to effectively operate our business. Net current and long-term employee advances were approximately $10.66 million at December 31, 2007 and $3.13 million as of December 31, 2006, and increase of $7.53 million, or 240.6%. We make cash advances to our sales representatives in an attempt to encourage and assist them in expanding the marketing and sales of our products into new regions. We employ a large number of sales representatives and, as a result, the aggregate amount advanced to sales representatives is a significant amount. By making such cash advances, we will not have advanced amounts to operate our business, harming our liquidity and forcing us to look to other, possibly unfavorable means, sources of capital to fund our operations. In addition, if we are unable to collect the amounts advanced, or if it takes a significant amount of time and resources to collect such advances, our results of operation may suffer, and the value of our stock may decline.

Our Three Largest Customers Account For A Significant Percentage of Our Sales. We Cannot Be Certain That These Sales Will Continue; If They Do Not, Our Revenues Will Likely Decline.

Our three largest customers accounted for approximately 21.7%, 32.1% and 21.6% of our sales for the years ended December 31, 2005, 2006 and 2007, respectively. We do not have any long-term contracts with these customers, each of whom orders only on a “purchase order” basis. There can be no assurances that any of these customers will continue to purchase products from us. The loss of any or all of these customers or a significant reduction in their orders would have a materially adverse effect on our revenues.

The Failure To Manage Growth Effectively Could Have An Adverse Effect On Our Business, Financial Condition, And Results Of Operations

The rapid market growth, if any, of our pharmaceutical products may require us to expand our employee base for managerial, operational, financial, and other purposes. As of December 31, 2007, we had 540 full-time, salaried employees, in addition to our employment over 400 sales representatives who are paid on a commission basis. The continued future growth will impose significant added responsibilities upon the members of our management to identify, recruit, maintain, integrate, and motivate new employees. Aside from increased difficulties in the management of human resources, we may also encounter working capital issues, as we need increased liquidity to finance the purchases of raw materials and supplies, research and development of new products, acquisition of new businesses and technologies, and the hiring of additional employees. For effective growth management, we will be required to continue improving our operations, management, and financial systems and control. Our failure to manage growth effectively may lead to operational and financial inefficiencies that will have a negative effect on our profitability.

Our Planned Expansion Of Sales Into Overseas Markets Could Fail, Reduce Operating Results And/Or Expose Us To Increased Risks Associated With Different Market Dynamics And Competition In Any Of The Foreign Countries Where We Attempt To Sell Our Products.

We would face many new obstacles in our planned expansion of product sales in overseas markets. These markets are untested for our products and we face risks in expanding our business overseas, which include differences in regulatory product testing requirements, patent protection, taxation policy, legal systems and rules, marketing costs, fluctuations in currency exchange rates and changes in political and economic conditions. We may not be as successful as our competitors in generating revenues in international markets due to the lack of recognition of our products or other factors. Developing product recognition overseas is expensive and time-consuming and our international expansion efforts may be more costly and less profitable than we expect. If we are not successful in our target markets, our sales could decline, our margins could be negatively impacted and we could lose market share, any of which could materially harm our business, results of operations and profitability.
 
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We Are Dependent On Certain Key Personnel And Loss Of These Key Personnel Could Have A Material Adverse Effect On Our Business, Financial Condition And Results Of Operations.

Our success is, to a certain extent, attributable to the management, sales and marketing, and pharmaceutical factory operational expertise of key personnel. Gui Hua Lan, our Chief Executive Officer, Zheng Yi Wang, our Executive Director of Exports, Feng Lan, our President, Lei Lan, our Executive Director of Sales, and Qiong Hua Gao, our Chief Financial Officer, perform key functions in the operation of our business. There can be no assurance that we will be able to retain these officers after the term of their employment contracts expire. The loss of these officers could have a material adverse effect upon our business, financial condition, and results of operations. We must attract, recruit and retain a sizeable workforce of technically competent employees. Our ability to effectively implement our business strategy will depend upon, among other factors, the successful recruitment and retention of additional highly skilled and experienced management and other key personnel. We cannot assure that we will be able to hire or retain such employees.

Our Business And The Success Of Our Products Could Be Harmed If We Are Unable To Maintain Our Brand Image.

We believe that establishing and strengthening our Lixuwang brand is critical to achieving widespread acceptance of our products and to establishing key strategic relationships. The importance of brand recognition will increase as current and potential competitors enter the Chinese pharmaceutical market with competing products. Our ability to promote and position our Lixuwang brand depends largely on the success of our marketing efforts and our ability to provide high quality products and customer service. These activities are expensive and we may not generate a corresponding increase in sales to justify these costs. If we fail to establish and maintain our brand, or if our brand value is damaged or diluted, we may be unable to maintain or increase our sales or revenue.

We Face Intense Competition In The Pharmaceutical Industry And Such Competition Could Cause Our Sales Revenue And Profits To Decline.

The pharmaceutical industry both within China and globally is intensely competitive and is characterized by rapid and significant technological progress, and our operating environment is increasingly competitive. We face intense competitors that will attempt to create or are marketing products in the PRC that are similar to our products. Our competitors, both domestic and international, include large pharmaceutical companies, universities, and public and private research institutions that currently engage in or may engage in efforts related to the discovery and development of new pharmaceuticals. Many of these entities have substantially greater research and development capabilities and financial, scientific, manufacturing, marketing and sales resources than we do, as well as more experience in research and development, clinical trials, regulatory matters, manufacturing, marketing and sales. There can be no assurance that our products will be either more effective in their therapeutic abilities and/or be able to compete in price with that of our competitors. Failure to do either of these may result in decreased profits.

If Our Pharmaceutical Products Fail To Receive Regulatory Approval Or Are Severely Limited In These Products’ Scope Of Use, We May Be Unable To Recoup Considerable Research And Development Expenditures.

The production of our pharmaceutical products is subject to the regulatory approval of the State Food and Drug Administration (SFDA) in China. The regulatory approval procedure for pharmaceuticals can be quite lengthy, costly, and uncertain. Depending upon the discretion of the SFDA, the approval process may be significantly delayed by additional clinical testing and require the expenditure of resources not currently available; in such an event, it may be necessary for us to abandon our application. Even where approval of the product is granted, it may contain significant limitations in the form of narrow indications, warnings, precautions, or contra-indications with respect to conditions of use. If approval of our product is denied, abandoned, or severely limited in terms of the scope of products use, it may result in the inability to recoup considerable research and development expenditures.

Currently, two of our products, Wei Dingkang Soft Capsules and Dencichine Hemostat, have pending applications with the SFDA. Phase II clinical testing for Wei DingKang Soft Capsules was completed in July 2007. Dencichine Hemostat completed a second review and was required to undergo neurotoxicity testing. The Chinese Military Medical Institute will perform these tests. The risk is that if we do not receive timely approval for either of these drugs, then production will be delayed and sales of the products cannot be planned for.

If All Or A Significant Portion Of Our Customers With Trade Receivables Fail To Pay All Or Part Of The Trade Receivables Or Delay The Repayment, Our Net Income Will Decrease And Our Profitability Will Be Adversely Affected.

As of December 31, 2007, our accounts receivable (less allowance for doubtful accounts of $2.08 million) were $9.65 million. The standard credit period for most of our new clients is two months. For certain clients, such as long-standing clients or large clients, we will extend the credit period. Currently, most of our clients have established a long-term corporate relationship with us, so their credit periods are generally six months. Within the medical industry in China, the collection period is generally longer than for other industries. Our estimated average collection period for the year ended December 31, 2007 was 90 to 180 days. There is no assurance that our trade receivables will be fully repaid on a timely basis. If all or a significant portion of our customers with trade receivables fail to pay all or part of the trade receivables or delay the payment due to us for whatever reason, our net profit will decrease and our profitability will be adversely affected.
 
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Our Success Is Highly Dependent On Continually Developing New And Advanced Products, Technologies, And Processes And Failure To Do So May Cause Us To Lose Our Competitiveness In The Pharmaceutical Industry And May Cause Our Profits To Decline.

To remain competitive in the pharmaceutical industry, it is important to continually develop new and advanced products, technologies, and processes. There is no assurance that our competitors’ new products, technologies, and processes will not render our existing products obsolete or non-competitive. Our competitiveness in the pharmaceutical market therefore relies upon our ability to enhance our current products, introduce new products, and develop and implement new technologies and processes. The research and development of new products and technologies is costly and time consuming, and there are no assurances that our research and development of new products will either be successful or completed within the anticipate timeframe, if ever at all. Our failure to technologically evolve and/or develop new or enhanced products may cause us to lose our competitiveness in the pharmaceutical industry and may cause our profits to decline.

If We Fail To Develop New Products With High Profit Margins And Our High Profit Margin Products Are Substituted By Competitor’s Products, Our Gross And Net Profit Margins Will Be Adversely Affected.

For the years ended December 31, 2007 and 2006, the gross profit margin for our products was approximately 74.8% and 67.9%, respectively. However, there is no assurance that we will be able to sustain such profit margins in the future. The pharmaceutical industry is very competitive, and there may be pressure to reduce sale prices of products without a corresponding decrease in the price of raw materials. In addition, the medical industry in China is highly competitive and new products are constantly being introduced to the market. In order to increase the sales of our products and expand our market, we may be forced to reduce prices in the future, leading to a decrease in gross profit margin. To the extent that we fail to develop new products with high profit margins and our high profit margin products are substituted by competitors’ products, our gross profit margins will be adversely affected.

The Commercial Success Of Our Products Depends Upon The Degree Of Market Acceptance Among The Medical Community And Failure To Attain Market Acceptance Among The Medical Community May Have An Adverse Impact On Our Operations And Profitability.

The commercial success of our products depends upon the degree of market acceptance among the medical community, such as hospitals and physicians. Even if our products are approved by the SFDA, there is no assurance that physicians will prescribe or recommend our products to patients. Furthermore, a product’s prevalence and use at hospitals may be contingent upon our relationship with the medical community. The acceptance of our products among the medical community may depend upon several factors, including but not limited to, the product’s acceptance by physicians and patients as a safe and effective treatment, cost effectiveness, potential advantages over alternative treatments, and the prevalence and severity of side effects. Failure to attain market acceptance among the medical community may have an adverse impact on our operations and profitability.

Our Primary Product Is Subject To Price Controls By The China Government, Which May Affect Both Our Revenues And Net Income.

The laws of the PRC provide for the government to fix and adjust prices. During the years ended December 31, 2005, 2006 and 2007, our primary product Xuesaitong Soft Capsules was subject to price controls which affected our gross profit, gross margin and net income. It is possible that additional products may be subject to price control, or that price controls may be increased in the future. To the extent that we are subject to price control, our revenue, gross profit, gross margin and net income will be affected since the revenue we derive from our sales will be limited and it may face no limitation on our costs. Further, if price controls affect both our revenue and costs, our ability to be profitable and the extent of our profitability will be effectively subject to determination by the applicable regulatory authorities in the PRC.
 
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Our Certificates, Permits, And Licenses Related To Our Pharmaceutical Operations Are Subject To Governmental Control And Renewal And Failure To Obtain Renewal Will Cause All Or Part Of Our Operations To Be Terminated.

We are subject to various PRC laws and regulations pertaining to the pharmaceutical industry. We have attained certificates, permits, and licenses required for the operation of a pharmaceutical enterprise and the manufacturing of pharmaceutical products in the PRC. We also obtained pharmaceutical products and health food GMP certificates. The pharmaceutical production permit and GMP certificates are valid for a term of five years and the health food certifications are valid for four year terms, and each must be renewed before their expiration. We originally obtained our Medicine Production Permit on November 4, 1996, which is valid until December 31, 2010. The Medicine Production Permit applies to products described as tablet, granule, capsule, soft capsule, powder, ointment and medicinal. If the permit expires without renewal, we will not be able to operate medicine production which will cause our operations to be terminated. We intend to apply for a renewed Medicine Production Permit before our current production permit expires on December 31, 2010.

We hold numerous GMP certificates that expire, as follows:

 
·
a GMP certificate for ointment products that expires on June 12, 2011;
 
 
·
a GMP certificate for powder products that expires on April 21, 2009;
 
 
·
a GMP certificate for products in the form of tablet, granule, capsule, and soft capsule that expires on July 12, 2012; and
 
 
·
a GMP certificate for health food products in the form of tablets, capsules, soft capsules, and granules that expires on October 13, 2009.
 
We intend to apply for renewal of these GMP certificates prior to expiration. During the renewal process, we will be re-evaluated by the appropriate governmental authorities and must comply with the then prevailing standards and regulations which may change from time to time. In the event that we are not able to renew the certificates, permits and licenses, all or part of our operations may be terminated. Furthermore, if escalating compliance costs associated with governmental standards and regulations restrict or prohibit any part of our operations, it may adversely affect our operation and profitability.

We Cannot Guarantee The Protection Of Our Intellectual Property Rights And If Infringement Or Counterfeiting Of Our Intellectual Property Rights Occurs, Our Reputation And Business May Be Adversely Affected.

To protect the reputation of our products, we have registered and applied for registration of our trademarks in the PRC where we have a major business presence. Our products are sold under these trademarks. There is no assurance that there will not be any infringement of our brand name or other registered trademarks or counterfeiting of our products in the future. Should any such infringement or counterfeiting occur, our reputation and business may be adversely affected. We may also incur significant expenses and substantial amounts of time and effort to enforce our intellectual property rights in the future. Such diversion of our resources may adversely affect our existing business and future expansion plans.

The Success of Our Expansion Into the Retail Distribution Of Our Cosmetic Products Thought Counters Depends On Our Ability To Open And Operate A Certain Number Of New Counters On An Ongoing Basis, Which Could Strain Our Resources And Cause The Performance Of Our Existing Operations To Suffer.

We have been opening a number of retail specialty counters to offer our cosmetic products at pharmacies throughout Eastern China, with plans to eventually expand our retail presence across China. Our retail strategy will largely depend on our ability to find sites for, open and operate retail locations successfully. Our ability to open and operate retail locations successfully depends on several factors, including, among others, our ability to:

identify suitable counter locations, the availability of which is outside our control;
     
   
purchase and negotiate acceptable lease terms;
     
   
prepare counters for opening within budget;
     
   
source sufficient levels of inventory at acceptable costs to meet the needs of counters;
     
   
hire, train and retain personnel;
 
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secure required governmental permits and approvals;
     
   
successfully integrate counters into our existing operations;
     
   
contain payroll costs; and
     
   
generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our retail strategy plans.
 
Any failure to successfully open and operate retail counters for our cosmetic products could have a material adverse effect on our results of operations. In addition, our proposed retail plan will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which, in turn, could cause deterioration in the financial performance of our overall business.

We Expect to Lose Certain Preferential Tax Concessions, Which May Cause Our Tax Liabilities To Increase And Our Profitability To Decline.

We enjoy preferential tax concessions in the PRC as a high-tech enterprise. Pursuant to the State Council’s Regulations on Encouraging Investment in and Development, we were granted a reduction in our income tax rate and have had an income tax rate of 15% since 2003. In addition, there is no assurance that the preferential tax treatment in the PRC will remain unchanged and effective. Our tax liabilities will increase and our profits may accordingly decline if our reduced income tax rate is no longer applicable and/or the tax relief on investment in PRC is no longer available.
 
Additionally, the PRC Enterprise Income Tax Law (the “EIT Law”) was enacted on March 16, 2007. Under the EIT Law, effective January 1, 2008, China will adopt a uniform tax rate of 25.0% for all enterprises (including foreign-invested enterprises) and cancel several tax incentives enjoyed by foreign-invested enterprises. On March 16, 2007, the National People’s Congress of China passed the new Enterprise Income Tax Law, (“EIT Law”), and on December 6, 2007, the State Council of China issued the Implementation Regulations for the EIT Law which took effect on January 1, 2008. The EIT Law and Implementation Regulations Rules impose a unified EIT of 25% on all domestic-invested enterprises and Foreign Invested Entities unless they qualify under certain limited exceptions. We believe that we will continue to have a 15% rate with a tax preferences for 2008 and will have a favorable rate of 50% of the tax rates in effect during fiscal 2009 through 2011 as determined by the PRC government and the regional tax authorities, but it is unclear how any increases in the transition period will specifically occur. We believe that our profitability may be negatively affected in the near future as a result of the new EIT Law. Any future increase in the enterprise income tax rate applicable to us or other adverse tax treatments could increase our tax liabilities and reduce our net income. Further, any future increase in the enterprise income tax rate applicable to us or other adverse tax treatments, such as the discontinuation of preferential tax treatments for high and new technology enterprises altogether, would have a material adverse effect on our results of operations and financial condition.
 
We Do Not Carry Insurance To Cover Any Losses Due To Fire, Casualty Or Theft At Our Production Facility Located In Kunming, China.

We have not obtained fire, casualty and theft insurance, and there is no insurance coverage for our raw materials, goods and merchandise, furniture and equipment and production facility in China. Any losses incurred by us will have to be borne by us without any assistance, and we may not have sufficient capital to cover material damage to, or the loss of, our production facility due to fire, severe weather, flood or other cause, and such damage or loss would have a material adverse effect on our financial condition, business and prospects.

We May Suffer As A Result Of Product Liability Or Defective Products.

We may produce products which inadvertently have an adverse pharmaceutical effect on the health of individuals despite proper testing. Existing PRC laws and regulations do not require us to maintain third party liability insurance to cover product liability claims. However, if a product liability claim is brought against us, it may, regardless of merit or eventual outcome, result in damage to our reputation, breach of contract with our customers, decreased demand for our products, costly litigation, product recalls, loss of revenue, and the inability to commercialize some products.
 
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We Rely On The Cooperation With Research Laboratories And Universities, And If These Institutions Cease To Cooperate With Us And We Cannot Find Other Suitable Substitute Research And Development Partners, Our Ability To Develop New Products May Be Hindered And Our Business May Be Adversely Affected.

We cooperate with several research institutions including the Shijia Research Center of Beijing University. We rely to a certain extent on these institutions for our development of new products. There is no assurance that these institutions will continue cooperating with us to develop new products. In the event that these institutions cease to cooperate with us and it cannot find other suitable substitute research and development partners, our ability to develop new products may be hindered and our business may be adversely affected.

RISKS RELATED TO CONDUCTING BUSINESS IN CHINA

All Of Our Assets Are Located In China And Substantially All Of Our Revenues Are Derived From Our Operations In China, And Changes In The Political And Economic Policies Of The PRC Government Could Have A Significant Impact Upon The Business We May Be Able To Conduct In The PRC And Our Results Of Operations And Financial Condition.

Our business operations may be adversely affected by the current and future political environment in the PRC. The PRC has operated as a socialist state since the mid-1900s and is controlled by the Communist Party of China. The Chinese government exerts substantial influence and control over the manner in which we must conduct our business activities. The PRC has only permitted provincial and local economic autonomy and private economic activities since the 1970s. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy, particularly the pharmaceutical industry, through regulation and state ownership. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under our current leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.

The PRC Laws And Regulations Governing Our Current Business Operations Are Sometimes Vague And Uncertain. Any Changes In Such PRC Laws And Regulations May Have A Material And Adverse Effect On Our Business.

The PRC’s legal system is a civil law system based on written statutes, in which system decided legal cases have little value as precedents unlike the common law system prevalent in the United States. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We are considered a foreign persons or foreign funded enterprises under PRC laws, and as a result, we are required to comply with PRC laws and regulations. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. If the relevant authorities find that we are in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation:

 
·
levying fines;
 
 
·
revoking our business and other licenses;
 
 
·
requiring that we restructure our ownership or operations; and
 
 
·
requiring that we discontinue any portion or all of our business.
 
The Foreign Currency Exchange Rate Between U.S. Dollars And Renminbi Could Adversely Affect Our Financial Condition.

To the extent that we need to convert dollars into Renminbi for our operational needs, our financial position and the price of our common stock may be adversely affected should the Renminbi appreciate against the U.S. dollar at that time. Conversely, if we decide to convert our Renminbi into dollars for the operational needs or paying dividends on our common stock, the dollar equivalent of our earnings from our subsidiary in China would be reduced should the dollar appreciate against the Renminbi.
 
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Until 1994, the Renminbi experienced a gradual but significant devaluation against most major currencies, including dollars, and there was a significant devaluation of the Renminbi on January 1, 1994 in connection with the replacement of the dual exchange rate system with a unified managed floating rate foreign exchange system. Since 1994, the value of the Renminbi relative to the U.S. Dollar has remained stable and has appreciated slightly against the U.S. dollar. Countries, including the United States, have argued that the Renminbi is artificially undervalued due to China’s current monetary policies and have pressured China to allow the Renminbi to float freely in world markets. In July 2005, the PRC government changed its policy of pegging the value of the Renminbi to the dollar. Under the new policy the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of designated foreign currencies. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and more significant appreciation of the Renminbi against the dollar.

Inflation In The PRC Could Negatively Affect Our Profitability And Growth.

While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. During the past two decades, the rate of inflation in China has been as high as approximately 20%. According to the National Bureau of Statistics of China, the inflation rate in China reached a high point of 4.8% in 2007 as compared to the past several years. The inflation rate in China was 1.8% in 2005 and 1.5% in 2006. The inflation rate is expected to continue to increase in 2008. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies such as raw materials, it may have an adverse effect on our profitability. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. The implementation of such policies may impede economic growth. In October 2004, the People’s Bank of China, the PRC’s central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the Chinese economy. During 2007, the interest rate was increased from 5.67% to 7.83%. Repeated rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially increase our costs and also reduce demand for our products.

Recent PRC Regulations Relating To Acquisitions Of PRC Companies By Foreign Entities May Create Regulatory Uncertainties That Could Restrict Or Limit Our Ability To Operate. Our Failure To Obtain The Prior Approval Of The China Securities Regulatory Commission, Or The CSRC, For The Listing And Trading Of Our Common Stock On The American Stock Exchange Could Have A Material Adverse Effect On Our Business, Operating Results, Reputation And Trading Price Of Our Common Stock.

The PRC State Administration of Foreign Exchange, or SAFE, issued a public notice in January 2005 concerning foreign exchange regulations on mergers and acquisitions in China. The public notice states that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to strict examination by the relevant foreign exchange authorities. The public notice also states that the approval of the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of a PRC company’s assets or equity interests to foreign entities for equity interests or assets of the foreign entities.

In April 2005, SAFE issued another public notice further explaining the January notice. In accordance with the April notice, if an acquisition of a PRC company by an offshore company controlled by PRC residents has been confirmed by a Foreign Investment Enterprise Certificate prior to the promulgation of the January notice, the PRC residents must each submit a registration form to the local SAFE branch with respect to their respective ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transaction or use of assets in China to guarantee offshore obligations. The April notice also provides that failure to comply with the registration procedures set forth therein may result in restrictions on our PRC resident shareholders and our subsidiaries. Pending the promulgation of detailed implementation rules, the relevant government authorities are reluctant to commence processing any registration or application for approval required under the SAFE notices.

In addition, on August 8, 2006, the Ministry of Commerce (“MOFCOM”), joined by the State-Owned Assets Supervision and Administration Commission of the State Council, State Administration of Taxation, State Administration for Industry and Commerce, CSRC and SAFE, amended and released the Provisions for Foreign Investors to Merge and Acquire Domestic Enterprises, new foreign-investment rules which took effect September 8, 2006, superseding much, but not all, of the guidance in the prior SAFE circulars. These new rules significantly revise China’s regulatory framework governing onshore-offshore restructurings and how foreign investors can acquire domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign control transactions in key industries.
 
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Specifically, this regulation, among other things, has some provisions that purport to require that an offshore special purpose vehicle, or SPV, formed for listing purposes and controlled directly or indirectly by PRC companies or individuals shall obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, the application of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement.

Our PRC counsel, Tianyuan Law Firm, has advised us that because we completed our restructuring before September 8, 2006, the effective date of the new regulation, it is not necessary for us to submit the application to the CSRC for its approval, and the listing and trading of our Common Stock on the American Stock Exchange does not require CSRC approval.

If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval was required for our initial public offering that was completed in June 2007, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from our initial public offering or subsequent offerings into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our Common Stock. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt future offerings before settlement and delivery of the Common Stock offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur.

Also, if later the CSRC requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our Common Stock.

These new rules may significantly affect the means by which offshore-onshore restructurings are undertaken in China in connection with offshore private equity and venture capital financings, mergers and acquisitions. It is expected that such transactional activity in China in the near future will require significant case-by-case guidance from MOFCOM and other government authorities as appropriate. It is anticipated that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor how MOFCOM and other ministries apply the rules to ensure its domestic and offshore activities continue to comply with PRC law. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance.

It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of the SAFE notices and new rules. Our business operations or future strategy could be adversely affected by the SAFE notices and the new rules. For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities.

Failure To Comply With The United States Foreign Corrupt Practices Act Could Subject Us To Penalties And Other Adverse Consequences.

Upon completion of the Share Exchange, we became subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC. We can make no assurance, however, that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
 
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Any Recurrence Of Severe Acute Respiratory Syndrome, Avian Flu, Or Another Widespread Public Health Problem, In The PRC Could Adversely Affect Our Operations.

A renewed outbreak of Severe Acute Respiratory Syndrome, Avian Flu or another widespread public health problem in China, where all of our manufacturing facilities are located and where all of our sales occur, could have a negative effect on our operations. Such an outbreak could have an impact on our operations as a result of:

 
·
quarantines or closures of some of our manufacturing facilities, which would severely disrupt our operations,
 
 
·
the sickness or death of our key officers and employees, and
 
 
·
a general slowdown in the Chinese economy.
 
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.

A Downturn In The Economy Of The PRC May Slow Our Growth And Profitability.

The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any downturn will not have a negative effect on our business, especially if it results in either a decreased use of our products or in pressure on us to lower our prices.

We May Have Difficulty Establishing Adequate Management, Legal And Financial Controls In The PRC.

PRC companies have historically not adopted a Western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and, computer, financial and other control systems. In addition, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent it from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business.

If We Make Equity Compensation Grants To Persons Who Are PRC Citizens, They May Be Required To Register With The State Administration Of Foreign Exchange Of The PRC, Or SAFE. We May Also Face Regulatory Uncertainties That Could Restrict Our Ability To Adopt An Equity Compensation Plan For Our Directors And Employees And Other Parties Under PRC Law.
 
On April 6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company, also know as “Circular 78.” It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company after April 6, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company’s covered equity compensation plan prior to April 6, 2007. We intend to adopt an equity compensation plan in the future and make option grants to our officers and directors, most of whom are PRC citizens. Circular 78 may require our officers and directors who receive option grants and are PRC citizens to register with SAFE. We believe that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming. If it is determined that any of our equity compensation plans are subject to Circular 78, failure to comply with such provisions may subject us and participants of our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our ability to compensate our employees and directors through equity compensation would be hindered and our business operations may be adversely affected.
 
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You May Experience Difficulties In Effecting Service Of Legal Process, Enforcing Foreign Judgments Or Bringing Original Actions In China Based Upon U.S. laws, Including The Federal Securities Laws Or Other Foreign Laws Against Us Or Our Management.

All of our current operations are conducted in China. Moreover, all of our directors and officers are nationals and residents of China. All or substantially all of the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these persons. In addition, uncertainty exists as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities law of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof.

RISKS RELATED TO OUR CAPITAL STRUCTURE

The Price Of Our Common Stock May Be Volatile, And If An Active Trading Market For Our Common Stock Does Not Develop, The Price Of Our Common Stock May Suffer And Decline.

Prior to our initial public offering and listing of our common stock on the American Stock Exchange on June 14, 2007, there has been no public market for our securities in the United States. Accordingly, we cannot assure you that an active trading market will develop or be sustained or that the market price of our common stock will not decline. The price at which our common stock will trade after our initial public offering is likely to be highly volatile and may fluctuate substantially due to many factors, some of which are outside of our control.

Shares Eligible For Future Sale May Adversely Affect The Market Price Of Our Common Stock, As The Future Sale Of A Substantial Amount Of Outstanding Stock In The Public Marketplace Could Reduce The Price Of Our Common Stock. 

In June 2007, we completed a public offering and sale of 460,000 shares of common stock, all of which are currently freely tradeable. In addition, we registered 2,000,000 shares of common stock issued in a Private Placement, and all lock up restrictions regarding these shares have expired, therefore the shares are freely tradable. We also registered 2,006,400 additional shares of common stock. All of the shares included in an effective registration statement as described above may be freely sold and transferred except if subject to a lock up agreement.

Additionally, following the Share Exchange, the former stockholder of Shenghuo China may be eligible to sell all or some of our shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act (“Rule 144”), subject to certain limitations. Previously, in general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a one-year holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. February 15, 2008, Rule 144 was amended to, among other things, shorten the holding period from one year to six months and to remove the volume limitations, among other things, for non-affiliates of the company, all of which make it easier for a non-affiliate stockholder to sell shares under Rule 144. Any substantial sale of common stock pursuant to any resale prospectus or Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply.
 
Our Principal Stockholder Has Significant Influence Over Us.
 
Our largest shareholder, Lan’s Int’l Medicine Investment Co., Limited, or LIMI, beneficially owns or controls approximately 78% of our outstanding shares as of the close of the Share Exchange. Gui Hua Lan, our Chief Executive Officer, Feng Lan, our President, and Zheng Yi Wang, our Executive Director of Exports, are directors and have voting and investment control over the shares owned by LIMI. In addition, Gui Hua Lan, Feng Lan and Zheng Yi Wang owns 62.42%, 5.015% and 1.345%, respectively, of LIMI’s issued and outstanding shares. Other of our officers and directors hold equity interests in LIMI. LIMI has controlling influence in determining the outcome of any corporate transaction or other matters submitted to our shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors, and other significant corporate actions. LIMI also has the power to prevent or cause a change in control. In addition, without the consent of LIMI, we could be prevented from entering into transactions that could be beneficial to it. The interests of LIMI may differ from the interests of our other shareholders.
 
The Interests Of The Existing Minority Shareholder In Shenghuo China May Diverge From Our Own Interests And This May Adversely Affect Our Ability To Manage Shenghuo China.

Shenghuo China, our principal operating subsidiary, is an equity joint venture in which we directly own a 93.75% interest and SDIC Venture Capital Investment, Co., Ltd., or SDIC, a state-owned investment company, owns the remaining 6.25% interest. SDIC’s interest may not be aligned with our interest at all times. If our interests diverge, SDIC may exercise its right under PRC laws to protect its own interest, which may be adverse to us and our investors. For example, under China’s joint venture regulations, unanimous approval of members of a joint venture’s (such as Shenghuo China) board of directors who are present at a board meeting is required for any amendment to the joint venture’s articles of association, the termination or dissolution of the joint venture company, an increase or decrease in the registered capital of the joint venture company or a merger or de-merger of the joint venture. Accordingly, SDIC has the ability to block any action that requires unanimous board approval. Further, should we wish to transfer our equity interest in Shenghuo China, in whole or in part, to a third-party, SDIC has a right of first refusal under China’s joint venture regulations.
 
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In addition to our statutory rights as a minority shareholder, SDIC has additional rights under the joint venture contract and under the articles of association of Shenghuo China. The joint venture contract and articles of association require the consent of each of Shenghuo China’s shareholders and/or unanimous board approval on matters such as a major change in the business line of the company and expansion or amendment of the business scope of the company.

SDIC has thus far been cooperative with us in handling matters with respect to the business of Shenghuo China. There is no assurance, however, that SDIC will continue to act in a cooperative manner in the future.

The Ability Of Our Chinese Operating Subsidiaries To Pay Dividends May Be Restricted Due To Our Corporate Structure.
 
Substantially all of our operations are conducted in China and substantially all of our revenues are generated in China. As an equity joint venture, Shenghuo China is required to establish reserve funds and staff and workers’ bonus and welfare funds, each of which is appropriated from net profit after taxation but before dividend distributions in accordance with Chinese law. Shenghuo China is required to allocate at least 10% of our net profits to the reserve fund until the balance of this fund has reached 50% of Shenghuo China’s registered capital.

In addition, the profit available for distribution from our Chinese subsidiaries is determined in accordance with generally accepted accounting principles in China. This calculation may differ from the one performed under generally accepted accounting principles in the United States, or GAAP. As a result, we may not receive sufficient distributions from our Chinese subsidiaries to enable us to make dividend distributions to our stockholders in the future and limitations on distributions of the profits of Shenghuo China could negatively affect our financial condition and assets, even if our GAAP financial statements indicate that our operations have been profitable.

We May Not Be Able To Achieve The Benefits We Expected To Result From The Share Exchange.
 
On June 30, 2006, we entered into the Exchange Agreement, as amended on August 11 and 28, 2006, with the 93.75% shareholder of Shenghuo China pursuant to which we agreed to acquire 93.75% of the equity interest of Shenghuo China in exchange for shares of our common stock. On August 31, 2006, the Share Exchange closed, Shenghuo China became our 93.75%-owned subsidiary and our sole business operations became that of Shenghuo China. Also, the management and directors of Shenghuo China became the management and directors of us and we changed our corporate name to China Shenghuo Pharmaceutical Holdings, Inc.

The Share Exchange was effected for various reasons, including:

 
·
access to the capital markets of the United States;
 
 
·
the increased market liquidity expected to result from exchanging stock in a private company for securities of a public company that may eventually be traded;
 
 
·
the ability to use registered securities to make acquisition of assets or businesses;
 
 
·
increased visibility in the financial community;
 
 
·
enhanced access to the capital markets;
 
 
·
improved transparency of operations; and
 
 
·
perceived credibility and enhanced corporate image of being a publicly traded company.
 
24

 
There can be no assurance that any of the anticipated benefits of the Share Exchange will be realized in respect to our new business operations. In addition, the attention and effort devoted to achieving the benefits of the Share Exchange and attending to the obligations of being a public company, such as reporting requirements and securities regulations, could significantly divert management’s attention from other important issues, which could materially and adversely affect our operating results or stock price in the future.

If We Fail To Maintain Effective Internal Controls Over Financial Reporting Or Effective Disclosure Controls and Procedures, The Price Of Our Common Stock May Be Adversely Affected.

Our internal control over financial reporting or disclosure controls and procedures may have weaknesses and conditions that need to be addressed, the disclosure of which may have an adverse impact on the price of our common stock. We are required to establish and maintain appropriate internal controls over financial reporting and disclosure controls and procedures. Failure to establish those controls, or any failure of those controls once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations. In addition, management’s assessment of internal controls over financial reporting or disclosure controls and procedures may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting, disclosure controls and procedures or other matters that may raise concerns for investors. Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting or disclosure controls and procedures may have an adverse impact on the price of our common stock.

As of December 31, 2007, our Chief Executive Officer (CEO) and our Chief Financial Officer (CFO) performed an evaluation of our disclosure controls and procedures and concluded that our disclosure controls and procedures had significant deficiencies that resulted in a material weakness in our controls and procedures, resulting in them being ineffective. These deficiencies consisted of material adjustments related to the prior year audits were not recorded in the company’s accounting records that were necessary to reconcile the retained earnings to the prior year balances in accordance with US GAAP, the level of U.S GAAP expertise of our internal accounting staff, and our internal audit functions. We expect to expend a significant amount of funds to address these deficiencies, and there is no guarantee that we will be able to resolve these deficiencies, which may result in an adverse impact on the price of our common stock.

Standards For Compliance With Section 404 Of The Sarbanes-Oxley Act Of 2002 Are Uncertain, And If We Fail To Comply In A Timely Manner, Our Business Could Be Harmed And Our Stock Price Could Decline.
 
Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting, and attestation of this assessment by our company’s independent registered public accountants. The SEC extended the compliance dates for non-accelerated filers, as defined by the SEC. Accordingly, we believe that the annual assessment of our internal controls requirement will first apply to our annual report for the 2007 fiscal year and the attestation requirement of management’s assessment by our company’s independent registered public accountants will first apply to our annual report for the 2008 fiscal year. The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of our internal control over financial reporting. In addition, the attestation process by our independent registered public accountants is new and it may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of our assessment by our independent registered public accountants. If we cannot assess our internal control over financial reporting as effective, or our independent registered public accountants are unable to provide an unqualified attestation report on such assessment, investor confidence and share value may be negatively impacted.
 
Our Common Stock May Be Considered A “Penny Stock,” And Thereby Be Subject To Additional Sale And Trading Regulations That May Make It More Difficult To Sell.
 
Our common stock may be considered to be a “penny stock” if it does not qualify for one of the exemptions from the definition of “penny stock” under Section 3a51-1 of the Securities Exchange Act for 1934, as amended (the “Exchange Act”). Our common stock may be a “penny stock” if it meets one or more of the following conditions (i) the stock trades at a price less than $5.00 per share; (ii) it is not traded on a “recognized” national exchange; (iii) it is not quoted on the Nasdaq Capital Market, or even if so, has a price less than $5.00 per share; or (iv) is issued by a company that has been in business less than three years with net tangible assets less than $5 million.
 
25

 
The principal result or effect of being designated a “penny stock” is that securities broker-dealers participating in sales of our common stock will be subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document at least two business days before effecting any transaction in a penny stock for the investor’s account. Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult and time consuming for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.

We Do Not Foresee Paying Cash Dividends In The Foreseeable Future.
 
We currently intend to retain any future earnings for funding growth. We do not anticipate paying any dividends in the foreseeable future. As a result, you should not rely on an investment in our securities if you require dividend income. Capital appreciation, if any, of our shares may be your sole source of gain for the foreseeable future. Moreover, you may not be able to resell your shares in our company at or above the price you paid for them.

ITEM 2.
DESCRIPTION OF PROPERTY
 
We have land use rights to two parcels of land with a total area of approximately 66.7 acres and own a 161,460 square foot factory. The land use rights for both parcels have terms of 50 years and end in 2048 and 2050. Our principal executive offices are located at No. 2, Jing You Road, Kunming National Economy & Technology Developing District, People’s Republic of China 650217.
 
ITEM 3.
LEGAL PROCEEDINGS
 
The Company was sued by a former employee for violation of his contract and the courts entered a judgment in favor of the employee in 2003 for $128,978, which included litigation costs. The Company accrued the liability for this loss at December 31, 2003 and paid the amount of the judgment on April 27, 2004. In 2006, the plaintiff has asked the court to have the Company pay a penalty for not paying the judgment timely in the amount of $100,000. The court had frozen a bank account that had $105,284. During the fourth quarter of 2006, the court rejected the request for the penalty and released the funds back to the Company. The employee has now asserted claims for allegedly ruining the employee’s reputation and causing mental anguish. The lawsuit was settled in January of 2008, which resulted in the payment of $65,136 by the Company.

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

None.
 
PART II
 
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Commencing on June 14, 2007, our shares of common stock have been listed for trading on AMEX under the ticker symbol “KUN.” As of March 15, 2008, we had 49 registered shareholders.

From June 14, 2007, which was our first day of trading, through December 31, 2007, the high and low sales price for our common stock on AMEX are as set forth below. The closing sales price of our common stock on March 28, 2008 was $3.56 per share.

 
 
2007
 
 
 
High
 
Low
 
4th Quarter
 
$
19.75
 
$
3.80
 
3rd Quarter
   
6.65
   
3.10
 
2nd Quarter (from listing on June 14, 2007)
   
8.15
   
3.50
 
 
26


The price of our common stock will likely fluctuate in the future. The stock market in general has experienced extreme stock price fluctuations in the past few years. In some cases, these fluctuations have been unrelated to the operating performance of the affected companies. Many companies have experienced dramatic volatility in the market prices of their common stock. We believe that a number of factors, both within and outside our control, could cause the price of our common stock to fluctuate, perhaps substantially. Factors such as the following could have a significant adverse impact on the market price of our common stock:

 
Our ability to obtain additional financing and, if available, the terms and conditions of the financing;
     
 
Our financial position and results of operations;
     
 
Concern as to, or other evidence of, the reliability and efficiency of our products and services or our competitors’ products and services;
     
 
Announcements of innovations or new products or services by us or our competitors;
     
 
U.S. federal and state governmental regulatory actions and the impact of such requirements on our business;
     
 
The development of litigation against us;
     
 
Period-to-period fluctuations in our operating results;
     
 
Changes in estimates of our performance by any securities analysts;
     
 
The issuance of new equity securities pursuant to a future offering or acquisition;
     
 
Changes in interest rates;
     
 
Competitive developments, including announcements by competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
     
 
Investor perceptions of us; and
     
 
General economic and other national conditions.

Dividend Policy

We have not declared or paid any cash dividends on our common stock, and we currently intend to retain future earnings, if any, to finance the expansion of our business, and we do not expect to pay any cash dividends in the foreseeable future. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant. We currently intend to retain our earnings for funding growth and, therefore, do not expect to pay any dividends in the foreseeable future.

Equity Compensation Plan

As of December 31, 2007, we did not have an equity compensation plan.

 
 
   
 
 
 
# of securities remaining
 
 
   
 
 
 
available for future
 
 
# of securities to be issued
 
Weighted-average
 
issuance under equity
 
 
upon exercise of
 
exercise price of
 
compensation plans
 
 
outstanding options,
 
outstanding options,
 
(excluding securities
 
 
warrants and rights 
 
warrants and rights
 
reflected in column (a))
Equity compensation plans approved by security holders
 
-
 
-
 
-
Equity compensation plans not approved by securities holders
 
6,000
(1) 
$
3.50  
-
 Total
 
6,000
 
$
3.50  
-
 

(1) A total of 6,000 warrants were granted to two of our non-employee directors in 2007.
 
27

 
Recent sales of unregistered securities

In June 2007, upon the closing of our initial public offering, we issued to WestPark Capital, Inc. warrants to purchase up to 40,000 shares of our common stock in exchange for its underwriting services provided to us in connection with our initial public offering. The warrants are exercisable at a per share exercise price of $4.20, subject to standard anti-dilution adjustments for stock splits and similar transactions, and will expire after five years. The securities were issued to WestPark Capital in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.
 
28


ITEM 6.
MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

Forward-Looking Statements

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes, and the other financial information included in this report.

This filing contains forward-looking statements. The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, general economic and business conditions; changes in foreign, political, social, and economic conditions; our expansion into the retail distribution of our cosmetic products; regulatory initiatives and compliance with governmental regulations; the ability to achieve further market penetration and additional customers; and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments. Refer to the sections entitled “Risk Factors” and “Special Note Regarding Forward-Looking Statements” contained in this report.

Overview

We are primarily engaged in the research, development, manufacture, and marketing of pharmaceutical, nutritional supplement and cosmetic products. Almost all of our products are derived from the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow plant that only grows in a few geographic locations, one of which is Yunnan Province in southwest China, where we are located. The main root of Panax notoginseng are cylindrical shaped and are most commonly one to six centimeters long and one to four centimeters in diameter. Panax notoginseng saponins (PNS), the active ingredients in Panax notoginseng, are extracted from the plant using high-tech equipment and in accord with Good Manufacturing Practice (GMP) standards. Our main product, Xuesaitong Soft Capsules, accounted for more than 80% and 90% of our sales for the year ended December 31, 2006 and the year ended December 31, 2007, respectively.

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

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

Xuesaitong Soft Capsules, which are subject to wholesale and retail price controls by the Chinese government, are primarily sold in China, but the product is also sold in various developing countries, including Malaysia, Indonesia and Kyrgyzstan. Sales of the product in China are regulated by the SFDA as a prescription drug and therefore must be sold to consumers through hospital pharmacies and cannot be advertised, thus limiting the ability of the company to market the brand. Approximately 1.8% of sales of Xuesaitong Soft Capsules are sold to hospitals directly while approximately 98.2% of sales are made to distributors. Our three largest customers are Yunnan Province Pharmaceutical, LTD.; Nanyang Jikang Medicine LTD; and Beijing Ai’xin Weiye Medicine, LTD, all of which accounted for 7.3%, 6.1% and 5.6% of our sales for the year ended December 31, 2007.
 
29

 
As of December 31, 2007, our marketing team maintains sales offices or agents in approximately 20 provinces throughout China. The sales network covers approximately 186 cities and is staffed by approximately 400 sales representatives. We intend to grow our internal marketing and sales function and increase our relationships with other national distributors to expand the distribution and presence of our non-prescription brands and cosmetics.

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

We believe that among the most important economic or industry-wide factors relevant to our growth in the short term are reform of the medical system in China and the adjustment of medicine prices, which will affect the sale of our main product, Xuesaitong Soft Capsules, in hospitals. In order to increase long-term growth, we have applied for the designation of Xuesaitong Soft Capsules as a medicine with “good quality worthy of high price,” which we received in February 2007. We believe this designation may help prevent future price reductions and possibly offset revenue decreases in case of declining future sales. Currently, the Chinese government supports the medical system in urban and rural communities. We hope to stabilize the sales channel into hospitals and widen the reach of sales in urban and rural communities at the same time. Large increases in medicine sales at an average lower price will ensure the growth of general medical sales over the next few years.

In September 2007, we expanded the geographic region in which our 12Ways cosmetic products were sold from our native Yunnan province to a number of cities and provinces outside our local region. We have opened a number of retail specialty counters to offer our cosmetic products at pharmacies throughout Eastern China, eventually expanding our retail presence across China. As of December 31, 2007, we have opened about 106 retail specialty counters in Beijing, Shanghai, Hangzhou, Dongwan, Shengzhen, and Shaoguang. In addition, we intend to open a 12Ways Chinese Herbal Beauty Salon in Kunming that will feature approximately ten traditional Chinese medicine practitioners and beauticians that provide a variety of services, including acupuncture, body massage, foot massage and other services. All products used in the salon will be supplied by us. Management hopes that the opening of this salon and the opening of retail counters will allow us to increase our brand recognition and strengthen marketing. Our ability to effectively open and operate new retail locations depends on several factors, including, among others, our ability to identify suitable counter locations, the availability of which is outside our control; prepare counters for opening within budget; hire, train and retain personnel; secure required governmental permits and approvals; contain payroll costs; and generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plans.

We do face certain challenges and risks, including our relatively high debt ratio, which is one of our main risks. If we fail to raise capital in overseas markets, we will encounter great difficulties as a result of the shortage of working capital which we expect to face when our new cosmetic and health products come onto the market. There is potential for growth in production and sales, due to the growth of new products and expansion of new channels into urban and rural communities. However, it will be uncertain which of our new products will pass the applicable tests and get clinical approval without difficulty because the uncertainty of test results and clinical approvals, which relates only to our new products. Over the last three years, the price of the main raw material we use - sanchi - has stabilized and is rising slightly, which will likely increase our cost of products sold.

Company History

We were incorporated in the State of Delaware on May 24, 2005. We were originally organized as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. Our principal business operations from inception to August 31, 2006, to closing of the Share Exchange, was to achieve long-term growth potential through a combination with a business rather than immediate, short-term earnings. On June 30, 2006, we entered into a Share Exchange Agreement (the “Exchange Agreement”) with Kunming Shenghuo Pharmaceutical (Group) Co., Ltd. (“Shenghuo China”) and Lan’s Int’l Medicine Investment Co., Limited, a Hong Kong corporation and shareholder holding 93.75% of the equity interest of Shenghuo China (“LIMI”). On August 11, and 28, 2006, the parties entered into Amendment No. 1 and 2 to the Exchange Agreement, respectively. Pursuant to the Exchange Agreement, as amended, we agreed to issue an aggregate of 16,255,400 shares of our common stock to LIMI and its designees in exchange for 93.75% of the equity interest of Shenghuo China (the “Share Exchange”). The Share Exchange closed on August 31, 2006. Upon the closing of the Share Exchange, we (i) became the 93.75% parent of Shenghuo China, (ii) assumed the operations of Shenghuo China and its subsidiaries and (iii) changed our name from SRKP 8, Inc. to China Shenghuo Pharmaceutical Holdings, Inc.
 
30

 
Shenghuo China was formed in 1995 as a limited company under the laws of the People’s Republic of China (“PRC”) with an initial capitalization of approximately $602,000, with Kunming Nanguo Biology Source Development Institute (“Nanguo”) owning approximately 55% of its outstanding equity interests and Guangdong Maoming Huazhou Company (“Guangdong”) owning approximately 45% of its equity interests. In November 1999, Guangdong transferred all of its equity interests to Nanguo, which, as a result, became Shenghuo China’s 100% parent. Also in November 1999, Nanguo entered into an agreement with the Pharmaceutical Institute of Kunming Medical College (the “College”) to purchase the rights to the technology for the preparation of Sanchi, including the technology of extracting and separating the Sanchi from Panax notoginseng, analysis data, the conditions and methods of synthesize, manufacture and the quality-control. Terms of the agreement required an initial payment of approximately $217,000 and a final payment of approximately $3.9 million upon receiving governmental approval and protection for the developed techniques. In March 2000, Nanguo made an additional net investment of approximately $1.3 million and a new investor, Yunnan Yunwei (Group) Co., LTD (“Yunwei”) made a capital investment of approximately $3.7 million into Shenghuo China, and in May 2002, a new investor, SDIC Venture Capital Investment, Co., Ltd. (“SDIC”), made an investment of approximately $483,000. In August 2004, Nanguo sold the rights to the technology to Shenghuo China for approximately $3.5 million, and in January 2005, Nanguo purchased all of the equity interests held by Yunwei for approximately the same amount, resulting in Nanguo becoming Shenghuo China’s 93.75% parent, and SDIC’s percentage holding in Shenghuo China became 6.25% of Shenghuo China’s outstanding equity interests. In 2006, Nanguo transferred its 93.75% interest to Lan’s Int’l Medicine Investment Co., Ltd., a company formed under the laws of Hong Kong (“LIMI”), and Shenghuo China was restructured into Chinese Foreign Equity Joint Venture under the laws of the PRC. On August 31, 2006, pursuant to the terms of the Share Exchange Agreement, we issued an aggregate of 16,255,400 shares of our common stock to LIMI and its designees in exchange for 93.75% of the equity interest of Shenghuo China.

The acquisition of Shenghuo China by us pursuant to the Share Exchange was accounted for as a recapitalization by us. The recapitalization was, at the time of the Share Exchange, the merger of a private operating company (Shenghuo China) into a non-operating public shell corporation (us) with nominal net assets and as such is treated as a capital transaction, rather than a business combination. As a result no goodwill is recorded. The transaction is the equivalent to the issuance of stock by the private company for the net monetary assets of the shell corporation. The pre-acquisition financial statements of Shenghuo China are treated as the historical financial statements of the consolidated companies.

Recent Events

On June 19, 2007, we sold 460,000 shares of our common stock at a price of $3.50 per share in an initial public offering for gross proceeds of $1,610,000. We received an aggregate of $1,094,381 of net proceeds, after deducting underwriter’s fees and other expenses of $515,619 incurred in connection with the sale. In conjunction with the sale of common stock, we issued a warrant to the underwriter for services performed to purchase 40,000 shares of our common stock at an exercise price of $4.20 per share which expires on June 14, 2012. The proceeds were allocated to the warrant based upon its fair value of $206,268, and the remaining proceeds were allocated to the shares of common stock. The warrant holder has unlimited piggyback registration rights, as well as the ability to request, at our expense a single registration of the shares underlying the warrant.

On October 10, 2007, a warrant holder fully exercised warrants to purchase an aggregate of 100,000 shares of our common stock at a per share exercise price of $2.50. The exercise of the warrants was conducted in accordance with the warrant agreement entered into by the holder and us on August 31, 2006. As a result of the exercise, we issued the holder 100,000 shares of common stock and we received aggregate exercise proceeds of $250,000.
 
Critical Accounting Policies and Estimates

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

Basis of Presentation and Translating Financial Statements - The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The functional currency of the operating subsidiaries in the PRC is the Chinese Yuan Renminbi (“CNY”); however, the consolidated financial statements have been expressed in United States Dollars (“USD”). The accompanying consolidated balance sheets have been translated into USD at the exchange rates prevailing at each balance sheet date. The consolidated statements of operations have been translated using the average exchange rates prevailing during the operating periods of each statement.

31

 
Cash and Cash Equivalents - Our cash and cash equivalents are maintained in bank deposit accounts. We have not experienced any losses with respect to these deposits. Cash and cash equivalents include interest bearing and non-interest bearing bank deposits, money market accounts, and short-term certificates of deposit with original maturities of three months or less. We do not have any restricted cash as of December 31, 2007. We did not enter into any hedge contracts during any of the periods presented.

Accounts Receivable, Employee Advances and Allowance for Doubtful Accounts – Trade receivables and employee advances are carried at original invoiced amounts less an allowance for doubtful accounts. An allowance for uncollectible accounts receivable is established by charges to operations for amounts required to maintain an adequate allowance, in management’s judgment, to cover anticipated losses from customer accounts and sales returns. Such accounts are charged to the allowance when collection appears doubtful. Any subsequent recoveries are credited to the allowance account. Customers that have outstanding balances for longer than three months have their credit curtailed. Employee advances consist of business advances to employees for travel and related expenses and various prepaid expenses. As time passes from when advances are made to employees for travel and related expenses, we will create an allowance for these older receivables as the likelihood of collection from each particular employees decreases as their respective advances age. We believe that the allowance for doubtful accounts is consistent with industry standards in the PRC based on the products that are being sold. The allowance for doubtful accounts at December 31, 2007 for trade accounts receivable and current and long-term employee advances was $2,083,561 and $2,600,893, respectively.

Advances to Suppliers and Advances from Customers - As is customary in the PRC, we will often make advanced payments to suppliers for materials, which may include provisions that set the purchase price and delivery date of raw materials, or receive advance payments from customers.

Basic and Diluted Earnings per Share – Basic and diluted earnings per share are calculated by dividing net earnings attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the year. Diluted earnings per share are calculated to give effect to potentially issuable dilutive common shares. Potentially dilutive securities as of December 31, 2007 are comprised of warrants to purchase 40,000 shares of common stock at an exercise price of $4.20 and warrants to purchase 6,000 shares of common stock at an exercise price of $3.50. There were no potentially dilutive shares at December 31, 2006.

Advertising Expense – We expense advertising costs as incurred. Advertising expense was $330,937 and $9,396 for the years ended December 31, 2007 and 2006, respectively.

Comprehensive Income - Other comprehensive income presented in the consolidated financial statements consists of cumulative foreign currency translation adjustments.
 
32

 
Results of Operations

The following table sets forth our results of operations in dollars and as a percentage of revenues for the years ended December 31, 2007 and 2006.
 
   
Years Ended December 31,
 
   
2007
 
2006
 
   
In Dollars
 
Percent of
Revenues
 
In Dollars
 
Percent of
Revenues
 
   
(dollar amounts in thousands, except for share
and earnings per share data)
 
                   
Sale of Products
 
$
19,974
   
100.0
%  
$
19,960
   
100.0
%
Cost of Products Sold
   
5,038
   
25.2
%
 
6,400
   
32.1
%
                           
Gross Profit
   
14,936
   
74.8
%
 
13,560
   
67.9
%
                           
Operating Expenses:
                         
Selling expense
   
6,841
   
34.3
%
 
5,256
   
26.3
%
General and administrative expense
   
4,936
   
24.7
%
 
3,903
   
19.6
%
Research and development expense
   
272
   
1.4
%
 
28
   
0.1
%
Total Operating Expenses
   
12,049
   
60.4
%
 
9,187
   
46.0
%
                           
Income from Operations
   
2,887
   
14.4
%
 
4,373
   
21.9
%
                           
Other Income (Expense):
                         
Interest income
   
22
   
0.1
%
 
8
   
0.0
%
Income from research and development activities
   
448
   
2.2
%
 
105
   
0.5
%
Interest expense
   
(946
)
 
-4.7
%
 
(757
)
 
-3.8
%
Non-operating expenses
   
(78
)
 
-0.4
%
 
(7
)
 
0.0
%
Net Other Expense
   
(554
)
 
-2.8
%
 
(652
)
 
-3.3
%
                           
Income Before Income Taxes
   
2,333
   
11.7
%
 
3,721
   
18.6
%
Benefit from (provision for) income taxes
   
1,979
   
9.9
%
 
(406
)
 
-2.0
%
Minority interest in income of subsidiaries
   
(295
)
 
-1.5
%
 
(313
)
 
-1.6
%
                           
Net Income
 
$
4,017
   
20.1
%
$
3,001
   
15.0
%
                           
Net Income
 
$
4,017
   
20.1
%
$
3,001
   
15.0
%
Foreign currency translation adjustment
   
810
   
4.1
%
 
176
   
0.9
%
Comprehensive Income
 
$
4,827
   
24.2
%
$
3,178
   
15.9
%
                           
Earnings Per Share
                         
Basic
 
$
0.21
       
$
0.17
       
Diluted
 
$
0.21
       
$
0.17
       
Weighted-Average Shares Outstanding
                         
Basic
   
19,387,619
         
17,198,308
       
Diluted
   
19,439,077
         
17,198,308
       

Fiscal Years Ended December 31, 2007 and 2006

Sale of products: Sale of products for the year ended December 31, 2007 was approximately $19.97 million, which is approximately equal to our sale of products of approximately $19.96 million for the year ended December 31, 2006. The sale of products in 2007 was consistent with that of 2006 because we experienced a decrease in our sales volume in the second half of 2007 due to the adoption of stricter credit policies as described above. We also experienced an increase in sales prices, which offset the decrease of sales volume.

Cost of products sold:  Our costs of products sold for the year ended December 31, 2007 was approximately $5.04 million, a decrease of approximately $1.36 million, or 21.2%, from approximately $6.40 million for the year ended December 31, 2006. Though the sale of products for the years ended December 31, 2007 and 2006 were relatively equal, we had a decrease in sales volume, which decreased our cost of products sold. The production level of our primary product Xuesaitong Soft Capsules and the production efficiency for its main ingredient, Sachi Saponin, has improved, which lead to a decrease in our unit cost and cost of products sold.

Gross profit: Our gross profit for the year ended December 31, 2007 was approximately $14.94 million as compared with approximately $13.56 million for the year ended December 31, 2006. Gross profit as a percentage of revenues was approximately 74.8% for the year ended December 31, 2007, which is an increase as compared to 67.9% for the year ended December 31, 2006. The increase in gross margin was primarily due to a decrease in cost of products sold, which was due to the increase of sale price and the decrease of unit cost of Xuesaitong Soft Capsules.
 
33


Selling expense: Selling expenses were approximately $6.84 million for the year ended December 31, 2007, an increase of $1.59 million, or 30.2%, from approximately $5.26 million for the year ended December 31, 2006. As a percentage of total revenue, selling expense was 34.3% for the year ended December 31, 2007, as compared to 26.3% for the year ended December 31, 2006. The primary reasons for the increase are (i) the higher commissions that we paid to sales representatives and sales offices in an effort to stimulate the sales market, (ii) an increase in marketing and advertising of new products, particularly in our cosmetics line, (iii) costs related to our restructuring an integration of our commercial channels. We analyzed and re-evaluated 328 distributor firms that we used throughout China on the basis of their operation scale, business reputation and strength, among other things, in an attempt to eliminate unqualified or small distributors, reducing our number of distributor firms to 80. We believe that this integration will improve the efficiency of our commercial channels, facilitate our management of distribution, accelerate a return on our funds provided to distributors, and reduce the occurrence of bad debts. We also amended our sale policies in an attempt to streamline our sales teams, re-aligning sales teams to specific hospitals as opposed to geographic regions. We believe this reform will re-focus our sales teams, reduce expenses in the long-term, and increase market share.

General and administrative expense: General and administrative expenses were $4.94 million for the year ended December 31, 2007, an increase of approximately $1.03 million, or 26.4%, from approximately $3.90 million for the year ended December 31, 2006. As a percentage of total revenue, general and administrative expense was 24.7% for the year ended December 31, 2007, an increase as compared to 19.6% for the year ended December 31, 2006. The increase in dollar amount and as a percentage of revenue was primarily a result of expenses related to our status as a public company with its securities traded on a U.S. national exchange. These fees and expenses are related to professional fees, including auditing, legal, investor relations, as well AMEX fees and the cost of compliance with federal securities laws.

Research and development expense: Research and development expense for the year ended December 31, 2007 was approximately $272,000 as compared to approximately $28,000 for the year ended December 31, 2006. The increase was primarily due to our efforts to enhance our product development during the year ended December 31, 2007, which we expect to continue over the next three years. We expended funds to enhance our production technology and manufacturing capabilities.

Net other expense: Net other expense, which includes interest income, income from research and development activities, interest expense and non-operating expenses, was $554,000 for the year ended December 31, 2007 as compared to $652,000 for the year ended December 31, 2006, a decrease of approximately $98,000, or 14.98%. The decrease in net other expense was primarily due to the increase of income from research and development activities, partially offset by an increase in interest expense.

Benefits from (Provision for) income taxes: Benefit from income taxes was approximately $1.98 million for the year ended December 31, 2007 as compared to a provision for income tax of approximately $406,000 for the year ended December 31, 2006. The increase in the benefits from income taxes was related to our receipt of a grant of relief from income taxes. On March 15, 2007, one of our major subsidiaries, Shenghuo Medicine Co., Ltd., was granted an approval of their application by the PRC government for relief of income taxes for the years ended December 31, 2006 and 2005. As a result, Shenghuo Medicine Co., Ltd. recognized an aggregate of approximately $976,000 in income taxes that are no longer payable as of March 15, 2007. The remaining amount of approximately $1.0 million is principally comprised of deferred tax benefits from net operating losses and adjustments of bad debt allowances.

Net income: Net income increased to $4.02 million for the year ended December 31, 2007 as compared to approximately $3.00 million for the year ended December 31, 2006, an increase of $1.02 million, or 33.8%. Considering the foreign currency translation adjustments of approximately $810,000 and $176,000 for the years ended December 31, 2007 and 2006, respectively, comprehensive income of $4.83 million and $3.18 million was realized for the years ended December 31, 2007 and 2006, respectively.

Liquidity and Capital Resources

General - As of December 31, 2007, we had cash and cash equivalents of $2.80 million. We have historically financed our business operations through bank loans, in addition to equity offerings. As of December 31, 2007, we had borrowed from banks and other institutions and had amounts of approximately $5.33 million in short-term notes payable. As of December 31, 2007, we had also borrowed $ 4.10 million in our current portion of long-term debt. For the year ended December 31, 2007, the net decrease in cash and cash equivalents was approximately $891,000. The gross proceeds that we received in June 2007 as a result of the sale of 460,000 shares of our common stock in an initial public offering were offset primarily by increases in receivables from related parties, accounts receivable and employee advances. In addition, we received gross proceeds of $250,000 in October 2007 from an exercise of warrants by a warrant holder to purchase 100,000 shares of our common stock at a per share exercise price of $2.50.
 
34


On August 17, 2007, we received a loan for $6,651,094 (RMB 50 million) from Shuang Long Branch of Agricultural Bank of China with a term of two years. The loan bears interest at a rate of 7.722%, which is due quarterly. Principal payments for the loan were agreed to as follows:

2007
 
$
665,109
 
2008
   
1,995,328
 
2009
   
3,990,657
 
     
6,651,094
 

The loan is for working capital and is guaranteed by Lan's International Medicine Investment Co Ltd. (“LIMI”). Gui Hua Lan, our Chief Executive Officer; Feng Lan, our President; and Zheng Yi Wang, our Executive Director of Exports, are directors and have voting and investment control over the shares owned by LIMI, which beneficially owns or controls approximately 77.3% of our outstanding shares. In addition, Gui Hua Lan, Feng Lan and Zheng Yi Wang owns 62.42%, 5.15% and 1.45%, respectively, of LIMI’s issued and outstanding shares. LIMI is not receiving any compensation for the guarantee of our loan.

The following table provides summary information about net cash flow for the year ended December 31, 2007 and 2006:

   
Years ended December 31,
 
   
2007
 
2006
 
   
(in thousands)
 
           
Net cash provided by (used in) operating activities
 
$
(5,037
)
$
1,500
 
               
Net cash provided by (used in) investing activities
   
378
   
(315
)
               
Net cash provided by financing activities
   
3,563
   
1,170
 
               
Cash and Cash Equivalents at End of Period
 
$
2,801
 
$
3,691
 

Operating Activities: Net cash used in operating activities for the year ended December 31, 2007 was approximately $5.04 million, as compared to cash provided by operating activities of $1.50 million for the year ended December 31, 2006. The increase in cash used was primarily due to three primary factors. First, there was an increase in employee advances in the amount of $7.0 million during the year ended December 31, 2007 (see below for more information regarding employee advances). Second, there was an increase in inventory of $1.3 million. Third, there was an increase of advances to suppliers and a decrease of advances from customers, which were partially offset by the increases related to deferred income taxes during the year ended December 31, 2007.

Investing Activities: Net cash provided by investing activities was approximately $378,000 for the year ended December 31, 2007, as compared to net cash used in the amount of approximately $315,000 for the year ended December 31, 2006. The increase in net cash provided by investing activities was primarily a result of $487,000 in cash provided by a release of restricted cash for the year ended December 31, 2007, as compared to cash used for restricted cash in the amount of $76,000 for the same period in 2006.
 
35


Financing Activities: Net cash provided by financing activities was approximately $3.56 million for the year ended December 31, 2007 compared to $1.17 million provided for the year ended December 31, 2006. The increase in cash provided was primarily due to our sale of stock in an initial public offering in June 2007 pursuant to which we sold 460,000 shares of our common stock at a price of $3.50 per share in an initial public offering for gross proceeds of $1,610,000. We received an aggregate of $1.1 million of net proceeds, after deducting underwriter’s fees and other expenses of approximately $516,000 incurred in connection with the sale. In addition, net proceeds from short and long-term loans increased by approximately $2.4 million as compared to the same period in 2006.

As of December 31, 2007, our accounts receivable (less allowance for doubtful accounts of $2.08 million) were $9.65 million, a decrease of $0.26 million, or 2.58%, as compared to our accounts receivable of $ 9.91 million as of December 31, 2006. The collection period typically runs from nine months to one year, considering the relatively long collection period in our industry. In the third quarter of 2007, we adopted more stringent credit policies designed to improve the quality and mix of our customer base, in addition to reducing the amount of uncollectible account receivables. Due to these stricter credit policies, we experienced a decrease in sales volume during the third and fourth quarter but believe the implementation of these policies will improve our customer base and reduce the amount of uncollectible account receivables in future periods.

Our company normally requires one to two months to receive products that we order. Inventory increased during the year ended December 31, 2007 by approximately $1.54 million, an increase of 59.8% over inventory as of December 31, 2006. The increase in inventory was primarily due to the increase in work in progress. We purchased a significant amount of Sanchi, which is our main raw material for products. In order to avoid a risk of spoilage by storing the Sanchi in our warehouse, our production department purified the Sanchi into powder for storage. As a result, inventory increased. Moreover, our payment cycle is considerably shorter than our receivable cycle, since we typically pay our suppliers all or a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. We require our customers to pay a certain percentage of the sales price as deposit before we ship products to them. The percentage varies from customer to customer. During the course of business, we reduce the deposit requirement for some customers with good credit. To the extent that we cannot satisfy our cash needs, whether from operations or from a financing source, our business would be impaired in that it may be difficult for us to obtain products which could, in turn, impair our ability to generate sales. We have implemented new policies aimed at improving collection of accounts receivable in the future, including more detailed reporting from and increased control over provincial sales offices and representatives, incentives for sales representatives more closely tied to timely collection and more stringent enforcement of payment terms with distributors.

In addition, in the course of our business, we must make significant deposits to our suppliers when we place an order. As of December 31, 2007, our advance payments to our suppliers totaled approximately $670,000. We are confident that our available funds and cash generated from operations will provide us with sufficient capital for a sustainable operation; however, we may require additional capital for acquisitions or for the operation of the combined companies. As of the date of this report, we have no material commitments for capital expenditures. We cannot assure that such funding will be available.

We make significant cash advances to our sales representatives to assist and encourage them to expand the marketing and sales of our products into new markets and gain new customers. We believe the sales representatives are able to expand into new markets and obtain new customers if they have advanced funds for their travel, meals, and other incidental expenses that arise over the time they perform their functions as sales representatives. Because recently the Chinese economy has grown quickly and because competition in the pharmaceutical industry is intense, prior to September 2006, we did not ask sales representatives to pay off advances immediately. Instead, we encouraged sales representatives to expand their markets and gain more customers. However, beginning in September of 2006, we began to more vigorously pursue collection of all employee advances. Nonetheless, there are some employee advances that have aged significantly that, based on prior experience, we do not expect to collect on every outstanding advance and have estimated the uncollectible balance based on the age of the advances. When we makes advances to sales representatives, we require that our selling offices sign advance agreements with sales representatives to arrange the specific purpose of the advance, the amount of the advance, and the term of the advance. Our finance department records the detail of advances and checks the remaining balance with sales representatives every month. We also supervise the repayment of the advances. For sales representatives who do not have good credit, we require them to use real property as collateral when receiving advances from us. Additionally, for sales representatives who refuse to pay off the advances, we attempt to collect on the advances and decrease the risk of bad debt as much as possible by withholding sales commissions, prosecuting delinquent sales representatives, and by other valid means of collection. On January 1, 2007, we added punitive measures for overdue advances to the advance agreement.

Current and long-term employee advances were approximately $10.66 million at December 31, 2007 and $3.13 million as of December 31, 2006, and increase of $7.53 million, or 240.6%. The large increase was due to us advancing more money to sales representatives to encourage them to expand their markets and increase sales. As of December 31, 2007, the gross amount of employee advances was $13.26 million and as of December 31, 2006 it was $4.56 million, an increase of $8.70 million in that year period. As of December 31, 2007, the gross amount of employee advances aged over one year was $2.2 million. Additionally, beginning September 2006, we began to employ more sales representatives, and, as a result, we made more advances to sales representatives in an attempt to encourage and assist sales representatives to expand into new selling markets and gain new customers. Because of the increase in the balance of employee advances, we, in compliance with our established policy to reserve an allowance for specific percentages of our aged receivables, accrued a larger allowance for the increased employee advances in order to consistently apply our established allowance policy.
 
36


The table below sets forth the outstanding gross and net amount of outstanding balances of employee advances for the years ended December 31, 2007 and 2006.

   
Balance at beginning
of period
 
Additions
 
Reductions
 
Balance at
end of
period
 
                   
For the year ended December 31, 2006
                         
Gross amount of employee advances
 
$
2,635,269
 
$
3,492,160
 
$
1,567,958
 
$
4,559,471
 
Allowance for doubtful accounts
   
658,401
   
771,025
   
-
   
1,429,426
 
Net amount
 
$
1,976,868
 
$
2,721,135
 
$
1,567,958
 
$
3,130,045
 
                           
For the year ended December 31, 2007
                         
Gross amount of employee advances
 
$
4,559,471
 
$
13,338,719
 
$
4,635,840
 
$
13,262,350
 
Allowance for doubtful accounts
   
1,429,426
   
1,171,467
   
-
   
2,600,893
 
Net amount
 
$
3,130,045
 
$
12,167,252
 
$
4,635,840
 
$
10,661,457
 
 
As of December 31, 2007, we had accrued taxes that included approximately $736,000 million in Value Added Taxes, or VAT taxes. In China, companies are required to file income tax returns for the current year before April 15 of the following year and file VAT tax returns for the current month within ten days of the end of the month. In the past, we filed VAT tax returns every month after getting VAT invoices; however, because some customers did not immediately process these invoices, we did not include on a timely basis those invoices in the income and VAT tax returns for our returns. In June 2006, we became aware that there were some income taxes and VAT taxes that were not included on a timely basis on our tax returns and we requested that these customers process all invoices from us. On March 15, 2007, one of our majority owned subsidiaries was granted an exemption from income taxes for the years ended December 31, 2006 and 2005. The approval of this exemption by the government of the PRC reduced the amount of prior income tax payable during 2007 by approximately $976,000. During 2008, we believe that we will have sufficient cash flows from operations to meet the accrued tax liabilities. Further, the income tax exemption granted to one of our majority owned subsidiaries will reduce the cash required to relieve these liabilities.

Off-Balance Sheet Arrangements

None.

Foreign Currency Risk

Since all of our operations are conducted in the PRC, we are subject to special considerations and significant risks not typically associated with companies operating in the United States of America. These risks include, among others, the political, economic and legal environments and foreign currency exchange rate fluctuations. Our operational results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to medical reforms and other laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from its operations in the PRC. In addition, all of our revenue is denominated in the Chinese Yuan Renminbi (“CNY”), which must be converted into other currencies before remittance out of the PRC. Both the conversion of CNY into foreign currencies and the remittance of foreign currencies abroad require approval of the PRC government. The effect of the fluctuations of exchange rates is not considered to be material to our business operations.

Interest Rate Risk

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

ITEM 7.
FINANCIAL STATEMENTS
 
The information required by this Item 7 is incorporated by reference to the Index to Consolidated Financial Statements beginning at page F-1 of at the end of this Form 10-KSB.
 
37

 
ITEM 8.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 8A.
CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, our management, including Lan Gui Hua our Principal Executive Officer, and Qionghua Gao, our Principal Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007.
 
Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.
 
Management conducted its evaluation of disclosure controls and procedures under the supervision of our principal executive officer and our principal financial officer. Based on that evaluation, management concluded that because of the material weakness in internal control over financial reporting described below, our disclosure controls and procedures were not effective as of December 31, 2007.
 
Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act.  Our management is also required to assess and report on the effectiveness of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”).  Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007.  In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework.  During our assessment of the effectiveness of internal control over financial reporting as of December 31, 2007, management identified significant deficiencies which related to our material weakness as follows:
 

§  
Material audit adjustments related to the prior year audits were not recorded in the company’s local accounting records that were necessary to reconcile the retained earnings to the prior year balances in accordance with US GAAP.
 
§  
The U.S. GAAP expertise of our internal accounting staff
 
§  
Our internal audit functions
 
 
38

 

Although our accounting staff is professional and experienced in accounting requirements and procedures generally accepted in the PRC, management has determined that they require additional training and assistance in U.S. GAAP matters.  Management has determined that our internal audit function is also significantly deficient. 

In order to correct the foregoing material weaknesses, we have taken the following remediation measures:
 
§  
We will maintain a separate, independent set of accounting records to record all US GAAP audit adjustments along with the local GAAP accounting records so as to reconcile our records according to US GAAP.
 
§  
We will arrange necessary training and engage with external professional accounting or consultancy firms to assist us in the preparation of the US GAAP accounts .
 
§  
We have recently established an internal audit function to strengthen the overall internal control environment, and the current skill and experience mix of the internal audit staff. However, this may not ensure an effective internal audit function. To ensure that it becomes an effective monitoring component of internal control framework of the Company, we will focus on preparing internal audit manual, audit planning and provide for sufficient training and development of the internal audit team. Moreover, the Company has begun the recruitment process to strengthen the overall effectiveness of the team and to oversee the implementation of our internal controls over financial reporting. The internal audit department is independent and reports directly to the audit committee.  
 

In addition, we have allocated significant financial and human resources to strengthen the internal control structure. As part of our efforts to comply with Section 404 of the Sarbanes-Oxley Act for fiscal year 2008, we are actively working with external consultants to assess our data collection, financial reporting, and control procedures and to strengthen our internal controls over financial reporting.

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

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

Our management is not aware that the material weakness in our internal control over financial reporting causes them to believe that any material inaccuracies or errors existed in our financial statement as of December 31, 2007.  The reportable conditions and other areas of our internal control over financial reporting identified by us as needing improvement have not resulted in a material restatement of our financial statements. Nor are we aware of any instance where such reportable conditions or other identified areas of weakness have resulted in a material misstatement of omission in any report we have filed with or submitted to the Commission.   

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

Auditor Attestation

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

Changes in Internal Controls over Financial Reporting

Except as described above, there were no changes in our internal controls over financial reporting during the fourth quarter of fiscal year 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
ITEM 8B.
OTHER INFORMATION
 
None.

PART III
 
ITEM 9.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

The information required by this Item 9 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2007 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-KSB/A, not later than the end of the 120-day period.
 
39

 
ITEM 10.
EXECUTIVE COMPENSATION

The information required by this Item 10 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2007 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-KSB/A, not later than the end of the 120-day period.

ITEM 11.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item 11 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2007 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-KSB/A, not later than the end of the 120-day period.

ITEM 12.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item 12 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2007 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-KSB/A, not later than the end of the 120-day period.

ITEM 13.
EXHIBITS
 
EXHIBIT INDEX

Exhibit
No.
 
Description
2.1
 
 
Share Exchange Agreement, dated as of June 30, 2006, by and among the Registrant, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and Lan’s Int’l Medicine Investment Co., Limited (incorporated by referenced from Exhibit 2.1 to the Quarterly Report on Form 10-QSB filed with the Securities and Exchange Commission on July 28, 2006).
 
2.1(a)
 
 
Amendment No. 1 to the Share Exchange Agreement, dated as of August 11, 2006, by and among the Registrant, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and Lan’s Int’l Medicine Investment Co., Limited (incorporated by reference from Exhibit 2.1(a) to the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on December 21, 2006).
 
2.1(b)
 
 
Amendment No. 2 to the Share Exchange Agreement, dated as of August 28, 2006, by and among the Registrant, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and Lan’s Int’l Medicine Investment Co., Limited (incorporated by reference from Exhibit 2.1(b) to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
3.1
 
 
Certificate of Incorporation of the Registrant (incorporated by reference from Exhibit 3.1 to Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on August 3, 2005).
 
3.2
 
 
Bylaws of the Registrant (incorporated by reference from Exhibit 3.2 to Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on August 3, 2005, and incorporated herein by reference).
 
3.3
 
 
Articles of Merger Effecting Name Change (incorporated by reference from Exhibit 3.3 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.1
 
 
Form of Subscription Agreement dated August 31, 2006 (incorporated by reference from Exhibit 10.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
40

 
Exhibit
No.
 
Description
 10.2*  
 Employment Agreement dated December 3, 2004 by and between Gui Hua Lan and the Registrant (translated to English) (incorporated by reference from Exhibit 10.2 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.3*
 
 
Employment Agreement dated December 3, 2004 by and between Feng Lan and the Registrant (translated to English) (incorporated by reference from Exhibit 10.3 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.4*
 
 
Employment Agreement dated December 3, 2004 by and between Lei Lan and the Registrant (translated to English) (incorporated by reference from Exhibit 10.4 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.5*
 
 
Employment Agreement dated December 3, 2004 by and between Qiong Hua Gao and the Registrant (translated to English) (incorporated by reference from Exhibit 10.5 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.6*
 
 
Employment Agreement dated December 3, 2004 by and between Peng Chen and the Registrant (translated to English) (incorporated by reference from Exhibit 10.6 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.7*
 
 
Employment Agreement dated December 3, 2004 by and between Zheng Yi Wang and the Registrant (translated to English) (incorporated by reference from Exhibit 10.7 to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2006).
 
10.8
 
 
Joint Establishment Agreement of Kunming Beisheng Science & Technology Development Co., Ltd. dated January 1, 2006 entered into by and between the Registrant and Beijing University Shijia Research Center (translated to English) (incorporated by reference from Exhibit 10.8 to the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on December 21, 2006).
 
10.9
 
 
Joint Venture Agreement for Kunming Shenghuo Pharmaceutical Group Co., Ltd. dated May 22, 2006 entered into by and between Lan’s Int’l Medicine Investment Co., Limited and SDIC Venture Capital Investment, Co., Ltd. (translated to English) (incorporated by reference from Exhibit 10.9 to the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on December 21, 2006).
 
10.10
 
 
Form of Lock Up Agreement for Investors in the August 2006 Private Placement (incorporated by reference from Exhibit 10.10 to the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on December 21, 2006).
 
21.1
 
 
List of Subsidiaries (incorporated by reference from Exhibit 21.1 to the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on April 25, 2007).
 
23.1
 
Consent of Hansen, Barnett & Maxwell, P.C.
________________
*  Indicates management contract or compensatory plan or arrangement.

ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item 14 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2007 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-KSB/A, not later than the end of the 120-day period.

41



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the Province of Yunnan, People’s Republic of China, on the date indicated.

   
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
     
Date: March 31, 2008
 
/s/ Gui Hua Lan
   
Gui Hua Lan, Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Date: March 31, 2008
 
/s/ Gui Hua Lan
   
Gui Hua Lan, Chief Executive Officer and
Chairman of the Board (Principal Executive Officer)
     
Date: March 31, 2008
 
/s/ Qiong Hua Gao
   
Qiong Hua Gao, Chief Financial Officer
(Principal Financial and Accounting Officer)
     
Date: March 31, 2008
 
/s/ Feng Lan
   
Feng Lan, President and Director
     
Date: March 31, 2008
 
/s/ Zheng Yi Wang
   
Zheng Yi Wang, Executive Director of Exports,
Corporate Secretary and Director
     
Date: March 31, 2008
 
/s/ Yunhong Guan
   
Yunhong Guan, Director
     
Date: March 31, 2008
 
/s/ Mingyang Liao
   
Mingyang Liao, Director
     
Date: March 31, 2008
 
/s/ Gene Michael Bennett
   
Gene Michael Bennett, Director

42

CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
AND SUBSIDIARIES

TABLE OF CONTENTS

Report of Independent Registered Public Accounting Firm
 
F-2
 
   
Consolidated Balance Sheets as of December 31, 2007 and 2006
 
F-3
 
   
Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2007 and 2006
 
F-4
 
   
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2006 and 2007
 
F-5
 
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2007 and 2006
 
F-6
 
   
Notes to the Consolidated Financial Statements
 
F-8
 
F-1

 
HANSEN, BARNETT& MAXWELL, P.C.  
A Professional Corporation
CERTIFIED PUBLIC ACCOUNTANTS
5 Triad Center, Suite 750
Salt Lake City, UT 84180-1128
Phone: (801) 532-2200
Fax: (801) 532-7944
www.hbmcpas.com
Registered with the Public Company
Accounting Oversight Board
 
Baker Tilly Logo
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
China Shenghuo Pharmaceutical Holdings, Inc.

We have audited the accompanying consolidated balance sheets of China Shenghuo Pharmaceutical Holdings, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Shenghuo Pharmaceutical Holdings, Inc. and subsidiaries as of December 31, 2007 and 2006 and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
 
HANSEN, BARNETT & MAXWELL, P.C.

Salt Lake City, Utah
March 28, 2008
 
F-2

 
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS

   
December 31,
 
   
2007
 
2006
 
ASSETS:
         
Current Assets:
         
Cash and cash equivalents
 
$
2,800,641
 
$
3,691,438
 
Restricted cash
   
-
   
474,576
 
Accounts receivable, less allowance for doubtful accounts of $2,083,561 and $794,468, respectively
   
9,651,304
   
9,907,184
 
Employee advances, less allowance for doubtful accounts of $883,815 and $1,429,426, respectively
   
10,147,415
   
3,130,045
 
Advances to suppliers
   
669,858
   
46,620
 
Inventory, net of reserve for obsolescence of $136,359 and $111,128, respectively
   
4,125,193
   
2,581,519
 
Receivable from related parties
   
27,555
   
76,751
 
Other current assets
   
159,657
   
17,454
 
Total Current Assets
   
27,581,623
   
19,925,587
 
Property, plant and equipment, net of accumulated depreciation of $4,247,993 and $3,333,305, respectively
   
7,573,204
   
7,554,747
 
Intangible assets, net of accumulated amortization of $42,957 and $22,569, respectively
   
648,090
   
624,426
 
Long-term employee advances, less allowance for doubtful accounts of $1,717,078 and $0, respectively
   
514,042
   
-
 
Deferred income taxes
   
1,593,159
   
655,223
 
TOTAL ASSETS
 
$
37,910,118
 
$
28,759,983
 
LIABILITIES AND STOCKHOLDERS' EQUITY:
             
Current Liabilities:
             
Accounts payable
 
$
745,514
 
$
764,636
 
Accrued expenses
   
2,017,748
   
1,966,822
 
Deposits
   
3,439,892
   
1,573,426
 
Payable to related parties
   
94,939
   
393,213
 
Short-term notes payable
   
5,334,260
   
12,758,426
 
Advances from customers
   
119,287
   
342,531
 
Taxes and related payables
   
855,084
   
3,057,471
 
Current portion of long-term debt
   
4,101,667
   
-
 
Total Current Liabilities
   
16,708,391
   
20,856,525
 
Long-Term Debt
   
6,836,111
   
-
 
Total Liabilities
   
23,544,502
   
20,856,525
 
               
Minority Interest in Net Assets of Subsidiaries
   
655,962
   
385,067
 
               
Stockholders' Equity:
             
Preferred stock, $0.0001 par value, 10,000,000 shares authorized, 0 shares outstanding
   
-
   
-
 
Common stock, $0.0001 par value, 100,000,000 shares authorized, 19,679,400 and 19,119,400 outstanding, respectively
   
1,968
   
1,912
 
Additional paid-in capital
   
6,193,927
   
4,829,633
 
Statutory reserves
   
147,023
   
147,023
 
Retained earnings
   
6,335,590
   
2,318,950
 
Accumulated other comprehensive income, foreign currency translation
   
1,031,146
   
220,873
 
Total Stockholders' Equity
   
13,709,654
   
7,518,391
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
37,910,118
 
$
28,759,983
 
 
The accompanying notes are an integral part of these consolidated financial statements
F-3

 
CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME

   
Years Ended
December 31,
 
   
2007
 
2006
 
           
Sale of Products
 
$
19,973,918
 
$
19,959,971
 
Cost of Products Sold
   
5,038,290
   
6,400,234
 
Gross Profit
   
14,935,628
   
13,559,737
 
               
Operating Expenses:
             
Selling expense
   
6,840,824
   
5,255,907
 
General and administrative expense
   
4,935,754
   
3,903,287
 
Research and development expense
   
272,295
   
28,001
 
Total Operating Expenses
   
12,048,873
   
9,187,195
 
               
Income from Operations
   
2,886,755
   
4,372,542
 
               
Other Income (Expense):
             
Interest income
   
22,431
   
7,791
 
Income from research and development activities
   
448,254
   
105,053
 
Interest expense
   
(946,456
)
 
(757,432
)
Non-operating expenses
   
(78,164
)
 
(6,932
)
Net Other Expense
   
(553,935
)
 
(651,520
)
               
Income Before Income Taxes
   
2,332,820
   
3,721,022
 
Benefit from (provision for) income taxes
   
1,978,963
   
(406,082
)
Minority interest in income of subsidiaries
   
(295,143
)
 
(313,444
)
Net Income
 
$
4,016,640
 
$
3,001,496
 
Foreign currency translation adjustment
   
810,273
   
176,060
 
Comprehensive Income
 
$
4,826,913
 
$
3,177,556
 
               
Earnings Per Share
             
Basic
 
$
0.21
 
$
0.17
 
Diluted
 
$
0.21
 
$
0.17
 
Weighted-Average Shares Outstanding
             
Basic
   
19,387,619
   
17,198,308
 
Diluted
   
19,439,077
   
17,198,308
 

The accompanying notes are an integral part of these consolidated financial statements
 
F-4


CHINA SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

           
Additional
     
Retained
 
Accumulated
Other
 
Total
 
   
Common Stock
 
Paid-in
 
Statutory
 
Earnings
 
Comprehensive
 
Stockholders'
 
   
Shares
 
Amount
 
Capital
 
Reserves
 
(Deficit)
 
Income
 
Equity
 
Balance, December 31, 2005
   
16,227,200
 
$
1,626
 
$
2,659,134
 
$
147,023
 
$
(682,546
)   
$
44,813
  
$
2,170,050
 
Conversion of common shares to minority interest
   
(1,014,200
)   
 
(101
)   
 
(223,211
)   
 
-
      
-
   
-
     
(223,312
)
Issuance of common shares for services
   
1,242,400
   
121
   
1,118,040
   
-
   
-
   
-
   
1,118,161
 
Issuance of warrants for services
   
-
   
-
   
11,240
   
-
   
-
   
-
   
11,240
 
Issuance of common shares for cash, net
                                           
of offering costs
   
2,000,000
   
200
   
1,264,496
   
-
   
-
   
-
   
1,264,696
 
Issuance to acquire SRKP 8
   
664,000
   
66
   
(66
)
 
-
   
-
   
-
   
-
 
Net income for the year
   
-
   
-
   
-
   
-
   
3,001,496
   
-
   
3,001,496
 
Foreign currency translation adjustment
   
-
   
-
   
-
   
-
   
-
   
176,060
   
176,060
 
                                             
Balance, December 31, 2006
   
19,119,400
   
1912
   
4,829,633
   
147,023
   
2,318,950
   
220,873
   
7,518,391
 
Shares issued in public offering , net of costs
   
460,000
   
46
   
1,094,336
   
-
   
-
   
-
   
1,094,382
 
Exercise of warrants for cash
   
100,000
   
10
   
249,990
   
-
   
-
   
-
   
250,000
 
Issuance of warrants for services
   
-
   
-
   
19,968
   
-
   
-
   
-
   
19,968
 
Net income for the year
   
-
   
-
   
-
   
-
   
4,016,640
   
-
   
4,016,640
 
Foreign currency translation adjustment
   
-
   
-
   
-