To the Board of Directors and Stockholders

China Sky One Medical Inc. and Subsidiaries

 

We have audited the accompanying consolidated balance sheets of China Sky One Medical Inc. and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2009.  We also have audited the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission .  The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

 

/s/ MSPC                                                                            

MSPC

Certified Public Accountants and Advisors,

A Professional Corporation

 

 

New York, New York

March 15, 2010

F-2

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

[Letterhead of Sherb & Co., LLP]

 

To the Board of Directors and Stockholders of

China Sky One Medical, Inc.

 

We have audited the accompanying consolidated balance sheets of China Sky One Medical, Inc. and its Subsidiaries as of December 31, 2007 and the related consolidated statements of operations, stockholders’ equity and cash flows for the year ended December 31, 2007. China Sky One Medical, Inc. management is responsible for these financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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, and audit of its internal control over financial reporting. Our audit 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 purposes 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 audit provides 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 Sky One Medical, Inc. as of December 31, 2007 and the results of its operations and its cash flows for the year ended December 31, 2007 in conformity with accounting principles generally accepted in the United States.

 

 

/s/ Sherb & Co., LLP                                         

Certified Public Accountants

Boca Raton, Florida

March 25, 2008

 

F-3

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China Sky One Medical, Inc. and Subsidiaries

Consolidated Statements of Operations and Comprehensive Income

$ in thousands, except share and per share data

 

		Years Ended December 31,
		2009				2008				2007
Revenues		$	130,092			$	91,816			$	49,318
Cost of Goods Sold			31,671				22,403				10,940
Gross Profit			98,421				69,413				38,379
Operating Expenses
Selling expense			30,763				22,968				14,784
General and administrative expense			4,191				2,514				1,380
Depreciation and amortization			2,255				858				443
Research and development			14,960				7,413				3,158
Total Operating Expenses			52,170				33,753				19,765
Income from Operations			46,251				35,659				18,614
Other Income (Expenses)
Interest Income			71				112				10
Miscellaneous income (Expenses)			(32	)			702				28
Change in fair value of derivative liability			(1,330	)			-				-
Total Other Income (Expenses)			(1,291	)			814				38
Income Before Provision for Income Tax			44,960				36,473				18,652
Provision for income taxes			10,503				7,616				3,319
Net Income		$	34,457			$	28,857			$	15,333
Basic Earnings Per Share		$	2.08			$	1.91			$	1.27
Basic Weighted Average Shares Outstanding			16,575,885				15,101,833				12,094,949
Diluted Earnings Per Share		$	2.07			$	1.87			$	1.15
Diluted Weighted Average Shares Outstanding			16,668,452				15,429,136				13,370,528
Other Comprehensive Income
Foreign currency translation adjustment			312				3,295				1,850
Net income		$	34,457			$	28,857			$	15,333
Comprehensive Income		$	34,769			$	32,152			$	17,183

 

 

See accompanying notes to the consolidated financial statements.

 

F-4

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China Sky One Medical, Inc. and Subsidiaries

Consolidated Balance Sheets

$ in thousands, except share data

 

		Year Ended December 31,
		2009				2008
ASSETS
Current Assets
Cash and cash equivalents		$	52,756			$	40,288
Accounts receivable, net			21,146				14,979
Inventories			2,413				462
Prepaid and other current assets			74				106
Total current assets			76,389				55,835
Property and equipment, net			15,491				14,797
Intangible assets, net			25,114				15,852
Construction in progress			12,932				4,317
Land use rights, net			4,586				1,945
Construction deposit			5,851				8,513
Total Assets		$	140,363			$	101,259
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses		$	4,186			$	2,937
Taxes payable			3,873				3,363
Deferred revenue			-				26
Derivative liability			1,330				-
Total current liabilities			9,389				6,326
Commitments and Contingencies
Stockholders' Equity
Preferred stock ($0.001 par value, 5,000,000 shares authorized,none issued and outstanding)			-				-
Common stock ($0.001 par value, 50,000,000 shares authorized,16,714,267 and 16,306,184 issued and outstanding at December 31, 2009 and 2008, respectively)			17				16
Additional paid-in capital			41,376				40,105
Retained earnings			5,879				5,567
Accumulated other comprehensive income			130,974				94,933
Total stockholders' equity			83,702				49,245
		$	140,363			$	101,259

 

 

See accompanying notes to the consolidated financial statements.

 

F-5

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China Sky One Medical, Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity

$ in thousands, except share data

 

																		Accumulated
										Additional								Other				Total
		Common Stock								Paid-in				Retained				Comprehensive				Stockholders'
		Shares				Amount				Capital				Earnings				Income				Equity
Balance at December 31, 2006			12,031,536			$	12			$	8,822			$	5,055			$	422			$	14,311
Issuance of common stock for service			30,000				-				195												195
Warrants exercised			166,827				-				516												516
Employee stock options											40												40
Foreign currency translation adjustment																			1,850				1,850
Net income															15,333								15,333
Balance at December 31, 2007			12,228,363				12				9,573				20,388				2,272				32,245
Issuance of common stock through private placement, net			2,500,000				3				23,485												23,488
Warrants and options exercised under cash and cashless			1,142,302				1				1,866												1,867
Issuance of common stock under business acquistions			405,456				-				4,865												4,865
Share-based compensation			30,063				-				316												316
Foreign currency translation adjustment																			3,295				3,295
Net income															28,857								28,857
Balance at December 31, 2008			16,306,184				16				40,105				49,245				5,567				94,933
Warrants and options exercised under cash and cashless			355,239				-				29												29
Share-based compensation			52,844				-				1,242												1,242
Foreign currency translation adjustment																			312				312
Net income															34,457								34,457
Balance at December 31, 2009			16,714,267			$	17			$	41,376			$	83,702			$	5,879			$	130,974

 

See accompanying notes to the consolidated financial statements.

 

F-6

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China Sky One Medical, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

$ in thousands

 

		Years Ended December 31,
		2009				2008				2007
Cash Flows From Operating Activities
Net income		$	34,457			$	28,857			$	15,333
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Allowance for bad debt			17				38				-
Depreciation and amortization			2,747				858				443
Share-based compensation			1,242				316				235
Change in fair value of derivative liability			1,330				-				-
Decrease (increase) in operating assets:
Accounts receivable and other receivables			(6,204	)			(3,398	)			(7,479	)
Inventories			(1,948	)			(66	)			(73	)
Prepaid expenses and others			92				(24	)			93
Increase (decrease) in operating liabilities:
Accounts payable and accrued liabilities			1,215				(678	)			2,136
Tax payable			501				1,660				960
Deferred revenue			-				(26	)			(48	)
Net cash provided by operating activities			33,449				27,538				11,601
Cash Flows From Investing Activities
Purchase of property and equipment			(254	)			(11,167	)			(2,222	)
Land and construction deposit			-				-				(8,003	)
Construction in progress			(9,932	)			4				-
Purchase of intangible assets			(10,968	)			(11,951	)			(35	)
Net cash used in investing activities			(21,154	)			(23,115	)			(10,261	)
Cash Flows From Financing Activities
Sale of common stock for cash, net of offering costs			-				23,488				-
Proceeds from warrants conversion			29				1,868				516
Repayment of short-term loan			-				-				(548	)
Net cash provided by (used in) financing activities			29				25,355				(33	)
Effect of exchange rate changes on cash			272				1,318				1,296
Net Increase in Cash and Cash Equivalents		$	12,468			$	31,097			$	2,604
Cash and Cash Equivalents at Beginning of Year			40,288				9,191				6,587
Cash and Cash Equivalents at End of Year		$	52,756			$	40,288			$	9,191
Supplemental disclosure of cash flow information
Interest paid		$	-			$	135			$	10
Taxes paid		$	10,164			$	6,630			$	2,359

 

 

See accompanying notes to the consolidated financial statements.

 

F-7

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

1.	Description of Business

 

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

 

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

 

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

 

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

 

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

 

As of October 16, 2006, the Company organized Harbin Tian Qing Biotech Application Company as a wholly-owned PRC subsidiary of TDR (“Tian Qing”), to conduct research and development in the areas of tissue and stem cell banks.  As of December 31, 2010, Tian Qing had insignificant operation.

 

On September 30, 2008 (the “Record Date”), we obtained the written consent of the holders of 8,158,251 shares of our common stock, which as of the Record Date, represented 51.3% of our outstanding voting securities, to increase our number of authorized shares of common stock from twenty million (20,000,000) to fifty million (50,000,000) shares.

 

2.	Acquisition of Businesses

 

On April 3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical, Inc., a corporation with a multitude of medicines approved by the PRC’s State Food and Drug Administration (“SFDA”) and new medicine applications, organized under the laws of the PRC (“Tianlong”), which is in the business of manufacturing external-use pharmaceuticals. Our TDR subsidiary previously acquired the Beijing sales office of Tianlong in mid 2006. Pursuant to the Equity Transfer Agreement, TDR acquired 100% of the issued and outstanding capital stock of Tianlong from Tianlong’s sole stockholder, in consideration for an aggregate purchase price of approximately $8,300,000, consisting of (i) $8,000,000 in cash, and (ii) 23,850 shares of China Sky One (at $12 per share). The acquisition received regulatory approval and closed on April 3, 2008.

 

F-8

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

2.	Acquisition of Businesses (Continued)

 

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

 

		$ in thousands
Fixed assets		$	6,315
Intangible assets – SFDA licenses for drug batch numbers			1,787
Other			170
Net assets acquired		$	8,272

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

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

 

		$ in thousands
Cash		$	84
Intangible assets - Goodwill			353
Net assets acquired		$	437

 

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

 

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

 

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

 

		$ in thousands
Fixed assets		$	4,177
Intangible assets - SFDA licenses for drug batch numbers			2,917
Net assets acquired		$	7,094

The following table contains pro forma condensed consolidated statement of operations information assuming the Tianlong, Haina and Peng Lai transactions closed on January 1, 2007, for the years December 31, 2008 and 2007.  Peng Lai had dormant operations until October 2008.

 

		Years Ended December 31,
		2008				2007
		($ in thousands)
Revenue		$	92,378			$	51,334
Operating income		$	35,747			$	17,143
Net income		$	28,934			$	13,822
Basic earnings per common share		$	1.92			$	1.14
Basic weighted average shares outstanding			15,358,843				12,500,405
Diluted earnings per common share		$	1.88			$	1.03
Diluted weighted average shares outstanding			15,686,146				13,775,984

 

F-9

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

3.	Summary of Significant Accounting Policies

 

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

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

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

Certain items in the 2008 and 2007 financial statements have been reclassified to conform to the 2009 financial statements presentation.

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

Significant estimates include values and assigned lives to acquired tangible and intangible assets, uncollectible accounts receivable, impairment testing of goodwill and other long-lived assets. Actual results may differ from these estimates.

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

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

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

A significant amount of our cash and cash equivalents are held in commercial bank checking accounts in the PRC and earn   interest income (annual yield of approximately 0.36% for the year ended December 31, 2009). For all the bank accounts in the PRC, the Company earned interest income of approximately $71,000, $112,000 and $10,000  for the years ended December 31, 2009, 2008 and 2007, respectively.

Accounts receivable – Accounts receivable are stated at net realizable value, net of an allowance for doubtful accounts. The allowance for estimated bad debts is based upon the periodic analysis of individual customer balances including an evaluation of days of sales outstanding, payment history, recent payment trends, and perceived credit worthiness. As of December 31, 2009 and 2008, the Company’s allowance for doubtful accounts was $56,000 and $50,000, respectively.

F-10

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

3.	Summary of Significant Accounting Policies (Continued)

Inventories – Inventories include finished goods, raw materials, freight-in, packing materials, labor, and overhead costs and are valued at the lower of cost or market using the first-in, first-out method. Inventory units are valued using the weighted average method. Provisions are made for slow moving, obsolete and/or damaged inventory based upon the periodic analysis of individual inventory items including an evaluation of historical usage and/or movement, age, expiration date, and general conditions. The Company recorded no inventory reserve position as of December 31, 2009 and 2008.

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

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

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

Property and equipment are evaluated for impairment in value whenever an event or change in circumstances indicates that the carrying values may not be recoverable. If such an event or change in circumstances occurs and potential impairment is indicated because the carrying value exceeds the estimated future undiscounted cash flows of the asset, the Company will measure the impairment loss as the amount by which the carrying value of the asset exceeds its fair value. The Company did not record any impairment charges of property and equipment in the years ended December 31, 2009, 2008 and 2007.

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

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

Intangible assets – Intangible assets are accounted for in accordance with ASC topic 350, “Intangibles – Goodwill and Other.” Intangible assets with finite useful lives are amortized while intangible assets with indefinite useful lives are not amortized. The Company reviews its long-lived assets and finite-lived intangible assets for impairment on at least an annual basis or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. To determine recoverability of its long-lived assets, the Company evaluates the probability that future undiscounted net cash flows will be less than the carrying amount of the assets. Impairment costs, if any, are measured by comparing the carrying amount of the related assets to their fair value. The Company recognizes an impairment loss based on the excess of the carrying amount of the assets over their respective fair values. Fair value is determined by the use of undiscounted future cash flows, independent appraisals or other approximate methods. The Company did not record any impairment charges for the years ended December 31, 2009,2008 and 2007.

 

F-11

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

3.	Summary of Significant Accounting Policies (Continued)

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

Derivative Instruments – The fair value of the Company’s derivative warrants liability was provided by an independent third party valuation expert.  Certain derivatives with limited activity are valued using externally developed models that consider unobservable market parameters.

Foreign Currency - The Company’s principal country of operations is in the PRC. The financial position and results of operations of the Company are recorded in Renminbi (“RMB”) as the functional currency. The results of operations denominated in foreign currency are translated at the average rate of exchange during the reporting period.  Assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the market rate of exchange at that date. The registered equity capital denominated in the functional currency is translated at the historical rate of exchange at the time of the capital contribution. All translation adjustments resulting from the translation of the financial statements into U.S. Dollars are recorded as accumulated other comprehensive income, a component of stockholders’ equity.

Revenue recognition - Revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. The Company believes that all of these criteria are satisfied upon shipment from its facilities. Historically, the Company’s estimated returns, allowances and claims have been deemed immaterial. The Company’s sale agreements only allow a return if the product has quality related issues. In such event, the Company accepts the return for equivalent product exchange from inventory only.

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

Deferred revenues - The Company recognizes revenues as earned. Amounts billed in advance of the period in which goods are delivered are recorded as a liability under “Deferred revenues.”

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

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

The Company recognizes in-process research and development in accordance with ASC topic 730, “Research and Development.” Assets to be used in research and development activities, specifically, compounds that have yet to receive new drug approval and would have no alternative use, should approval not be given, are immediately charged to expense when acquired. Certain assets and other technologies acquired that has foreseeable future cash flows are capitalized as intangible assets. Such intangible assets are amortized starting from the year revenue is generated and amortized over an estimated period of 10 years. Should under any circumstances these capitalized intangible assets have no future benefit; the Company will record an immediate write-off for the remaining net carrying value within the consolidated statement of operations.

The Company incurred research and development expenses of approximately $14,960,000, $7,413,000, and $3,158,000, for the years ended December 31, 2009, 2008, and 2007, respectively.

 

F-12

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

3.	Summary of Significant Accounting Policies (Continued)

Advertising – The Company signs contracts with agents who then place its advertising in the mediums of television, radio and internet.  Advertising expense is incurred in the period the advertisements take place. Thus, costs of advertising are expensed as incurred. Advertising costs for the years ended December 31, 2009, 2008, and 2007 were approximately $14,527,000, $7,299,000 and $4,385,000, respectively.  An immaterial amount of the Company’s advertisement expenses in 2009, 2008 and 2007 were related to advertising production costs.  Advertising costs are reported as part of selling expenses in the statements of operations.

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

 

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

 

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

Enterprise income tax

According to “Enterprise Income Tax and Certain Preferential Policies Notice” published by the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise is authorized by the State Council as a special entity, the enterprise income tax rate is reduced to 15%. The following table sets forth the Company’s income tax rate for TDR and its subsidiaries for the year ended December 31, 2009, 2008 and 2007:

 

Income Tax Rate	2009	2008	2007
TDR	15%	15%	15%
First	15%	25%	25%
Tianlong	15%	12%	-
Haina	25%	25%	-
Peng Lai	2% of Revenue	25%	-

 

Value added tax

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

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

 

F-13

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

3.	Summary of Significant Accounting Policies (Continued)

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

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

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

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

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

Contributions to the pension or retirement plan are calculated at 22% of the employees’ salaries above a fixed threshold amount. The employees contribute between 2% to 8% to the pension plan, and the Company contributes the balance. The Company has no other material obligations for the payment of retirement benefits beyond the annual contributions under this plan. The Company incurred costs of $209,000, $89,000, and $22,000 for the years ended December 31, 2009, 2008, and 2007, respectively.

Fair value of financial instruments – The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts receivable, other receivables, accounts payable, accrued expenses, and other payables approximate their fair values at December 31, 2009 and 2008 because of the relatively short-term maturity of these instruments.  The fair value of derivative instruments is provided by the use of an independent third party valuation expert.  Certain derivatives with limited market activity are valued using externally developed models that consider unobservable market parameters.

 

Subsequent Events

 

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

Recent accounting pronouncements

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

In December 2007, the FASB issued new accounting guidance on business combinations. The new guidance establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. The new accounting guidance also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The new guidance is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, and was adopted by the Company in the first quarter of Fiscal 2009.

 

F-14

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

3.	Summary of Significant Accounting Policies (Continued)

In April 2009, the FASB issued new accounting guidance addressing the interim disclosures about the fair value of financial instruments, which amended the previous disclosures regarding the fair value of financial instruments, and interim financial reporting. This new guidance requires disclosures about the fair value of financial instruments in interim financial statements, in addition to the annual financial statements as already required. This new accounting guidance became effective for interim periods ending after June 15, 2009, and was adopted by us in the third quarter of Fiscal 2009. The adoption of this new guidance had no material impact on our consolidated financial statements.

 

In April 2009, the FASB issued new accounting guidance regarding the determination of fair value when the volume and level of activity for assets or liabilities have significantly decreased, and identifying transactions that are not orderly. This guidance requires an evaluation of whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. If there has, transactions or quoted prices may not be indicative of fair value and a significant adjustment may need to be made to those prices to estimate fair value. Additionally, an entity must consider whether the observed transaction was orderly (that is, not distressed or forced). If the transaction was orderly, the obtained price can be considered a relevant observable input for determining fair value. If the transaction is not orderly, other valuation techniques must be used when estimating fair value. This new accounting guidance must be applied prospectively for interim periods ending after June 15, 2009, and was adopted by us effective June 30, 2009, but had no material impact on our consolidated financial statements.

In May 2009, the FASB issued new accounting guidance, “Subsequent Events”, which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or available to be issued. The guidance requires new disclosure in financial statements of the date through which reporting entities have evaluated events or transactions that occur after the balance sheet date but before the financial statements are issued or available to be issued. The guidance requires public entities, including the Company, to evaluate subsequent events through the date that the financial statements are issued. Financial statements are considered issued when they are widely distributed to stockholders and other financial statement users for general use and reliance in a form and format that complies with U.S. GAAP. The guidance is effective for interim and annual financial periods ending after June 15, 2009 and shall be applied on a prospective basis.

In April 2008, the FASB issued new accounting guidance regarding the determination of useful lives of intangible assets that amends the factors that should be considered in developing renewal or extension assumptions used for purposes of determining the useful life of a recognized intangible asset. This guidance is intended to improve the consistency between the useful life of a recognized intangible asset under accounting guidance related to goodwill and other intangible assets and the period of expected cash flows used to measure the fair value of the asset under accounting guidance related to business combinations and other U.S. GAAP. This guidance is effective for fiscal years beginning after December 15, 2008, and was adopted by us in the first quarter of Fiscal 2009. The adoption of this guidance did not have a material effect on the Company’s results of operations and financial condition.

Standards Not Yet Adopted

In April 2009, the FASB issued new accounting guidance regarding the accounting for assets acquired and liabilities assumed in a business combination due to contingencies. This new guidance clarifies the initial and subsequent recognition, subsequent accounting and disclosure of assets and liabilities arising from contingencies in a business combination. This new guidance requires that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value, if the acquisition date fair value can be reasonably estimated. If the acquisition-date fair value of an asset or liability cannot be reasonably estimated, the asset or liability would be measured at the amount that would be recognized using the accounting guidance related to accounting for contingencies or the guidance for reasonably estimating losses. This new accounting guidance becomes effective for us on November 1, 2010; however, as the provision of the guidance will be applied prospectively to business combinations with an acquisition date on or after the guidance becomes effective, the impact to us cannot be determined until a transaction occurs.

 

F-15

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

4.           Revenue By Product Category and Geographic Region

 

In 2009, 2008 and 2007, overseas sales were approximately $10,121,000, $7,570,000 and $12,404,000, respectively.

 

Our total revenues during fiscal 2009, 2008, and 2007 were approximately $130,092,000, $91,816,000, and $49,318,000, respectively. The following table sets forth our principal product categories based on application type and the approximate amount and percentage of revenue from each of such product categories, during the fiscal years ended December 31, 2009, 2008, and 2007:

 

	For the Years Ended December 31, ($ in thousands)
	2009		2008		2007
Product Category	Sales	% of Sales	Sales	% of Sales	Sales	% of Sales
Patches	$40,770	31.3%	$35,484	38.6%	$19,609	39.9%
Ointments	28,862	22.2%	23,068	25.1%	3,270	12.6%
Sprays	$18,499	14.2%	10,613	11.6%	8,742	18.7%
Diagnostic Kits	10,239	7.9%	8,781	9.6%	2,994	6.1%
Contract Sales	$0	0.0%	5,655	6.2%	12,998	16.6%
Others	31,722	24.4%	8,215	8.9%	1,705	6.2%
Total	$130,092	100.0%	$91,816	100.0%	$49,318	100.0%

Year over year – 2009 to 2008

 

The Company’s revenues increased in 2009 compared to 2008, primarily due to its cooperation with more reputable sales agents and distributors, which have been able to put the Company’s products in more extensive sales networks, and the full-year effect of sales of products of Tianlong and Peng Lai, two of the businesses the Company acquired in fiscal 2008.  As a result of signing agreements with these distributors, the sales revenues for products in the patches, sprays, and diagnostic kits categories increased 14.9%, 74.3%, and 16.6% year over year.  The revenue increase of approximately $5,794,000 in the ointment category, and the revenue  increase of approximately $23,507,000 in other products category, are primarily due to the Company’s increased spending in marketing and advertising for certain products in these categories.  Tianlong’s products generated approximately $43,138,000 and $13,803,000 in 2009 and 2008, respectively.  Revenue generated by Tianlong’s products are included in the ointment, spray and other product categories.  Peng Lai’s products generated approximately $11,188,000 and $2,164,000 in 2009 and 2008, respectively.  Revenue generated by Peng Lai’s products are included in the other product category.

 

Out of the 91 products the Company commercialized in fiscal year 2009, 10 products accounted for approximately 68% of the total revenue.  Out of the 97 products the Company commercialized in fiscal year 2008, 10 products accounted for approximately 72% of total revenue.

 

Year over year – 2008 to 2007

 

During the fiscal year ended December 31, 2008, the Company acquired Tianlong  (April 2008), Haina (April 2008) and Peng Lai (September 2008).  The Company’s increase in revenues in 2008 as compared to 2007 was due to a combination of these business acquisitions, as well as the Company’s internal growth driven by increases in the revenues of TDR and First.

 

The Company’s internal growth was driven by increases in the revenues of TDR, which increased from approximately $33,326,000 in 2007 to approximately $60,078,000 in 2008 and First, which increased from approximately $2,994,000 in 2007 to approximately $8,781,000 in 2008.  These increases were partially offset by a decrease in the Company’s contract sales of approximately $7,358,000, or 57%, from approximately $12,998,000 in fiscal 2007 to approximately $5,640,000 in fiscal 2008, due primarily to our discontinuance of contract sales of Tianlong products following the acquisition of Tianlong as of April 3, 2008.

 

F-16

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

4.	Revenue By Product Category and Geographic Region (Continued)

 

In 2008, before TDR acquired Tianlong, the majority of the Company’s contract sales consisted of products purchased from Tianlong.  In 2008, TDR began to discontinue contract sales, and in 2009, TDR discontinued contract sales as part of its strategic goals and, in 2009 TDR discontinued contact sales. Revenues derived from the sale of a Tianlong product of approximately $4,805,000 and approximately $1,477,000 for 2007 and 2008 respectively, have been reallocated to each of the appropriate product categories to present a more appropriate measure of our revenues by product line.

 

Following the Tianlong acquisition, the Company was able to fully integrate Tianlong’s products into its marketing and distribution channels and increase overall sales.  As a result, the Company derived an aggregate of approximately $13,803,000 from the sale of Tianlong’s products for the remainder of 2008, in addition to approximately $1,447,000 of contract sales of Tianlong’s products from January 1, 2008 through the Tianlong acquisition.

 

Prior to the Company’s acquisition of Peng Lai, as of September 5, 2008, Peng Lai had nominal production and operations.  Following the acquisition, Peng Lai contributed revenue of approximately $2,164,000 to the Company’s total revenue in 2008.

 

Haina did not have an established sales network and was acquired only for its GSP license.

 

5.	Concentrations of Business and Credit Risk

 

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

 

The Company maintains certain bank accounts in the PRC which are not protected by FDIC insurance or other insurance. As of December 31, 2009 the Company held approximately $1,960,000 of cash balances within the U.S. and all of the deposits were within  the FDIC insurance limits. At December 31, 2009, the Company had approximately $50,796,000 in China bank deposits, which is not insured..

 

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

 

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

 

The Company is self-insured for all risks and carries no liability or property insurance coverage of any kind. The Company does not set aside any reserves for product liability risks or other potential claims. The Company’s policy is to record losses associated with its lack of insurance coverage at such time as a realized loss is incurred. Historically, the Company has not had any material losses in connection with its lack of insurance coverage and was not party to any material pending legal proceedings as of December 31, 2009. Management’s intention is to use the Company’s working capital to fund any such losses incurred due to the Company’s exposure to inadequate insurance coverage.

 

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

 

Major Customers

 

For the year ended December 31, 2009, Harbin Shiji Baolong Medicine Company and Shanxi Xintai Medicine Company accounted for approximately 16% and 11% respectively of total revenues. For the year ended December 31, 2009, Harbin Bao Da Medicine Company and Harbin Shiji Baolong Medicine Company accounted for approximately 16% and 14% respectively of all accounts receivable. For the year ended December 31, 2008, Shanxi Xintai and Harbin Shiji Baolong accounted for 15% and 12% respectively of total revenues. Harbin Shiji Baolong and Shanxi Xintai accounted for approximately 29% and 11% respectively of all accounts receivable. For the year ended December 31, 2007, Ning BoYue Hua Trading Company and Guang Zhou Xing He Trading Company accounted for approximately 14% and 11% of total revenues, respectively. Hua Li Jiu Zhou Company accounted for approximately 11% of all accounts receivable. No other customers accounted for 10% or more of our total revenues or accounts receivable in 2009 and 2008.

 

F-17

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

5.	Concentrations of Business and Credit Risk (Continued)

 

Major Suppliers

 

Harbin Zhong Jia Medicine Company and Heilongjiang Kangda Medicine Company accounted for approximately 16% and 42% of the Company’s total inventory purchases for the year ended December 31, 2009. Heilongjiang Kangda Medicine Company accounted for approximately 33% of the Company’s total inventory purchases for the year ended December 31, 2008. Harbin Yong Heng accounted for 23% of the Company’s total inventory purchases for the year ended December 31, 2007. No other suppliers accounted for 10% or more of our total inventory purchases in 2009, 2008, and 2007.

 

6.	Earnings per Share

 

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

 

Stock warrants to purchase 750,000 shares of common stock were outstanding and exercisable as of December 31, 2009. Stock warrants and options to purchase 1,151,000 shares of common stock, all were exercisable and outstanding during the year ended December 31, 2008. These common stock equivalents were included in the computation of diluted earnings per share because the option exercise prices were less than the average market price of our common stock during these periods. As of December 31, 2008, there were 12,500 options with exercise price of $3.65 outstanding and remained unvested, These options were all cashless exercised during the fiscal year of 2009. Stock warrants and options to purchase 1,617,483 shares of common stock were all exercisable and outstanding during the year ended December 31, 2007.

 

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

 

The following table sets forth our computation of basic and diluted net income per share for the years ended December 31, 2009, 2008 and 2007:

 

		$ in thousands, except share and per share data
		For the year ended December 31,
Numerator:		2009				2008				2007
Net income used in calculation of basic and diluted earnings per share		$	34,457			$	28,857			$	15,333
Denominator:
Weighted-average common shares outstanding used in calculation of basic earnings per share			16,575,885				15,101,833				12,094,949
Effect of dilutive securities:
Warrants and Options			750,000				327,303				1,275,579
Weighted-average common shares used in calculation of diluted earnings per share			16,668,452				15,429,136				13,370,528
Net income per share:
Basic		$	2.08			$	1.91			$	1.27
Diluted		$	2.07			$	1.87			$	1.15

 

F-18

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

7.	Equity and Share-based Compensation

 

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”), for options granted to employees and directors, using the modified prospective transition method, and therefore have not restated results from prior periods. Compensation cost for all stock-based compensation awards granted is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Under the fair value recognition provisions of SFAS No. 123R, we recognize stock-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest on a straight-line prorated basis over the requisite service period of the award. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment (“SAB No. 107”), regarding the SEC’s guidance on SFAS No. 123R and the valuation of share-based payments for public companies. We have applied the provisions of SAB No. 107 in the adoption of SFAS No. 123R.

 

In July 2006, the Company’s stockholders approved the 2006 Stock Incentive Plan (the “2006 Plan”). The 2006 Plan, provides for the grant of stock options, restricted stock awards, and performance shares to qualified employees, officers, directors, consultants and other service providers. The 2006 Plan originally authorized the Company to grant options and/or rights to purchase up to an aggregate of 1,500,000 shares of common stock.  As of December 31, 2009, there have been a total of 198,202 common shares granted based on the 2006 Plan to Company employees and consultants. These 198,202 common shares are consisted as the following:

 

In 2006, non-qualified options to purchase a total of 113,500 shares were granted under the 2006 Stock Incentive Plan to certain company employees and consultants. All options had an exercise price of $3.65 per share. All these options were cashless exercised at various prices during 2009 in exchange for  85,295 common shares.

 

In 2007, a total of 30,000 common shares were granted to certain company employees at a fair value of $195,000.

 

In 2008, a total of 30,063 common shares were granted to certain company employees, consultants, and independent directors at a fair value of $316,000.

 

In 2009, a total of 52,844 common shares were granted to certain company employees, consultants, and independent directors. The fair value of these shares is determined to be approximately $1,242,000 based on the stock closing price at the date of the grant.

 

In 2009, we issued an aggregate of 355,239 shares of our common stock in connection with their exercise of outstanding warrants and stock options of ours, as follows:

 

·

In January 2009,  warrants to purchase an aggregate of  8,334 shares of our common stock, which we issued to “accredited” investors in connection with the private offering we completed in October 2006 (the “2006 Offering”), were cash exercised at a price of $3.50 per share, for an aggregate proceeds of $29,169.

 

·

In January and May 2009, warrants to purchase an aggregate of 300,000 shares of our common stock at $2.00 per share, which we issued to a consultant in consideration for services rendered in connection with the share exchange transaction we consummated in May 2006, were exercised on a cashless basis at various prices in exchange for  261,610 common shares.

 

·

In 2006, non-qualified options to purchase a total of 113,500 shares were granted under the 2006 Stock Incentive Plan to certain Company employees and consultants. All options had an exercise price of $3.65 per share. All these options were cashless exercised in various prices during 2009 in exchange for  85,295 common shares.

 

F-19

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

8.	Securities Purchase Agreement and Related Transaction

 

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

 

Pursuant to the Purchase Agreement, among other things, if, and whenever, within twelve (12) months of the Closing Date, the Company issues or sells, or is deemed to have issued or sold, any shares of common stock, or securities convertible into or exercisable for shares of common stock, or modifies any of the foregoing which may be outstanding (with the exception of certain excluded securities), to any person or entity at a price per share, or conversion or exercise price per share less than the Unit Purchase Price, then the Company shall issue, for each such occasion, additional shares of its common stock to the Investors in such number so that the average per share purchase price of the shares of common stock purchased by the Investors in the 2008 Offering shall automatically be reduced to such other lower price per share.  At December 31, 2009, management deemed the estimated fair value of this derivative warrant liability to be immaterial.

 

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

 

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

 

The Class A Warrants represent the right to purchase an aggregate of 750,000 shares of common stock, at an exercise price of $12.50 per share. Additional information relating to these Class A Warrants is provided in Note 9.

 

9.	Outstanding Warrants and Options

 

		Shares Underlying Warrants				Weighted average Exercise Price Warrants				Shares underlying Options				Weighted average Exercise Price Options
Outstanding as of December 31, 2008			1,050,000			$	9.50				113,500			$	3.65
Exercised (See Note 7)			(300,000	)			(50,000	)			(113,500	)			(113,500	)
Outstanding as of December 31, 2009			750,000			$	12.50				-				-

F-20

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

9.	Outstanding Warrants and Options (Continued)

The following table summarizes information about stock warrants outstanding and exercisable as of December 31, 2009.

Exercise Price			Outstanding December 31, 2009				Weighted Average Remaining Life in Years				Number exercisable
$  12.50				750,000				3.0				750,000
				750,000								750,000

 

The remaining Class A Warrants represent the right to purchase an aggregate of 750,000 shares of Common Stock of the Company granted with the Securities Purchase Agreement, at an exercise price of $12.50 per share, all were exercisable  as of December 31, 2009, and have the following additional characteristics:

 

The Class A Warrants issued in our January 2008 Offering described in Note 8 above, represent the right to purchase an aggregate of 750,000 shares of common stock, at an exercise price of $12.50 per share, and have the following additional characteristics:

 

·	The Class A Warrants are exercisable beginning on the six-month anniversary of the closing of the January 2008 Offering and will expire July 31, 2011.

 

·

Commencing on one-year anniversary of the Closing Date, in the event the Warrant Shares may not be freely sold by the holders of the Class A Warrants due to the Company’s failure to satisfy its registration requirements, and an exemption for such sale is not otherwise available to the Warrant-holders under Rule 144, the Class A Warrants will be exercisable on a cashless basis. The Company accounts for this warrant derivative liability in accordance with ASC 815.

 

·

The Exercise Price and number of Warrant Shares will be subject to adjustment for standard dilutive events, including the issuance of common stock, or securities convertible into or exercisable for shares of common stock, at a price per share, or conversion or exercise price per share less than the Class A Warrant exercise price of $12.50 per share. There was no issuance of securities during 2009 which would have resulted in an adjustment to the Exercise Price or number of Warrant Shares. At December 31, 2009, the Company recorded an expense and related derivative liability of  $1,330,000.  The Company’s significant assumptions to calculate the derivative liability at December 31, 2009 included (i) life of warrants of 3.7 years; (ii) expected volatility of 68%; (iii) a risk free interest rate of 2.16% and a (iv) a risk-neutral  probability that the stock price will be below $12.50 at warrant expiration of 12%.

 

·

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

 

·

If, among other things, we fail to cause a Registration Statement covering the Warrant Shares to be declared effective prior to the applicable dates set forth in the Registration Rights Agreement, the expiration date of the Class A Warrants shall be extended one day for each day beyond the Effectiveness Deadlines. The Company engaged an independent third-party consultant to calculate the derivative liability using the Black Scholes model resulting from its failure to register the Warrant Shares. The estimated registration rights derivative liability was determined to be immaterial as of December 31, 2008.

 

F-21

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

9.	Outstanding Warrants and Options (Continued)

 

·

If a Warrant-holder exercises its Put Right under the Put Agreement (as previously defined above), such Warrant-holder’s right to exercise the Class A Warrants shall be suspended, pending the satisfaction of our obligations to pay the Warrant-holder the applicable Repurchase Price. Upon receipt of the Repurchase Price in full by the Warrant-holder, the Warrant-holder’s right to exercise the Class A Warrants shall automatically and permanently terminate and expire, and the Class A Warrants shall be immediately cancelled on the books of the Company.

 

10.	Inventories

 

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

 

As of December 31, 2009 and 2008, inventories consist of the following:

 

		$ in thousands
		December 31, 2009				December 31, 2008
Raw Material		$	1,192			$	330
Work-in-Process			578				76
Finished Products			642				56
Total Inventories		$	2,413			$	462

 

 

The increase in our inventory level at December 31, 2009 versus December 31, 2008 is principally due to the 42% increase in our 2009 revenue compared to 2008. The increased inventory level at December 31, 2009 is deemed sufficient to support our estimated sales in the near term of 2010.

 

Historically, our inventory is at its lowest levels at the end of each calendar year and in the first fiscal quarter. We draw down our inventory levels in December of each year for two main reasons. First, our customers want to receive goods prior to the holiday season.  In addition, the first calendar quarter is traditionally our slowest sales period. Since a lower volume of sales activity normally occurs during the first quarter of each calendar year, we believe it is prudent to avoid incurring unnecessary inventory carrying costs. At the appropriate time toward the end of the first calendar quarter of each fiscal year, we begin to ramp up its inventory levels to prepare for increased demand during the coming stronger selling periods.

Historically, we signed agreements with suppliers that allowed us to hold extra raw materials at the cost of the suppliers. As a result, we could minimize our own inventory carrying costs, and improve our cash management, by keeping the inventory at the minimum level required to support the short-term sales. However, due to price increases of raw materials, in addition to overhead costs for storing such raw materials, the Company started to increase the inventory levels at our own cost at the end of year 2009.

 

F-22

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

11.	Property and Equipment, net

 

As of December 31, 2009 and 2008, Property and Equipment, net consist of the following:

 

		$ in thousands
		December 31,				December 31,
		2009				2008
Buildings and improvements		$	10,570			$	9,962
Machinery and equipment			5,868				4,946
Transportation equipment			955				886
Furniture and equipment			325				299
Total Property and Equipment			17,718				16,093
Less: Accumulated Depreciation			(2,227	)			(1,297	)
Property and Equipment, Net		$	15,491			$	14,796

For the years ended December 31, 2009, 2008 and 2007, annual depreciation expense totaled $926,000, $584,000 and $187,000, respectively.

Depreciation expense included with Cost of Goods Sold for 2009, 2008 and 2007, amounted to $491,000, $226,000, and $68,000, respectively.

12.	Intangible Assets, net

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

A breakdown of our intangible assets, net by subsidiaries as of December 31, 2009 is as follows::

 

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

Historically, we included our proprietary technologies and SFDA licenses for drug batch numbers under the category of patents.  We now believe it is more accurate to categorize such IP in separate categories.

As of December 31, 2009, the weighted average amortization period for our proprietary technologies and SFDA licenses for drug batch numbers is approximately 8 years.

F-23

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

12.	Intangible Assets, net (Continued)

 

A breakdown of our intangible assets, net by subsidiaries as of December 31, 2008 is as follows:

 

	Intangible Assets as of December 31, 2008, net ($ in thousands)
Item	TDR	Haina	Tianlong	First	Peng Lai	Total
Proprietary Technologies	$1,471	-	-	$6,739	-	$8,210
SFDA licenses for drug batch numbers	-	-	$1,947	-	$4,936	$6,883
Goodwill	$406	$353	-	-	-	$759
Total	$1,877	$353	$1,947	$6,739	$4,936	$15,852

 

The increase in intangible assets of approximately $9.3 million in 2009 compared to 2008 is primarily due to our acquisitions of proprietary technologies by Tianlong and First during the fourth quarter of 2009. These proprietary technologies include Antroquinonol for the treatment of lung and liver cancers and Small RNA diagnosing technology used for detecting heart diseases in its early stage.

 

Amortization expense of our intangible assets with finite lives for each of the years ended December 31, 2009, 2008 and 2007 was approximately $1,821,000, $274,000 and $256,000 respectively. Future amortization for the next five years and thereafter is as follows:

 

Years Ended December 31,		$ in thousands
2010		$	2,717
2011		$	2,717
2012		$	2,717
2013		$	2,715
2014		$	2,715
Thereafter		$	10,773
		$	24,355

 

13.	Taxes Payable

 

Taxes payable for the years ended December 31, 2009, 2008, and 2007 consists of the following:

 

		December 31,
		($ in thousands)
		2009				2008				2007
Value Added Tax, net		$	1,291			$	1,179			$	612
Enterprise Income Tax		2,452					2,107				941
City Tax			43				32				5
Other Taxes and additions		86					45				9
Total Taxes Payable		$	3,873			$	3,363			$	1,567

F-24

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

14.	Income Taxes

 

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

 

According to “Enterprise Income Tax and Certain Preferential Policies Notice” published by the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise is authorized by the State Council as a special entity, the enterprise income tax rate is reduced to 15%. The following table sets force the income tax rate for TDR and its subsidiaries for the years ended December 31, 2009, 2008 and 2007:

 

Income Tax Rate	2009	2008	2007
TDR	15%	15%	15%
First	15%	25%	25%
Tianlong	15%	12%	-
Haina	25%	25%	-
Peng Lai	2% of Revenue	25%	-

 

The Company’s effective tax rate was approximately 23.4% in fiscal 2009. If the Company’s effective tax rate was 25% in 2009, its net income will be $33,720,000, basic earnings per share and diluted earnings per share would be $2.03 and $2.02, respectively.

 

The Company’s effective tax rate was approximately 20.1% in fiscal 2008. If the Company’s effective tax rate was 25% in 2008, its net income will be $27,355,000, basic earnings per share and diluted earnings per share would be $1.81 and $1.77, respectively.

 

The Company’s effective tax rate was approximately 17.8% in fiscal 2007. If the Company’s effective tax rate was 25% in 2009, its net income will be $13,989,000, basic earnings per share and diluted earnings per share would be $1.16 and $1.05, respectively.

 

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

 

Pursuant to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of the Company’s net operating losses and tax credit carryforwards may be limited because of cumulative changes in ownership of more than 50% that have occurred. As of December 31, 2009, the Company has US net operating loss carryforwards of approximately $8.8 million which will begin to expire in 2029.  Accordingly, as mentioned above, any deferred tax asset that would result from these carryforwards have been fully reserved as of December 31, 2009.

 

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

 

F-25

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

14.	Income Taxes (Continued)

 

Net deferred tax assets consist of the following components as of December 31, 2009 and 2008:

 

		December 31, ($ in thousands)
		2009				2008
Deferred tax assets:
NOL Carryover from China Sky One (formerly known as Comet)		$	2,566			$	1,646
Share-based compensation expenses based on SFAS 123R			422				121
			2,988				1,767
Less valuation allowance			(2,988	)			(1,767	)
Net deferred tax asset		$	-			$	-

The Company recognizes that virtually all tax positions in the PRC are not free of some degree of uncertainty due to tax law and policy changes by the state. However, the Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current state officials.

 

Based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits as of December 31, 2009, is not material to its results of operations, financial condition or cash flows. The Company also believes that the total amount of unrecognized tax benefits as of December 31, 2009, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible, based on current Chinese tax law and policy, that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the company’s results of operations, financial position or cash flows.

 

The Company’s corporate tax returns are subject to examination in both China and the U.S. for the years 2006 through 2009.

 

15.	Land Use Rights and Construction in Progress

 

The Company considers the fact that, in the PRC, there is no land ownership but rather the land use right and it is more appropriate to allocate land use rights under a separate category and amortize land use rights based on 50 years of the land use rights, or the term of the lease. The land use rights are approximately $4,586,000 and $1,945,000 for the years ended December 31, 2009 and 2008, respectively.

 

During the second quarter in 2007 TDR entered into an agreement with the Development and Construction Administration Committee of Harbin Song Bei New Development district to purchase the land use rights for 50 years for the development of a new biotech engineering project. We spent approximately $9.9 million, $730,000, and $2.1 million in the years of 2009, 2008, and 2007 respectively for this construction in progress.  The Company moved into its new facilities in January 2010 and anticipates the final stage of construction will be completed during the third quarter of 2010 at an additional cost of approximately $3.0 million.

 

16.	Commitments and Contingencies

 

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

 

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

 

F-26

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China Sky One Medical, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

16.	Commitments and Contingencies (Continued)

 

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

 

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

 

17.	Quarterly Results (Unaudited)

 

The following table presents the Company’s selected unaudited quarterly operating results for the eight quarters ended December 31, 2009. The Company believes that all adjustments of a normal recurring natural have been made to present fairly the related quarterly results:

 

		$ in thousands, except per share data
Year 2009		First Quarter				Second Quarter				Third Quarter				Fourth Quarter				Total
Revenues		$	24,834			$	32,182			$	43,227			$	29,850			$	130,092
Gross profit		$	18,793			$	24,429			$	32,330			$	22,870			$	98,422
Income from operations		$	9,051			$	12,082			$	16,030			$	9,088			$	46,251
Net income		$	7,243			$	9,457			$	12,459			$	5,298			$	34,457
Basic EPS		$	0.44			$	0.57			$	0.75			$	0.32			$	2.08
Diluted EPS		$	0.43			$	0.57			$	0.74			$	0.32			$	2.07

 

		$ in thousands, except per share data
Year 2008		First Quarter				Second Quarter				Third Quarter				Fourth Quarter				Total
Revenues		$	12,413			$	23,749			$	29,699			$	25,955			$	91,816
Gross profit		$	9,553			$	18,226			$	22,333			$	19,300			$	69,413
Income from operations		$	4,850			$	10,128			$	11,751			$	8,931			$	35,659
Net income		$	3,865			$	8,111			$	9,943			$	6,938			$	28,857
Basic EPS		$	0.26			$	0.54			$	0.66			$	0.45			$	1.91
Diluted EPS		$	0.25			$	0.53			$	0.64			$	0.45			$	1.87

F-27

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Item 9.  Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.  Controls and Procedures.

 

Management’s Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2009.  The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act are accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as described above.  Based on this evaluation, our management, including our chief executive officer and chief financial officer, concluded that as of December 31, 2009, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Management’s Annual Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) under the Securities Exchange Act as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

 

·	pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of a company;

 

·

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles and that receipts and expenditures of a company are being made only in accordance with authorizations of management and directors of a company; and

 

·	provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the financial statements.

 

Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements.  All internal control systems, no matter how well designed, have inherent limitations which may not prevent or detect misstatements.  Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.  Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009.  In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework.

 

Based on this assessment, management concluded that, as of December 31, 2009, our internal control over financial reporting was effective based on those criteria.

 

50

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Attestation Report of the Registered Public Accounting Firm

The effectiveness of our internal control over financial reporting as of December 31, 2009 has been audited by MSPC

Certified Public Accountants and Advisors, an independent registered public accounting firm, as stated in their attestation report, which is included as apart of our 2009 Financial Statements filed as Item 8 of this report.

Changes in Internal Control Over Financial Report

During our fourth fiscal quarter, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

Item 9B.  Other Information.

 

Except as set forth below, there was no information we were required to disclose in a report on Form 8-K during the fourth quarter of our fiscal year ended December 31, 2009, or subsequent period through the date hereof, which was not so reported.

 

51

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PART III

 

Item 10.   Directors, Executive Officers and Corporate Governance.

 

Directors and Executive Officers

 

The following table sets forth certain information regarding our directors and executive officers during the fiscal year ended December 31, 2009, and the subsequent period through the date hereof:

 

Name		Age		Position
Liu Yan-qing		46		Chief Executive Officer, President and Chairman of the Board of Directors
Han Xiao-yan		43		Vice Chairman and Director
Stanley Hao		39		Chief Financial Officer, Secretary and Director
Song Chun-fang		70		Director
William Wei Lee		55		Director
Zhao Jie		47		Director
Qian Xu-feng		42		Director

The following information reflects the business background and experience of each director and executive officer:

 

Liu Yan-qing has been our Chairman, Chief Executive Officer and President since May 2006, a Director of TDR since September 2000, and General Manager of First since April 2003.  Mr. Liu graduated from Prophylactic Department of Harbin Medicine University, where he obtained his bachelor’s degree.  In 2005, he studied at Tsing Hua University and earned an Executive Masters of Business.   

 

Han Xiao-yan has been our Vice Chairman and Director since May 2006, a General Manager of TDR since September 2004, and Vice Director of First since April 2003.  She also serves as our senior marketing manager and administrative manager.  Ms. Han received a master of business administration at Harbin Industrial University.

 

Stanley Hao has been employed by us in various capacities since June 2008 and as Chief Financial Officer, Secretary and a Director since November 2008.  From January 2006 through June 2008, Mr. Hao served as President’s Assistant and Financial Officer for Sumitomo Group Canadian Branch, an integrated trading company.  Prior to this, commencing in September 2004, Mr. Hao served as Marketing Executive and Canadian Market Analyst for MGM Mirage, an entertainment company which owns and operates casino properties.  From September 1997 through the time he joined MGM Mirage, he was Chief Executive Officer of SunnyZone Consulting Co. Ltd., a financial consulting company he co-founded.  Mr. Hao holds a Bachelor’s degrees in Economics and Arts from Beijing Union University and an MBA from the University of Phoenix.

 

Song Chun-fang joined our board of directors on February 22, 2008.  From 1964 to the present, Mr. Song has been employed by the First Clinical College of Harbin Medical University in Heilongjiang, China, where he has served as the Director of the Surgery Research Room and the Director of graduate students of the Surgery Department since 1996.  From 1998 to the present, he has been the acting Director of the Heilongjiang Professional Surgery Committee, the Commissary of the Degree Commission of China, the Director of the Key Laboratory of Cell Transplantation of the Ministry of Public Health of China, the Vice-Chairman of the Heilongjiang Medicine Association, the Vice-Chairman of the Heilongjiang Physician Association, and the Director of Heilongjiang (Special) Medical Treatment Application Administration Committee.   Mr. Song received a Bachelor’s Degree in Medical Treatment from Harbin Medical University in 1964.

 

William Wei Lee joined our board of directors on August 4, 2009.  He has been a Managing Director with Transworld Capital Group, a U.S. investment service firm specializing in cross-border M&A and fund raising between U.S. and China, since January 2007, with a break between April 2008 and November 2008, when he served as Chief Operating Officer (on loan) for Legend Media Corporation, a U.S.-listed company specializing in radio advertising in China.  From April 2004 through December 2006, he served as Director of Strategic Development at TNT N.V., an Amsterdam-based provider of postal and logistics services, where he was responsible for M&A and China business strategy.  Prior to this, between June 2003 and March 2004, he was a Project Manager at Roland Berger Strategy Consultants Ltd.  Mr. Lee earned a Master’s degree in Political Science from North Illinois University in 1989 and a Ph.D. in Political Science from Massachusetts Institute of Technology in 1994, where he completed MBA course work at Sloan School.  He completed post-doctoral studies at the Fairbank Center for East Asia Studies, Harvard University, in 1995.

 

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Zhao Jie joined our board of directors on February 22, 2008.  From 1999 to the present, Mr. Zhao has served as the Tissue Specialist of the Replant Department of Capital Health Transplant Services in Alberta, Canada, responsible for various aspects of tissue transplantation, including determining donee acceptability, processing and preserving tissue, performing surgical procedures, and quality control.  In addition, he has written and published several books and articles regarding tissue transplantation.  Mr. Zhao has received awards from Capital Health for Quality and Safety (2006), Recognition of Excellence and Achievement (2002), and Teamwork (2002).  He received a Bachelor’s Degree in Medicine from Harbin Medical University in 1988.

 

Qian Xu-feng joined our board of directors on February 22, 2008.  From March 2005 to the present, Ms. Qian has been employed by Moody’s Investors Service.  From May 2007 to the present, she has been the Vice President and Senior Analyst, from May 2006 to May 2007, she was as the Assistant Vice President and Quantitative Analyst, and from March 2005 to April 2006, she was the Quantitative Analyst.  Prior to that, from June 2004 until February 2005, she was the Research Fellow of the Furman Center for Real Estate and Urban Policy of New York University, where she conducted empirical quantitative research in various aspects of commercial and residential properties.  From September 1990 to July 1996, Ms. Qian was an Assistant Professor of Economics at the Beijing Normal University.  She received a Ph.D. in Economics from Rutgers University in 2004, a Masters Degree in Economics from Rutgers University in 2001, a Masters Degree in Accounting from City University of New York in 1999, and a Bachelor’s Degree in Economics from Beijing Normal University in 1990.

 

Director Qualifications, Experience and Skills

 

All of our directors bring to our Board a wealth of executive leadership experience derived from their services as senior executives in the medical industry or knowledge specific consulting firms or operational businesses.  Each of our Board members has demonstrated strong business acumen and an ability to exercise sound judgment and has a reputation for integrity, honesty and adherence to ethical standards.  When considering whether directors and nominees have the experience, qualifications, attributes and skills, taken as a whole, to enable the Board to satisfy its oversight responsibilities effectively in light of our business and structure, the Nominating and Governance Committee and the Board focused primarily on the information discussed in each of the director’s individual biographies set forth above and the specific individual qualifications, experience and skills as described below:

 

·

Liu Yan-qing has over 10 years of experience in drug marketing, research and development of new drugs and enterprise management in the PRC.  His experience in these areas has been instrumental in establishing our sales program and sales network covering the PRC, and provides us with invaluable insight into our customers’ needs and requirements.

 

·	Han Xiao-yan’s hygiene and medical media experience has been integral in developing and marketing TDR’s products and expanding its sales.  In addition, she has over 10 years of financial management experience.

 

·

Stanley Hao’s prior experiences as Financial Officer for Sumitomo Group Canadian Branch, Marketing Executive and Canadian Market Analyst for MGM Mirage, and Chief Executive Offer of SunnyZone Consulting Co. Ltd., a financial consulting company he co-founded, give him extensive knowledge of accounting, the capital markets, financial reporting and financial strategies.

 

·	Song Chun-fang has over four decades of experience working in high level positions in the medical departments in universities in China.  His background and experience provides us with key industry specific contacts and information.

 

·	William Wei Lee Lee’s experience in cross-border M&A, fund raising and business strategy between the U.S. and China, including with public companies, provides us with crucial understanding of relevant issues related to our listing on the Nasdaq Global Market.

 

·	Zhao Jie’s experience in the medical field, specifically in the area of tissue transplantation, provides us with valuable knowledge with respect to the needs of the medical industry.

 

·	Qian Xu-feng’s depth of knowledge in investor services and company analysis, and general expertise in economics, provides us with valuable understanding in these areas, which are vital to our business.

 

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Significant Employees

 

Zhang Wen-chao has been our Director of Scientific and Technological Development since March 2005.  Mr. Zhang graduated with a PhD in biology pharmaceuticals from South China University of Technology in 1997.  He has been employed in various R&D roles since his graduation.  Mr. Zhang completed our gene recombination medicine independently and has been responsible for researching and developing various products that have been launched by us since 2005.

 

Family Relationships

 

There are no family relationships among our directors, executive officers, or persons nominated to become directors of executive officers.

 

Board of Directors

 

We have seven (7) members serving on our Board of Directors (the “Board”).  Each Board member is nominated for election at our annual meeting to serve until the next annual meeting of stockholders and until their successors are duly elected and qualified.

 

Board Committees

 

The Board has five standing committees: Audit Committee, Compensation Committee, Nominating and Governance Committee, Executive Committee and Finance Committee.  Each of these committees, other than the Executive Committee, operates under a written charter adopted by the Board.  Copies of these charters are available on our website at www.cski.com.cn.  

 

Audit Committee

 

The Audit Committee is responsible for the annual engagement of a firm of independent accountants and reviews with the independent accountants the scope and results of audits, our internal accounting controls and audit practices and professional services rendered to us by our independent accountants. The Audit Committee also reviews and discusses with management and the board of directors, such matters as accounting policies, internal accounting controls and procedures for preparation of financial statements. The Audit Committee is required at all times to be composed exclusively of directors who, in the opinion of our board of directors, are free from any relationship that would interfere with the exercise of independent judgment as a committee member and who posses an understanding of financial statements and generally accepted accounting principles. The Audit Committee is comprised of solely independent directors, Messrs. William Wei Lee and Zhao Jie and Ms. Qian Xu-feng. Management believes, in good faith, that each of these members are considered “independent” under applicable Nasdaq rules, and that William Wei Lee qualifies as an “audit committee financial expert” as defined under Item 407(d)(5) of Regulation S-K.

 

Compensation Committee

 

The Compensation Committee is responsible for (a) reviewing and recommending to the Board of Directors on matters relating to employee compensation and benefit plans, and (b) determining the compensation of the Chief Executive Officer and making recommendations to the Board with respect to the compensation of the executive officers of the Company, other than the Chief Executive Officer, and independent directors. In making a determination, the Compensation Committee and the Board give material consideration to China Sky’s results of operations, financial condition and competitive factors.  The compensation may include grants of options under our stock option plan to the named executive officers. Executive officers may recommend the amount or form of compensation for consideration by the Compensation Committee. The Compensation Committee may delegate authority to one or more subcommittees consisting of one or more of its members.  The Compensation Committee may also retain consultants to assist in the evaluation of directors’, the Chief Executive Officer’s or the executive officers’ compensation, however the Compensation Committee has not hired such consultants.  The Compensation Committee is comprised of  independent directors, Messrs. William Wei Lee and Song Chun-fang and Ms. Qian Xu-feng.

 

Nominating and Governance Committee

 

The Nominating and Governance Committee assists the Board of Directors in identifying qualified individuals to become board members, in determining the composition of the Board of Directors and in monitoring the process to assess Board effectiveness.  The Nominating and Governance Committee also selects director nominees for election at each annual meeting of stockholders.  The Nominating and Governance Committee of the Board of Directors comprised of independent directors Zhao Jie, Qian Xu-feng and Song Chun-fang.

 

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Executive Committee

 

The Executive Committee may exercise all the powers and authority of the Board in the management of the business and affairs of the Company, including, without limitation, the power to authorize or take actions relating to the issuance of securities of the Company, with certain exceptions.  The Executive Committee of the Board of Directors is comprised solely of independent directors. Song Chun-fang, Zhao Jie and William Wei Lee serve as members of the Executive Committee.

 

Finance Committee

 

The Finance Committee reviews the financial planning process, the financial structure and the investment outlook of the Company and its subsidiaries. Qian Xu-feng, William Wei Lee and Song Chun-fang, independent directors, serve as members of the Finance Committee.

 

Director Independence

 

Our Board is composed of seven (7) directors. As required under the Nasdaq Stock Market, or Nasdaq listing standards, a majority of the members of a listed company’s board of directors must qualify as “independent,” as affirmatively determined by the listed company. Our Board consults with our counsel with respect to the Board’s applications of relevant securities and other laws and regulations regarding the definition of “independent,” including those set forth in pertinent listing standards of the Nasdaq, as in effect from time to time.

 

Under applicable Nasdaq rules, a director will only qualify as an “independent director” if, in the opinion of our Board, that person does not have a relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Our Board of Directors has determined that none of Song Chun-fang, William Wei Lee, Zhao Jie and Qian Xu-feng has a relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director, and that each of these directors is an “independent director,” as defined under Rule 5605(a)(2) of the Nasdaq Stock Market, Inc. Marketplace Rules.

 

Indemnification

 

Under Chapter 78 of the Nevada Revised Statutes, we have broad powers to indemnify and insure our directors and officers against liabilities they may incur in their capacities as such. Article VII of our articles of incorporation provides, in part, that we must indemnify our directors and officers, and their respective heirs, administrators, successors and assigns against any and all expenses, including amounts paid upon judgments, counsel fees and amounts paid in settlement by reason of their being or having been directors of officers.  This indemnification is in addition to any rights to which those indemnified may be entitled under any law, by law, agreement, vote of shareholder or otherwise.

 

This indemnification provisions may be sufficiently broad to permit indemnification of our directors and officers for liabilities (including reimbursement of expenses incurred) arising under the Securities Act.  Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, or persons controlling the registrant pursuant to the foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

 

The indemnity provisions may discourage stockholders from bringing a lawsuit against our directors for breach of their fiduciary duty. These provisions may also have the effect of reducing the likelihood of derivative litigation against directors and officers, even though such an action, if successful, might otherwise benefit us and our stockholders.  Furthermore, a stockholder’s investment may be adversely affected to the extent we pay the costs of settlement and damage awards against directors and officers pursuant to these indemnification provisions.  We believe that these provisions, the indemnification agreements and the insurance are necessary to attract and retain talented and experienced directors and officers.

 

At present, there is no pending litigation or proceeding involving any of our directors or officers where indemnification will be required or permitted. We are not aware of any threatened litigation or proceeding that might result in a claim for such indemnification.

 

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Anti-Takeover Provisions

 

Provisions of Nevada law, our articles of incorporation, or our bylaws could have the effect of delaying or preventing a third party from acquiring us, even if the acquisition would benefit our stockholders. The provisions of Nevada law and in our articles of incorporation and bylaws are intended to enhance the likelihood of continuity and stability in the composition of our Board of Directors and in the policies formulated by the Board of Directors and to discourage certain types of transactions that may involve an actual or threatened change of control of China Sky One. These provisions are designed to reduce our vulnerability to an unsolicited proposal for a takeover that does not contemplate the acquisition of all of our outstanding shares, or an unsolicited proposal for the restructuring or sale of all or part of our company. See the Subsection titled “Anti-Takeover Provisions” in the “Description of Capital Stock” Section below.

 

Director Fiduciary Duty and Business Judgment Provisions

 

Nevada has enacted several statutes governing the fiduciary duty and business judgment of our directors and officers including a provision that our directors and officers must exercise their powers in good faith and with a view to our interests. In the same section, the Nevada Revised Statutes state that our directors and officers, in deciding upon matters of business, are presumed to act in good faith, on an informed basis and with a view to our interests. They may rely on information, opinions, reports, financial statements and other financial data, that are prepared or presented by our directors, officers or employees who are reasonably believed to be reliable and competent.

 

Limitation on Liability

 

Section 78.138(7) of the Nevada Revised Statutes provides that our directors and officers will not be individually liable to us or our stockholders or our creditors for any damages as a result of any act or failure to act in their capacity as a director or officer unless it is proven that the act or failure to act breached fiduciary duties as a director or officer and such breach involved intentional misconduct, fraud or a knowing violation of law. As a result, neither we nor our stockholders nor our creditors have the right to recover damages against a director or officer for any act or failure to act in his capacity as a director or officer, except in the situations described above and except under very limited circumstances.

 

Compliance with Section 16(a) of the Exchange Act

 

To our knowledge, based solely on a review of such materials as are required by the SEC, none of our officers, directors or beneficial holders of more than 10% of our issued and outstanding shares of common stock failed to timely file with the SEC any form or report required to be so filed pursuant to Section 16(a) of the Exchange Act, during the fiscal year ended December 31, 2009 except that:  (i) Song Chun Fang filed a late Form 4 on January 26, 2010, to report the grant of 831 shares of common stock under our 2006 Stock Incentive Plan as of December 26, 2009, (ii) Qian Xu-feng filed a late Form 4 on January 26, 2010, to report the grant of 831 shares of common stock under our 2006 Stock Incentive Plan as of December 26, 2009, (iii) Zhao Jie filed a late Form 4 on January 26, 2010, to report the grant of 831 shares of common stock under our 2006 Stock Incentive Plan as of December 26, 2009, (iv) William Wei Lee filed a late Form 3 on February 3, 2010, as amended on February 11, 2010, to report his appointment to our Board as of September 24, 2009, and (v) William Wei Lee filed a late Form 4 on February 3, 2010, as amended on February 11, 2010, to report the grant of 1,038 shares of common stock under our 2006 Stock Incentive Plan as of December 26, 2009.

 

Code of Ethics

 

We have adopted a Code of Ethics that applies to our principal chief executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, as well as other employees (the “Code of Ethics”).  A copy of the Code of Ethics is appended as an exhibit to our Amended Report on Form 10-KSB for the year ended December 31, 2006.  The Code of Ethics was designed with the intent to deter wrongdoing, and to promote the following:

·	Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships,

 

·	Full, fair, accurate, timely and understandable disclosure in reports and documents that a small business issuer files with, or submits to, the Commission and in other public communications made by the small business issuer,

 

·	Compliance with applicable governmental laws, rules and regulations,

 

·	The prompt internal reporting of violations of the code to an appropriate person or persons identified in the code, and

 

·	Accountability for adherence to the code.

 

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Item 11.  Executive Compensation.

 

Compensation Discussion and Analysis

Objectives of our executive compensation program

 

We provide a compensation package for our executive officers we refer to as our “named executive officers” that we believe is designed to fairly compensate them and to enhance shareholder value.   We have disclosed the compensation packages for our named executive officers in the summary compensation table and related tables below.  We have structured our compensation packages to motivate our named officers to achieve our business objectives and to align their interests with the interests of our shareholders.

Specifically, our compensation program is designed to achieve the following objectives:

·	Attract and retain excellent executives who are appropriate for the Company’s needs;

·	Motivate and reward executives whose knowledge, skills and performance are critical to the Company’s success;

·	Motivate the executives to increase shareholder value for both the Company and its subsidiary operations through the use of options;

·	Tie compensation to corporate and individual performance; and

·	Align the interests of our executives with those of our shareholders.

 

Elements of Compensation

Base Salary.  All of our full time executives are paid a base salary.  We do not have employment agreements with any of our executives.  Base salaries for our executives are established based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies in our industry for similar positions, professional qualifications, academic background, and the other elements of the executive’s compensation, including stock-based compensation.  Our intent is to set our base salaries near the median of the range of salaries for executives in similar positions with similar responsibilities at comparable companies, in line with our compensation philosophy.  Base salaries are reviewed annually, and may be increased to align salaries with market levels after taking into account the subjective evaluation described previously.

Bonuses.  Historically, we have not  paid cash bonuses to our executive officers.  Bonuses may be paid on an ad hoc basis to recognize superior performance.  If the Compensation Committee determines to provide bonus compensation as a regular part of our executive compensation package, it will establish performance goals for each of the executive officers and maximum bonuses that may be earned upon attainment of such performance goals.

Equity Incentive Compensation.  We believe that long-term performance is achieved through an ownership culture participated in by our executive officers through the use of stock-based awards.  Currently, we do not maintain any incentive compensation plans based on pre-defined performance criteria.  The Compensation Committee has the general authority, however, to award equity incentive compensation to our executive officers in such amounts and on such terms as the committee determines in its sole discretion.  The Committee does not have a determined formula for determining the number of options available to be granted.  Incentive compensation is intended to compensate officers for accomplishing strategic goals such as mergers and acquisitions and fund raising.  The Compensation Committee will review each executive’s individual performance and his or her contribution to our strategic goals periodically and determine the amount of incentive compensation towards the end of the fiscal year.  Our Compensation Committee grants equity incentive compensation at times when we do not have material non-public information to avoid timing issues and the appearance that such awards are made based on any such information.

 

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Retirement Benefits.   Currently, we do not provide any company-sponsored retirement benefits or deferred compensation programs to any employee, including the named executive officers (other than a mandatory state pension scheme in which all of our employees in China participate) because it is not customary to provide such benefits and programs in China.

Perquisites.   At this time, we do not provide, nor do we plan to provide, perquisites to our named executive officers

Other Benefits.  At this time, we do not provide, nor do we plan to provide, deferred compensation, life insurance, or other benefits to our executive officers.

Determination of Compensation

Our Compensation Committee, which is comprised of  independent directors, Mr. William Wei Lee, Mr. Song Chun-fang and Ms. Qian Xu-feng, is responsible for reviewing and making recommendations to the Board on matters relating to employee compensation and benefit plans and determining the compensation of our Chief Executive Officer.  In addition, the Compensation Committee is responsible for making recommendations to the Board with respect to the compensation of the executive officers of the Company, other than the Chief Executive Officer, and independent directors.

In making determinations, the Compensation Committee and the Board give material consideration to our results of operations, financial condition and competitive factors.  The Compensation Committee may delegate authority to one or more subcommittees consisting of one or more of its members.  The Compensation Committee may also accept recommendations and ideas from senior management to determine the compensation to be paid to our executive officers. In addition, our Chief Executive Officer regularly provides information and recommendations to the committee on the performance of the executive officers, appropriate levels and components of compensation, including equity grants, as well as other information as the committee may request.

The Compensation Committee may also retain consultants to assist in the evaluation of compensation for our directors, the Chief Executive Officer or the executive officers, however the Compensation Committee has not hired such consultants.

We do not formally benchmark our compensation against any peer group.  However we informally consider competitive market practices with respect to the salaries and total compensation of our named executive officers.  We review the market practices by reviewing publicly available information of other companies in our sector and our geographical area. However while we review such market information, it is only one factor we consider in establishing compensation, and we did not make use of any formula incorporating such data.

 

Generally in determining whether to increase or decrease compensation to our named executive officers, we take into account any changes, of which we are aware, in the market pay levels, the performance of the executive officer, any increase or decrease in responsibilities and roles of the executive officer, the business needs for the executive officer, the transferability of managerial skills to another employer, the relevance of the executives officers experience to other potential employers and the readiness of the executive officer to assume a more significant role within the organization.

 

The base salaries for our executives were established based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies in our industry, and in Heilongjiang province, for similar positions, professional qualifications, academic background, and the other elements of the executive’s compensation, including stock-based compensation.  Base salaries are reviewed annually, and may be increased to align salaries with market levels after taking into account the subjective evaluation described previously.

 

Our practice is to periodically consider awarding stock bonuses based upon, among other things, accomplishments of key objectives and overall performance.  In addition, from time-to-time the committee may approve payment of stock bonuses to executives or key contributors for special accomplishments or other reasons.  In 2009, the Board determined to award our executive officers, independent directors and certain employees in the form of stock grants valued in the aggregate amount of approximately 1% of our total revenues.  The Board then considered each recipients performance and responsibilities in allocating the stock grants among the participants.

 

Change in Control and Employment Agreements

Through 2009 we had no change-in-control agreements, severance agreements or employment agreements of any kind, nor are there plans to institute change-in-control agreements, severance agreements or employment agreements in the near future.

Stock Ownership Guidelines

We have not implemented any stock ownership requirements for our named executive officers.  We have issued stock options to our named executive officers, which we believe allows management to own equity in our company and accordingly align their interest with those of other shareholders.

 

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Summary Compensation Table

The following table provides information regarding the compensation for each person serving as a principal executive officer or a principal financial officer of the Company during the year ended September 30, 2009, and the other most highly compensated officers during that period whose compensation exceeded $100,000.

Name and Principal Position		Year				Salary ($)			Stock Awards ($)(1)			Option Awards ($)(2)			Total ($)
Liu Yan-qing, Chairman, Chief Executive Officer and President			2009				35,083			439,152			—			474,235
			2008				34,320			51,380			—			85,700
			2007				68,512			—			—			68,512
Han Xiao-Yan, Vice Chairman and Director			2009				27,774			336,683			—			364,457
			2008				25,680			40,120			—			65,800
			2007				54,810			—			—			54,810
Stanley Hao, Chief Financial Officer, Secretary And Director			2009				17,542			146,384			—			163,926
			2008				17,542			11,424			—			28,966
			2007				—			—			—			—

(1)

In fiscal year 2009, we issued an aggregate of 52,844 shares of restricted stock to certain executives and directors pursuant to our 2006 Stock Incentive Plan. In fiscal 2008, we issued an aggregate of 30,063 shares of restricted stock to certain executives, directors an advisors pursuant to our 2006 Stock Incentive Plan.

 

Employment Agreements and Arrangements

 

We do not have formal employment agreements with any members of management.