FIRST CHINA PHARMACEUTICAL GROUP, INC.

The Group maintains its financial statements in the functional currency. The functional currency of the Company is US dollar (“USD”, “$”), the functional currency of FCPG HK is Hong Kong dollar (“HKD”), and the functional currency of XYT is Renminbi (“RMB”). For financial reporting purposes, the financial statements of the Company, FCPG HK and XYT have been translated into USD from their functional currencies. Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and stockholders’ equity is translated at historical exchange rates. Any translation adjustments resulting are not included in determining net income but are included in foreign exchange adjustment to other comprehensive income, a component of stockholders’ equity. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchanges rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

The Group had historically issued stock to various board members in connection with their services. The total cost associated with the stock awards are valued using the publicly quoted price of the stock on grant date. The expenses are recognized based on the vesting schedules in accordance with the stock award agreements. Expense for the nine months ended September 30, 2012 and 2011 was approximately $58,000 and $28,000, respectively.

          Gross profit increased from $3.6 million for the nine months ended September 30, 2011 to $4.2 million for the nine months ended September 30, 2012, representing an increase of approximately $0.6 million or 15%. We were able to maintain our gross margin percentage primarily due to our cooperation with Anhui Huayuan Pharmaceutical Inc. since June 2012. We are able to purchase from Huayuan at a significantly lower price due to their wide selection of suppliers. As a result, we were able to offer competitive pricing to our customers amid rising costs.

          Sales increased from $14.2 million for the three months ended September 30, 2011 to $17.4 million for the three months ended September 30, 2012, representing an increase of $3.2 million or 22%. The growth rate is consistent with our expectation. Our cooperation with Anhui Huayuan Pharmaceutical Inc. since June 2012 has yielded significant benefits. We are able to purchase inventory at a lower price. As a result, we can offer competitive pricing to attract customers.

          As of September 30, 2012, we had cash and equivalents on hand of approximately $6.4 million and a working capital deficit of approximately $3.8 million. We believe that our cash on hand and working capital will be sufficient to meet our operational cash requirements through December 31, 2012. In order to continue our growth, we will have to obtain additional capital in the form of debt or equity. Additional capital is required to acquire sufficient inventory to meet growing sales and to broaden our product line. Additional capital is also required to facilitate the ability to obtain exclusivity for the distribution of certain pharmaceutical products, as they require the Company to place large consistent orders with drug manufacturers. The incurrence of indebtedness would result in increased debt service obligations and could require the Company to agree to operating and financial covenants that would restrict its operations. Financing may not be available in amounts or on terms acceptable to the Company, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.