This Quarterly Report on Form 10-Q, including the following "Management's Discussion and Analysis of Financial Condition and Results of Operations", contains forward-looking statements which involve risks and uncertainties, including statements regarding our capital needs, business strategy and expectations. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may," "should," "will," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," "potential," "forecast," "project" or "continue," the negative of such terms or other comparable terminology.

You should not rely on forward-looking statements as predictions of future events or results. Any or all of our forward-looking statements may turn out to be wrong. They can be affected by inaccurate assumptions, risks and uncertainties and other factors which could cause actual events or results to be materially different from those expressed or implied in the forward-looking statements. In evaluating these statements, you should consider various factors, including the risks described in this Form 10-Q under "Risk Factors" and elsewhere. These factors may cause our actual results to differ materially from any forward-looking statement. In addition, new factors emerge from time to time and it is not possible for us to predict all factors that may cause actual results to differ materially from those contained in any forward-looking statements. We disclaim any obligation to publicly update any forward-looking statements to reflect events or circumstances after the date of this report, except as required by applicable law.

Except as otherwise indicated by the context, references in this Quarterly Report on Form 10-Q to "we," "us," or "our" are to the combined business of China-Biotics, Inc. (the "Company") and its wholly-owned direct subsidiaries, Sinosmart Group Inc. ("SGI") and Growing State Limited ("GSL"), and SGI's wholly-owned subsidiary, Shanghai Shining Biotechnology Co. Ltd. ("Shining"), and GSL's wholly-owned subsidiary, Growing Bioengineering (Shanghai) Co. Ltd. ("GBS"). References to "China" or to the "PRC" are references to the People's Republic of China. All references to "dollars" or "$" refers to United States dollars.

Overview

We manufacture and sell probiotics products. Probiotics comprise mainly live bacteria, which we produce using advanced proprietary fermentation technology. Currently, our products are mainly sold in the Greater Shanghai region.

The products are mainly sold to distributors, which then distribute them to various retail outlets such as drug stores and supermarkets. During the three months ended June 30, 2009, approximately 82% of our sales revenue comprises amounts receivable from the distributors for the sale of these products. Typically, 60 to 90 days' credits are given to the distributors.

We intend to expand our sales to other cities in China through a combination of distributors and our outlets (training and logistics centers). Our management believes that as China becomes more affluent, its citizens are becoming more health conscious. This has led to higher demand for health and functional food such as probiotics and yogurt.

In addition, probiotics are increasingly used as additives in the production of infant formula. According to statements made by the Nutrition Development Centre of National Development and Reform Commission in China, effective April 1, 2007, probiotics will be added to baby milk powders produced in China. Currently, the probiotics used in China for such purposes are imported. To capitalize on what we believe is a significant opportunity in this area, we are constructing a new plant that will enable us to capture the anticipated demand for food additives.

In 2008, milk samples (including samples of infant formula) from several Chinese dairy companies, including the three largest producers, were found to have been tainted with melamine, an industrial chemical. In September 2008, China's State Council, officiated by Premier Wen Jiabao, elected to take steps to conduct comprehensive testing of dairy products and carry out other industry reforms. Although sales of Chinese dairy products have fallen significantly as a result of the melamine scandal, there has not been a significant impact on our business to date as our current sales to the dairy industry are minimal. We believe that the strengthening of product quality and testing standards in the dairy industry are a positive development for domestic suppliers that operate to high international standards. We are engaged in discussion and qualification processes with several large global suppliers of infant formula and dairy products to the China market, and believe that we are well-positioned to benefit as more stringent requirements are implemented in the industry. We are also in discussions with a number of suppliers of bakery, dairy and pharmaceutical products in preparation for the opening of our new plant. Therefore, although the full scope of the melamine problem remains unknown, we do not foresee that it will have a material negative effect on our business and results of operations.

The Company's construction of its new production facility has been on schedule since the most recent year-end report. The company continues to plan to commence trial production in the second quarter of fiscal year 2010. The trial phase should be completed in approximately three months, before the regular production starts. The cost of the new plant, which is expected to be approximately $27.5 million for the first phase, will be funded by cash received from the convertible promissory notes issued in December 2007 and internal sources of funds. In this regard, we have leased 36,075 square meters of land in the Shanghai Qingpu Industrial Park District, on which we are constructing the new bulk manufacturing facilities. The new plant will have an initial capacity of 150 tons per year with room for expansion to 300 tons per year.

In preparation for the new plant commencing operations in the second fiscal quarter of this year, we have been in discussions with a large number of potential customers for our food additive products. As at June 30, 2009, we have entered into contracts with 16 customers for this food additives business. In this regard, we have created a number of formulations for testing by many potential future customers. We have established an array of business relationships with commercial customers located in Beijing, Qinghai, Shanghai cities, Jiangsu, Jiangxi, Shaanxi, Shandong and Zhejiang provinces. These growing companies are among the leaders in the baked foods, dairy and pharmaceutical industries. The Company's existing manufacturing facility, with current annual manufacturing capacity of 12 metric tons of probiotics for use as bulk additives and capsules, will supply the initial orders for these customers. The need to create a large number of new products for potential customers is pushing the capacity of our current production facility. With the delay in the commissioning of the new plant from our earlier projections, we have been carefully managing the use of our production capacity and selectively increasing the price of our products to make sure that we strike a balance between achieving current and future sales.

In connection with the expansion of our retail business, we originally intended to open 300 outlets by the end of fiscal year 2009. As at June 30, 2009, we have opened 107 outlets in Shanghai and 12 other cities in China (as of June 30, 2008, we had 27 retail outlets in Shanghai and Changchun). During the quarter ended on June 30, 2009, we put emphasis on the development of our new bulk additives line, in preparation for the commencement of the new plant. With the limited production capacity that we have in our existing production facility, management believes that it is prudent to slow the pace of opening new retail outlets so that we can focus on completing the new plant on time and signing on customers to take up the capacity of our new plant when it is up and running.

Results of Operations

Quarter Ended June 30, 2008 Compared with the Quarter Ended June 30, 2009

Our net income was $5.77 million in the quarter ended June 30, 2009. This included $0.51 million surplus arising from the revaluation of the conversion feature embedded in the convertible notes issued in December 2007 as required by FAS133. Excluding this revaluation surplus, our net income was $5.26 million, which was 17.39% higher than our net income of $4.48 million for the quarter ended June 30, 2008. The increase of net income before the revaluation surplus, resulted from a combination of volume and price increases. Shining Essence continued to be our best selling product, accounting for 27.99% of our sales revenue in the quarter ended June 30, 2009 (40% in the quarter ended June 30, 2008).

Our results for the three months ended June 30, 2009 and 2008 are summarized below:

                                                   Three months ended                     Three months ended
                                                     June 30, 2009                           June 30, 2008
                                              Amount          % of Net sales          Amount         % of Net sales
Net sales                                  $  15,412,462                  100 %    $ 11,370,657               100.00 %
Cost of sales                                 (4,498,673 )             (29.19 )%     (3,258,669 )             (28.66 )%
Gross profit                               $  10,913,789                70.81 %    $  8,111,988                71.34 %
Operating expenses:
Selling expenses                           $ (2,347,592)               (15.23 )%   $ (2,369,859 )             (20.84 )%
General and administrative expenses          (1,734,665)               (11.25 )%     (1,426,797 )             (12.55 )%
Other income                                      36,448                 0.23 %       1,452,503                12.77 %

Total operating expenses                   $  (4,045,809 )             (26.25 )%   $ (2,344,153 )             (20.61 )%
Income from operations                     $   6,867,980                44.56 %    $  5,767,835                50.73 %
Other income and expenses:
Change in the fair value of embedded
derivatives                                $     514,000                 3.33 %    $ (1,239,000 )             (10.90 )%
Interest income                                   67,088                 0.43 %          86,386                 0.75 %
Total other income (expenses)              $     581,088                 3.77 %    $ (1,152,614 )              (10.6 )%
Income before taxes                        $   7,449,068                48.33 %    $  4,615,221                40.59 %
Provision for income taxes                    (1,681,319 )             (10.91 )%     (1,378,471 )             (12.12 )%

Net income                                 $   5,767,749                37.42 %    $  3,236,750                28.47 %

Net sales

Net sales in our financial statements are stated at invoiced value less sales discount and sales tax. Our net sales for the three months ended June 30, 2009 and 2008 comprised the following:

                            Three months ended June 30,
                               2009               2008
Invoiced value on sales   $    16,464,125     $ 11,810,902
Less: sales discount             (787,069 )       (365,489 )
Less : sales tax                 (264,594 )        (74,756 )
                          $    15,412,462     $ 11,370,657

Net sales of $15,412,462 for the quarter ended June 30, 2009 were 35.55% above the net sales of $11,370,657 for the quarter ended June 30, 2008. The increase was mainly because of an increase in overall sales volume arising from new product sales, particularly, bulk additives, (offsetting decrease in sales volume of existing products) and increases in the sales price of selected products.

The contributions of each product as a percentage of the total value on sales for the three months ended June 30, 2009 and 2008 are summarized below:

                                                 Three months ended June 30,
                                                  2009                2008
Shining Essence Capsules                              27.99 %             40.45 %
Shining Signal Capsules                                7.21 %             10.34 %
Shining Golden Shield Capsules                        13.01 %             12.19 %
Shining Energy Capsules                                8.93 %             11.56 %
Shining Essence Stomach Protection Capsules            5.72 %              3.82 %
Shining Probiotics Protein Powder                      7.92 %              5.86 %
Other products                                         6.06 %              6.95 %
                                                      76.84 %             91.17 %
Bulk additives                                        23.16 %              8.83 %
                                                      100.0 %             100.0 %

Certain comparative figures have been reclassified to conform to the current year's presentation.

Unit volume and unit prices comparatives (on the invoiced value of sales) for the three months ended June 30, 2009 and 2008 are summarized below:

                                                      Percentage increase (decrease) from the prior year
                                                                 Three months ended June 30,
                                                    2009                                                2008
                                                                    Overall                                          Overall
                                 Unit            Selling           increase /           Unit          Selling       increase /
                                volume            prices           (decrease)          volume         prices        (decrease)
Shining Essence Capsules              12 %              (6 )%               (4 )%           (22 )%           6 %            (17 )%
Shining Signal Capsules               (5 )%              0 %                (3 )%           (27 )%           9 %            (20 )%
Shining Golden Shield
Capsules                              57 %              (7 )%               29 %            (15 )%          18 %              0 %
Shining Energy Capsules               83 %             (10 )%                8 %            (13 )%          23 %              7 %
Shining Essence Stomach
Protection Capsules                  779 %             (11 )%               36 %            100 %          100 %            100 %
Shining Probiotics Protein
Powder                               331 %             (33 )%              189 %            100 %          100 %            100 %
Other products                       129 %             (25 )%               64 %            214 %           39 %            336 %
Bulk additives                       482 %              76 %               266 %            100 %          100 %            100 %

Cost of sales

Cost of sales for the three months ended June 30, 2009 was $4,498,673 compared with $3,258,669 for the three months ended June 30, 2008. The increase in cost of sales was primarily because of the overall sales volume increase and increases in the cost of packaging materials.

Unit volume and unit costs comparatives for the three months ended June 30, 2009 and 2008 are summarized below:

                                                    Percentage increase (decrease) from the prior year
                                                                Three months ended June 30,
                                                   2009                                               2008
                                                                  Overall                                          Overall
                                Unit             Unit            increase /          Unit           Unit          increase /
                               volume            costs           (decrease)         volume          costs         (decrease)
Shining Essence Capsules             12 %              6 %                 5 %           (22 )%          16 %             (10 )%
Shining Signal Capsules              (5 )%             5 %                 1 %           (27 )%           5 %             (23 )%
Shining Golden Shield
Capsules                             57 %              8 %                22 %           (15 )%          11 %              (6 )%
Shining Energy Capsules              83 %              2 %                 9 %           (13 )%          34 %              16 %
Shining Essence Stomach
Protection Capsules                 779 %            (90 )%               24 %           100 %          100 %             100 %
Shining Probiotics Protein
Powder                              331 %              0 %               330 %           100 %          100 %             100 %
Other products                      129 %            (10 )%              144 %           214 %          (95 )%            (84 )%
Bulk additives                      482 %            104 %               205 %           100 %          100 %             100 %

Gross profit

Gross profit for the three months ended June 30, 2009 was $10,913,789 compared with $8,111,988 for the three months ended June 30, 2008. The increase in gross profit was primarily due to an increase in overall sales volume.

The average gross profit percentage for all of our products for the three months ended June 30, 2009 and 2008 are summarized below:

Three months ended June 30, 2009 2008

Average for all products 70.81 % 71.34 %

Gross profit margin slightly decreased from 71.34% in the quarter ended June 30, 2008 to 70.81% this quarter as a result of increases in cost of packaging materials and electricity largely offset by increase in sales prices. The 70.81% gross profit margin remains solidly above our full year projection of 70%.

Selling expenses

Selling expenses were $2,347,592 or 15.23% of net sales for the three months ended June 30, 2009 compared with $2,369,859 or 20.84% of net sales for the three months ended June 30, 2008. The operating costs of the retail outlets are included as selling expenses. With limited new retail outlet roll-out during the quarter, selling expenses remained steady. As of June 30, 2009, we had a total of 107 retail outlets in operation compared with 83 outlets as of June 30, 2008.

General and administrative expenses

General and administrative expenses were $1,734,665 or 11.25% of net sales for the three months ended June 30, 2009 compared with $1,426,797 or 12.55% of net sales for the three months ended June 30, 2008. The increase of general and administrative expenses was primarily due to the increase of legal and professional fees. As of June 30, 2009, we had a total of 379 employees, compared with 339 as of June 30, 2008.

Provision for income taxes

Provision for income taxes was $1.68 million and $1.38 million for the quarters ended June 30, 2009 and 2008, respectively. Excluding the $0.51 million surplus on revaluation of the convertible note, income before taxes was $6.94 million for the first quarter of fiscal year 2010 compared with $5.85 million for 2009. The increase in income tax payable is attributable to an increase in operating profit.

Segment reporting

We have adopted the "products" approach for segment reporting. For the three months ended June 30, 2009 and 2008, we had only one reporting segment-the probiotic products as health supplement. We manufactured and sold the probiotic products solely in China and delivered all shipments to destinations within China, and all of our long-lived assets were physically located in China. We made all sales to external customers.

Liquidity and Capital Resources

We had cash of $77.41 million and working capital of $59.71 million as of June 30, 2009. Cash generated from operations was $7.33 million in the three months ended June 30, 2009 and $8.35 million in the three months ended June 30, 2008. The cash generated from operations of $7.33 million was higher than the net income of $5.77million due to the non-cash surplus of revaluation of convertible notes of $0.51 million and lower working capital needs resulting from better working capital management.

We had capital expenditures totaling $0.88 million in the three months ended June 30, 2009, mainly in connection with the construction of the new plant. We spent $7.19 million on fixed assets in the three months ended June 30, 2008.

Our current facility commenced operations in 2000. With the increases in sales volume in the last couple of years, we are reaching our production capacity. We are constructing a new plant with an overall project size of $45.5 million. Phase 1 of the project involves constructing a facility capable of producing 150 tons of probiotics per annum and is estimated to cost $27.50 million, $25 million of which is expected to be paid in the third quarter of calendar year 2009 and the balance by the end of calendar year 2009. Subsequent phases of this project will only commence when expected demands for probiotics exceed the production capacity of the Phase 1 facility.

We did not have any changes related to financing activities for the three months ended June 30, 2009. On December 11, 2007, we issued a 4% Senior Convertible Promissory Note in the amount of $25,000,000 (the "Note") with a maturity date of December 11, 2010. The principal amount of the Note is convertible into shares of our common stock at an exercise price of $12.00 per share at any time until the maturity date. If the Note is not converted at maturity, we will redeem the Note at a price that gives a total yield of 10% per annum inclusive of the annual interest. The Note also provides for mandatory conversion into common stock if the Group achieve a net income of $60 million in fiscal year 2010. Net proceeds of the Note are being used to fund the construction of a proposed 150-metric-ton-per-year manufacturing facility and for other capital expenditures.

Taking into account our current cash position and our anticipated cash flows from operations, we expect we will be able to meet all our funding needs, including payments required in the next twelve months to settle our contractual obligations, for the construction of our new plant and for our opening of new outlets. No assurance, however, can be given that our business plan will succeed. Should we need to raise external financing for whatever reason, there can be no assurance that we will be able to raise needed capital on favorable terms, if at all. In addition, there is no assurance that our estimate of our liquidity needs is accurate or that new business development or other unforeseen events will not occur, resulting in the need to raise additional funds.

Inflation

During the quarter ended June 30, 2009, there were small increases in pulp and paper costs. However, overall we believe that inflation did not have a significant impact on our results of operations for the quarter.

Seasonality

Typically, 60% of our sales take place in the second half of the fiscal year because many of our customers purchase our products to give as gifts during the Chinese festivals that occur during this time of the year. While it is still too early to tell, we expect that our bulk additive sales will not be seasonal in nature because the bulk products are purchased by food manufacturers consistently over the year.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Contractual Obligations

The following table summarizes our principal contractual obligations and
commercial commitments over various future periods as of June 30, 2009.


Contractual Obligations                   Total          Less than 1 year       1-3 years         3-5 years         More than 5 years
Capital Lease Obligations(1)           $  4,515,560     $        4,515,560                -                  -                       -
Operating Lease Obligations(1)         $    477,956     $          477,956                -                  -                       -
Purchase Obligations(2)                $ 18,529,424     $       18,529,424                -                  -                       -
Long-term loan(3)                      $ 25,000,000                      -     $ 25,000,000                  -                       -
Total                                  $ 48,522,940     $       23,522,940     $ 25,000,000                  -                       -

Research and Development Expenditures

We have a strong research and development team supported by a technical advisory board of experts. In addition to having advanced technology in bacteria culturing and protection, we also conduct research to develop products that address specific health problems using our core technology and Chinese medicine to create genetically engineered drugs and drug delivery solutions and expand our product line. We incurred research and development costs of approximately $674,369 and $709,919 in the three months ended June 30, 2009 and June 30, 2008, respectively.

Critical Accounting Policies

Our critical accounting policies are described in the Notes to the Financial Statements included in our Annual Report filed with the SEC on Form 10-K for the fiscal year ended March 31, 2009, and this Form 10-Q should be read in conjunction with that Annual Report. This MD&A discusses our consolidated financial statements for the three months ended June 30, 2009 and 2008. These financial statements have been prepared in accordance with generally accepted accounting principles in the United States. In preparing these financial statements, we are required to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates and judgments on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for . . .