UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM 10-Q




(Mark
      One)x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934




For the
quarterly period ended March
31, 2010




or




o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934




For the
transition period from __________ to __________




Commission
File Number: 000-52174





EMERALD
      DAIRY INC.(Exact
      name of registrant as specified in its charter)


Nevada
            
            80-0137632(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      No.)11990
      Market Street, Suite 205
              Reston,
      Virginia
            
            20190(Address
      of principal executive offices)
            
            (Zip
      Code)




(703)
      867-9247(Registrant’s
      telephone number, including area code)


(Former
      name, former address and former fiscal year, if changed since last
      report)




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. xYes     oNo





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


o Yes     oNo





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act:





Large
      accelerated filer o
            Accelerated
      filer oNon-accelerated
      filer o(do not check if a
      smaller reporting company)
            Smaller
      reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).


o Yes  x No





The
registrant had 34,002,728 shares of common stock issued and outstanding as of
May 10, 2010 (not including an additional 1,944,444 shares of common stock of
the registrant currently being held in treasury).









QUARTERLY
REPORT ON FORM 10-Q


OF
EMERALD DAIRY INC. AND SUBSIDIARIES


FOR
THE PERIOD ENDED MARCH 31, 2010




TABLE
OF CONTENTS







PAGEPART I
      -
      FINANCIAL
      INFORMATIONItem
      1.
            
            Financial
      Statements
            
            1Condensed
      Consolidated Balance Sheets as of March 31, 2010 (unaudited) and December
      31, 2009
            
            1Condensed
      Consolidated Statements of Income for the Three Months Ended March 31,
      2010 and 2009 (unaudited)
            
            2Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended March 31,
      2010 and 2009 (unaudited)
            
            3Notes
      to Condensed Consolidated Financial Statements (unaudited)
            
            4Item
      2.
            
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            21Item
      3.
            
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            42Item
      4.
            
            Controls
      and Procedures
            
            42PART II
      - OTHER
      INFORMATIONItem
      1.
            
            Legal
      Proceedings
            
            44Item
      1A.
            
            Risk
      Factors
            
            44Item
      2.
            
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            44Item
      3.
            
            Defaults
      Upon Senior Securities
            
            44Item
      4.
            
            (Removed
      and Reserved)
            
            44Item
      5.
            
            Other
      Information
            
            44Item
      6.
            
            Exhibits
            
            45Signatures
            
            46




i




PART
I. FINANCIAL INFORMATION





Item
1.  Financial Statements





Emerald
Dairy Inc. and Subsidiaries


Condensed
Consolidated Balance Sheets


March
31, 2010 and December 31, 2009




ASSETSMarch
      31,
              
              
              December
      31,2010
              
              
              2009(Unaudited)Current
      AssetsCash
      and cash equivalents
              
              $
              6,482,593
              
              
              $
              13,486,429Trade
      accounts receivable,net
              
              
              6,925,247
              
              
              
              7,223,016Inventory,
      net
              
              
              1,921,028
              
              
              
              1,298,488Advances
      to equipment supplier
              
              
              8,787,779
              
              
              
              3,710,707Other
      current assets
              
              
              5,453,840
              
              
              
              1,292,749Total
      current assets
              
              
              29,570,487
              
              
              
              27,011,389Property,
      plant and equipmentProperty,
      plant and equipment, net
              
              
              5,860,017
              
              
              
              5,946,330Contruction
      in progress
              
              
              9,519,137
              
              
              
              8,772,93115,379,154
              
              
              
              14,719,261Intangible
      assets, net
              
              
              1,332,313
              
              
              
              1,341,534$
              46,281,954
              
              
              $
              43,072,184LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
              
              $
              3,026,838
              
              
              $
              2,917,798Notes
      payable, net of debt discount of $543,805 and $729,830 at March
      31, 2010 and December 31, 2009, respectively
              
              
              6,029,497
              
              
              
              5,843,472Other
      current liabilities
              
              
              423,325
              
              
              
              704,056Loan
      from shareholder
              
              
              210,176
              
              
              
              210,142Total
      current liabilities
              
              
              9,689,836
              
              
              
              9,675,468Commitments
      and Contingencies (Note 18)Stockholders'
      EquityPreferred
      stock ($0.001 par value, 10,000,000 shares authorized, none issued
      and outstanding at March 31, 2010 and December 31,
      2009)
              
              
              -
              
              
              
              -Common
      stock ($0.001 par value, 100,000,000 shares authorized, 34,890,267
      and 34,890,267 issued and outstanding at March 31, 2010 December
      31, 2009, respectively)
              
              
              34,890
              
              
              
              34,890Treasury
      Stock (1,944,444 shares at March 31, 2010 and December
      31, 2009, respectively)
              
              
              (1,944
              )
              
              
              (1,944
              )Additional
      paid-in capital
              
              
              22,488,323
              
              
              
              17,003,093Retained
      earnings (of which $3,191,614 and $1,834,742 are restricted at March
      31, 2010 and December 31, 2009, respectively, for common welfare
      reserves)
              
              
              12,021,781
              
              
              
              14,318,425Accumulated
      other comprehensive income
              
              
              2,049,068
              
              
              
              2,042,252Total
      stockholders' equity
              
              
              36,592,118
              
              
              
              33,396,716$
              46,281,954
              
              
              $
              43,072,184




The
accompanying notes are an integral part of these condensed consolidated
financial statements.




1




Emerald
Dairy Inc. and Subsidiaries


Condensed
Consolidated Statements of Income


For
the Three Months Ended March 31, 2010 and 2009


(Unaudited)




2010
              
              
              2009Sales
              
              $
              14,252,856
              
              
              $
              10,856,552Cost
      of Goods Sold
              
              
              7,153,772
              
              
              
              5,848,675Gross
      Profit
              
              
              7,099,084
              
              
              
              5,007,877Operating
      ExpensesSelling
      expenses and administrative expenses
              
              
              3,902,390
              
              
              
              3,026,704Liquidated
      damages
              
              
              5,021,669
              
              
              
              -Depreciation
      and amortization
              
              
              51,228
              
              
              
              43,238Total
      operating expenses
              
              
              8,975,287
              
              
              
              3,069,942Other
      Income (Expense)Interest
      income
              
              
              1,058
              
              
              
              953Interest
      expense
              
              
              -
              
              
              
              (48,352
              )Total
      other income (expense)
              
              
              1,058
              
              
              
              (47,399
              )Net
      Income (Loss) Before Provision for Income Tax
              
              
              (1,875,145
              )
              
              
              1,890,536Provision
      for Income TaxesCurrent
              
              
              421,499
              
              
              
              337,830421,499
              
              
              
              337,830Net
      Income (Loss)
              
              $
              (2,296,644
              )
              
              $
              1,552,706Basic
      Earnings Per Share
              
              $
              (0.07
              )
              
              $
              0.05Basic
      Weighted  Average Shares Outstanding
              
              
              32,945,823
              
              
              
              29,415,137Diluted
      Earnings (Loss) Per Share
              
              $
              (0.07
              )
              
              $
              0.05Diluted
      Weighted  Average Shares Outstanding
              
              
              32,945,823
              
              
              
              29,510,851The
      Components of Other Comprehensive IncomeNet
      Income
              
              $
              (2,296,644
              )
              
              $
              1,552,706Foreign
      currency translation adjustment
              
              
              10,295
              
              
              
              (55,826
              )Income
      tax related to other comprehensive income
              
              
              (3,500
              )
              
              
              18,981Comprehensive
      Income (Loss)
              
              $
              (2,289,849
              )
              
              $
              1,515,861




The
accompanying notes are an integral part of these condensed consolidated
financial statements.




2




Emerald
Dairy Inc. and Subsidiaries


Condensed
Consolidated Statements of Cash Flows


For
the Three Months Ended March 31, 2010 and 2009


(Unaudited)




2010
              
              
              2009Cash
      flows from operating activitiesNet
      Income (Loss)
              
              $
              (2,296,644
              )
              
              $
              1,552,706Adjustments
      to reconcile net cash provided by operating
      activitiesDepreciation
      and amortization
              
              
              141,255
              
              
              
              133,083Amortization
      of loan discount
              
              
              186,025
              
              
              
              21,971Capitalized
      interest
              
              
              (630,918
              )
              
              
              (62,012
              )Warrants
      modified for liquidated damages
              
              
              5,021,669
              
              
              
              -Incentive
      stock options
              
              
              213,361
              
              
              
              18,508Net
      change in assets and liabilitiesTrade
      accounts receivable
              
              
              298,933
              
              
              
              (634,733
              )Inventory
              
              
              (622,331
              )
              
              
              (480,552
              )Other
      current assets
              
              
              171,145
              
              
              
              36,018Accounts
      payable and accrued expenses
              
              
              358,770
              
              
              
              (223,133
              )Other
      current liabilities
              
              
              (280,844
              )
              
              
              (291,812
              )Net
      cash provided by operating activities
              
              
              2,560,421
              
              
              
              70,044Cash
      flows from investing activitiesDeposit
      on equipment and construction
              
              
              (9,411,275
              )
              
              
              -Construction
      in progress
              
              
              (113,874
              )
              
              
              -Purchases
      of fixed assets and intangibles
              
              
              (44,548
              )
              
              
              (4,933
              )Net
      cash used in investing activities
              
              
              (9,569,697
              )
              
              
              (4,933
              )Cash
      flows from financing activitiesExercise
      of warrants
              
              
              -
              
              
              
              758,230Net
      cash provided by financing activities
              
              
              -
              
              
              
              758,230Effect
      of exchange rate
              
              
              5,440
              
              
              
              (12,537
              )Net
      increase (decrease) in cash
              
              
              (7,003,836
              )
              
              
              810,804Cash
      and cash equivalents at beginning of period
              
              
              13,486,429
              
              
              
              7,343,588Cash
      and cash equivalents at end of period
              
              $
              6,482,593
              
              
              $
              8,154,392




The
accompanying notes are an integral part of these condensed consolidated
financial statements.




3


Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
  1.
Description of Business
 
 Emerald
Dairy, Inc. (the “Company”), a Nevada corporation, is a producer of milk powder,
rice powder and soybean milk powder in the People’s Republic of China (“PRC”)
through its wholly owned subsidiaries. Through the Company’s network of over
1,100 salespeople, the Company’s products are distributed throughout 20
provinces in the PRC, and sold in over 6,000 retail outlets.
 
 The
Company’s subsidiary, American International Dairy Holdings, Inc. (“AIDH”), a
Nevada corporation, was formed in 2005 for the purpose of acquiring the stock in
Heilongjiang Xing An Ling Dairy, Co. (“XAL”), a corporation formed on September
8, 2003 in Heilongjiang Providence, pursuant to the laws of the PRC. XAL is a
dairy company engaged in manufacturing of milk powder, soybean powder and rice
powder. On May 30, 2005, AIDH acquired  XAL, pursuant to a Share
Transfer Agreement. This transaction was treated as a recapitalization of XAL
for financial reporting purposes. The effect of this recapitalization was rolled
back to the inception of XAL for financial reporting purposes.
 
 Prior to
September 23, 2006, XAL owned 57.69% of Heilongjiang Be’ian Nongken Changxing
LvBao Dairy Limited Liability Company (“LvBao”), with the remaining balance
being held by the Company’s sole shareholder. On September 23, 2006, the
remaining 42.31% ownership in LvBao was transferred to XAL and was treated as an
additional capital contribution. The effect of this contribution by the sole
shareholder was rolled back to September 8, 2003 for financial reporting
purposes. LvBao was formed on January 20, 2000 and is engaged in manufacturing
and sales of dairy products.
 
 On May
22, 2008, the Company formed a new wholly-owned subsidiary,
Hailun Xinganling Dairy Co., Ltd. (“HXD”), pursuant to the laws of the
PRC. In July 2008, HXD commenced construction of a production facility in
Hailun City, Heilongjiang Province, PRC. It is expected that the
construction and equipping of this new facility will be completed in the third
fiscal quarter of 2010. Upon completion, it is anticipated that HXD will engage
in the manufacture of the Company's milk powder, soybean powder and rice powder
products at this new facility.
 
 2.
Basis of Preparation of Financial Statements
 
 XAL,
LvBao and HXD maintain their books and accounting records in Renminbi
(“RMB”).
 
 The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles the United
States of America (“US GAAP”) for interim financial information and with the
instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by US GAAP for complete financial statements
and related notes. The accompanying unaudited condensed consolidated financial
statements and related notes should be read in conjunction with the audited
consolidated financial statements of the Company and notes thereto for the year
ended December 31, 2009, which are included in the Company’s Form 10K/A for the
year ended December 31, 2009, filed with the SEC on April 1, 2010.
 
 In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (which include only normal
recurring adjustments) necessary to present fairly the consolidated balance
sheets of Emerald Dairy Inc. and subsidiaries as of March 31, 2010 and the
results of their operations for the three months ended March 31, 2010 and 2009,
and cash flows for the three months ended March 31, 2010 and 2009. The results
of operations for the three months ended March 31, 2010 are not necessarily
indicative of the results to be expected for the entire year ending December 31,
2010.
 
 The
financial statements have been prepared in order to present the consolidated
financial position and consolidated results of operations in accordance with US
GAAP and are expressed in terms of U.S. dollars (see paragraph “Foreign
Currency” below).
 
 The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries, AIDH, XAL, LvBao and HXD. All inter-company
transactions and balances have been eliminated in
consolidation.
  4
  Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 3.
Summary of Significant Accounting Policies
 
 Use of estimates - The
preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of net sales and expenses during the reported
periods.
 
 Significant
estimates and assumptions by management include, among others, values and lives
assigned to acquired intangible assets, reserves for customer returns and
allowances, uncollectible accounts receivable, slow moving, obsolete and/or
damaged inventory, deferred tax assets, property, plant and equipment, reserve
for employee benefit obligations, stock warrant valuation, income tax
uncertainties and other uncertainties. Actual results may differ from these
estimates.  The current economic environment has increased the degree
of uncertainty inherent in these estimates and assumptions.
 
 Cash and cash equivalents -Cash and cash equivalents represent cash on hand, demand deposits and all
highly liquid investments placed with banks or other financial institutions with
original maturities of three months or less. Substantially all of the Company’s
cash is held in bank accounts in the PRC and is not protected by Federal Deposit
Insurance Corporation (“FDIC”) insurance or any other similar insurance.
Accounts held at United States financial institutions are insured by the FDIC up
to $250,000. As of March 31, 2010, no U.S. balances are in excess of insured
amounts. Given the current economic environment and risks in the banking
industry, there is a risk that the deposits may not be readily available or
covered by such insurance.
 
 Trade accounts receivable -Trade accounts receivable are recorded at the invoiced amount and do not
bear interest. Amounts collected on trade accounts receivable are included in
net cash provided by operating activities in the consolidated statements of cash
flows. The Company maintains an allowance for doubtful accounts for estimated
losses inherent in its accounts receivable portfolio. In establishing the
required allowance, management considers historical losses, current receivables
aging, and existing industry and PRC economic data. The Company reviews its
allowance for doubtful accounts monthly. Past due balances over 90 days and over
a specified amount are reviewed individually for collectibility. Account
balances are charged off against the allowance after all means of collection
have been exhausted and the potential for recovery is considered remote. At
March 31, 2010 and December 31, 2009, there were no allowances for doubtful
accounts based on the review of the above factors. There were no write-off’s for
the three months ended March 31, 2010 and 2009. The Company does not have any
off-balance sheet credit exposure related to its customers.
 
 Construction-in-Progress -
Plant and production lines currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditure, professional fees and
the interest expenses capitalized during the course of construction for the
purpose of financing the project. Upon completion and readiness for use of the
project, the cost of construction-in-progress is to be transferred to fixed
assets, at which time depreciation will commence. As of March 31, 2010, the
Company has incurred and capitalized into construction-in-progress $8,245,669 of
construction costs and $1,273,468 of capitalized interest for a balance of
$9,519,137.  As of December 31, 2009, the Company had incurred and
capitalized into construction-in-progress $8,130,380 of construction costs and
$642,551 of capitalized interest.  The estimated cost to be incurred
in 2010 to complete the project is approximately $497,300.
  5
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 3.
Summary of Significant Accounting Policies (Continued)
 
 Capitalized Interest– The
Company’s policy is to capitalize interest costs on debt during the construction
of major projects exceeding one year.  A reconciliation of total
interest cost to interest expense as reported in the consolidated statements of
income for three months ended March 31, 2010 and 2009 is as
follows:
 
 Three Months
                  Ended March 31,2010
                
                2009Interest
      cost capitalized
                
                $
                630,918
                
                
                $
                62,012Interest
      cost charged to income
                
                
                --
                
                
                
                48,352$
                630,918
                
                
                $
                110,364
 
 Foreign Currency- The
Company’s principal country of operations is the PRC. The financial position and
results of operations of the Company are determined using the local currency
(“Renminbi” or “Yuan”) 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 exchange rates prevailing at the balance sheet date. The
registered equity capital denominated in the functional currency is translated
at the historical rate of exchange at the time of capital contribution. All
translation adjustments resulting from the translation of the financial
statements into the reporting currency (U.S. Dollars) are dealt with as a
separate component within stockholders’ equity. Translation adjustments net of
tax totaled $6,795 and ($36,845), for the three months ended March 31, 2010 and
2009, respectively.
 
 As of
March 31, 2010 and 2009, the exchange rate was 6.8259 Yuan and 6.8339 Yuan per
U.S. Dollar, respectively.
 
 Revenue recognition - Revenue
is recognized when the following criteria are met: (1) persuasive evidence
of an arrangement exists; (2) the service has been rendered; (3) the
selling price is fixed or determinable; and (4) collection of the resulting
receivable is reasonably assured.
 
 Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.
 
 As of
March 31, 2010, the Company has no sales or contracts that included multiple
deliverables that would fall under the accounting guidance.
 
 Earnings per share -Basic net
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. Diluted net earnings per common share is determined using the
weighted-average number of common share shares outstanding during the period,
adjusted for the dilutive effect of common stock equivalents, using the treasury
stock method, consisting of shares that might be issued upon exercise of common
stock warrants. In periods where losses are reported, the weighted-average
number of common shares outstanding excludes common stock equivalents, because
their inclusion would be anti-dilutive.
 
 Taxation - Taxation on
profits earned in the PRC has been calculated on the estimated assessable
profits for the year at the rates of taxation prevailing in the PRC in which the
Company operates after taking into effect the benefits from any special tax
credits or “tax holidays” allowed in the country of operations.
  The
Company accounts for income tax under accounting guidance that requires
recognition of deferred tax assets and liabilities for the expected future tax
consequences of the events that have been included in the financial statements
or tax returns. Deferred income taxes are recognized for all significant
temporary differences between tax and financial statements bases of assets and
liabilities. Valuation allowances are established against net deferred tax
assets when it is more likely than not that some portion or all of the deferred
tax asset will not be realized.
  6
  Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 3.
Summary of Significant Accounting Policies (Continued)
 
 The
Company does not have any long-term deferred tax assets or liabilities in China
that will exist once the tax holiday (See Note 10) expires. The Company
does not have any significant deferred tax asset or liabilities that relate to
tax jurisdictions not covered by the tax holiday.
  The
Company does not accrue United States income tax 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
 
 Under the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the State Council which came into effect on
January 1, 1994, income tax is payable by a “Wholly Foreign Owned Enterprises”
at a rate of 15% 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. XAL enjoyed a 100% exemption from enterprise
income taxes starting on January 10, 2006 due to its classification as a Wholly
Foreign Owned Enterprise. On March 16, 2007, the PRC enacted a new Enterprise
Income Tax Law for the purpose of unifying the tax treatment of domestic and
foreign enterprises. This new law eliminates the preferential tax treatment for
new Wholly Foreign Owned Enterprises but allows previously granted exemptions to
stay in place through 2012, with the exception that the statutory tax rate will
increase by 2% per year from 15% in 2006 to 25% by 2012. This exemption ended on
January 10, 2008, at which time XAL qualified under the current tax structure
for a 50% reduction in the statutory enterprise income tax rates for an
additional three years.
 
 Freestanding Financial Instruments
with Characteristics of Both Liabilities and Equity -The Company
accounts for financial instruments as a liability if it embodies an obligation
to repurchase the issuer’s equity shares, or is indexed to such an obligation,
and that requires or may require the issuer to settle the obligation by
transferring assets. Freestanding financial instruments are financial
instruments that are entered into separately and apart from any of the entity's
other financial instruments or equity transactions, or that is entered into in
conjunction with some other transaction and is legally detachable and separately
exercisable. The liability recorded is the per share price to be paid and is
offset to equity.
 
 Stock Based Compensation –The
Company has adopted accounting guidance which requires all share-based payments
to employees, including grants of employee stock options, to be recognized in
the financial statements based on the grant date fair value of the
award.
 
 Fair value of financial instruments -The Company applies the provisions accounting guidance that requires all
entities to disclose the fair value of financial instruments, both assets and
liabilities recognized and not recognized on the balance sheet, for which it is
practicable to estimate fair value.  The accounting guidance defines
fair value of a financial instrument as the amount at which the instrument could
be exchanged in a current transaction between willing parties.  As
of  March 31, 2010 and December 31, 2009 the fair value of cash, trade
accounts receivable, other receivables, accounts payable, commercial notes
payable, and accrued expenses approximated carrying value due to the short
maturity of the instruments, quoted market prices, or interest rates, which
fluctuate with market rates.
 
 Fair Value Measurements– On
January 1, 2008 the Company adopted accounting guidance that establishes a
framework for measuring fair value in generally accepted accounting principles,
clarifies the definition of fair value within that framework, and expands
disclosures about the use of fair value measurements. The accounting guidance
applies to fair value measurements required by existing accounting guidance and
does not require any new fair value measurements.
 
 On
January 1, 2009 the Company adopted accounting guidance for non-financial assets
and non-financial liabilities that are recognized or disclosed at fair value in
the consolidated financial statements on a nonrecurring basis as permitted by,
which provided a deferral of such provisions until 2009. The adoption of this
guidance did not have a material impact on the Company’s financial position,
results of operations, or cash flows.
  7
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 3.
Summary of Significant Accounting Policies (Continued)
 
 The
carrying value of financial assets and liabilities recorded at fair value is
measured on a recurring or nonrecurring basis. Financial assets and liabilities
measured on a non-recurring basis are those that are adjusted to fair value when
a significant event occurs. The Company had no financial assets or liabilities
carried and measured on a nonrecurring basis during the reporting periods.
Financial assets and liabilities measured on a recurring basis are those that
are adjusted to fair value each time a financial statement is prepared. The
Company’s had no financial assets and/or liabilities carried at fair value on a
recurring basis at March 31, 2010.
  The
availability of inputs observable in the market varies from instrument to
instrument and depends on a variety of factors including the type of instrument,
whether the instrument is actively traded, and other characteristics particular
to the transaction. For many financial instruments, pricing inputs are readily
observable in the market, the valuation methodology used is widely accepted by
market participants, and the valuation does not require significant management
discretion. For other financial instruments, pricing inputs are less observable
in the market and may require management judgment.
 
 Recent accounting
pronouncements
 
 In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (Topic 605): “Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task
Force.”  This update provides application guidance on whether
multiple deliverables exist, how the deliverables should be separated and how
the consideration should be allocated to one or more units of accounting. This
update establishes a selling price hierarchy for determining the selling price
of a deliverable. The selling price used for each deliverable will be based on
vendor-specific objective evidence, if available, third-party evidence if
vendor-specific objective evidence is not available, or estimated selling price
if neither vendor-specific or third-party evidence is available. On January 1,
2010 the Company adopted this amended accounting guidance, the adoption of this
guidance did not have a material impact on our financial condition, results of
operations or cash flows.
 
 In June
2009, the FASB issued guidance related to accounting for transfers of financial
assets. This guidance improves the information that a reporting entity provides
in its financial reports about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance and cash flows; and a
continuing interest in transferred financial assets. In addition, this guidance
amends various ASC concepts with respect to accounting for transfers and
servicing of financial assets and extinguishments of liabilities,  including
removing the concept of qualified special purpose entities. This guidance must be
applied to transfers occurring on or after the effective date. On January 1,
2010 the Company adopted this amended accounting guidance, the adoption of this
guidance did not have a material impact on our financial condition, results of
operations or cash flows.
 
 In June
2009, the FASB issued guidance which amends certain ASC concepts related to
consolidation of variable interest entities. Among other accounting and
disclosure requirements, this guidance replaces the quantitative-based risks and
rewards calculation for determining which enterprise has a controlling financial
interest in a variable interest entity with an approach focused on identifying
which enterprise has the power to direct the activities of a variable interest
entity and the obligation to absorb losses of the entity or the right to receive
benefits from the entity. On January 1, 2010 the Company adopted this amended
accounting guidance, the adoption of this guidance did not have a material
impact on our financial condition, results of operations or cash
flows.
 
 4.
Concentrations of Business and Credit Risk
 
 The
Company conducts all of its primary trade in the PRC.  There can be no
assurance that the Company will be able to successfully conduct its trade, and
failure to do so would have a material adverse effect on the Company’s financial
position, results of operations and cash flows. Also, the success of the
Company’s operations is subject to numerous contingencies, some of which are
beyond management’s control. These contingencies include general economic
conditions, price of raw material, competition, governmental and political
conditions, and changes in regulations.
  8
  Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 4.
Concentrations of Business and Credit Risk (Continued)
 
 Because
the Company is dependant on foreign trade in PRC, the Company is subject to
various additional political, economic and other uncertainties. Among other
risks, the Company’s operations will be subject to risk of restrictions on
transfer of funds, domestic and international customs, changing taxation
policies, foreign exchange restrictions, and political and governmental
regulations.
 
 Substantially
all of the Company’s bank accounts are in banks located in the PRC and are not
covered by any type of protection similar to that provided by the FDIC on funds
held in U.S banks. Accounts held at U.S. financial institutions are insured by
the FDIC up to $250,000. As of March 31, 2010 none of the U.S. cash balances are
in excess of insured amounts.
 
 Milk
powder is historically 75% to 95% of our total sales. Dairy product consumption
in China has historically been lower than in many other countries in the
world. Growing interest in milk products in China is a relatively recent
phenomenon which makes the market for our products less
predictable.  Consumers may lose interest in the
products.  As a result, achieving and maintaining market acceptance
for the Company’s products will require substantial marketing efforts and the
expenditure of significant funds to encourage dairy consumption in general, and
the purchase of our products in particular. There is substantial risk that
the market may not accept or be receptive to the Company’s
products.  Market acceptance of the Company’s current and proposed
products will depend, in large part, upon our ability to inform potential
customers that the distinctive characteristics of the Company’s products make
them superior to competitive products and justify their pricing.  The
Company’s current and proposed products may not be accepted by consumers or able
to compete effectively against other premium or non-premium dairy
products.  Lack of market acceptance would limit the Company’s
revenues and profitability.
 
 The
Company operates in China, which may give rise to significant foreign currency
risks from fluctuations and the degree of volatility of foreign exchange rates
between U.S. dollars and the Chinese currency RMB.
 
 Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash and trade accounts receivable, the balances of which
are stated on the balance sheet. Concentration of credit risk with respect to
trade accounts receivable is limited due to the Company's large number of
diverse customers in different locations in the PRC. The Company does not
require collateral or other security to support financial instruments subject to
credit risk.
 
 For the
three months ended March 31, 2010 and 2009, no single customer accounted for 10%
or more of sales revenues.
 
 Payments
of dividends may be subject to some restrictions due to the fact that the
operating activities are conducted in subsidiaries residing in the
PRC.
 
 The
operations of the Company are located in the PRC. Accordingly, the Company’s
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
 
 5.
Inventory
 
 As of
March 31, 2010 and December 31, 2009 inventory consists of the
following:
   2010
                
                
                2009Raw
      materials
                
                $
                1,402,309
                
                
                $
                689,984Work-in-process
                
                
                445,679
                
                
                
                579,806Finished
      goods
                
                
                64,794
                
                
                
                20,365Repair
      parts
                
                
                8,246
                
                
                
                8,333$
                1,921,028
                
                
                $
                1,298,488
  9
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 6.
Other Current Assets
 
 As of
March 31, 2010 and December 31, 2009, other current assets consist of the
following:
 
 2010
                
                
                
                2009Advances
      to milk suppliers
                
                $
                376,412
                
                
                $
                368,566Advances
      to construction contractor
                
                
                4,332,029
                
                
                
                -Advances
      to staff
                
                
                9,285
                
                
                
                15,496Deposit
      on contract
                
                
                194,670
                
                
                
                71,598Prepaid
      loan costs
                
                
                540,083
                
                
                
                828,725Prepaid
      expenses
                
                
                1,361
                
                
                
                8,364$
                5,453,840
                
                
                $
                1,292,749
 
 7.
Property, Plant, and Equipment
 
 As of
March 31, 2010 and December 31, 2009, Property, Plant, and Equipment consist of
the following:
 
 2010
                
                
                2009Building
                
                $
                3,768,592
                
                
                $
                3,767,984Plant
      and Machinery
                
                
                3,227,630
                
                
                
                3,227,110Motor
      vehicles
                
                
                567,519
                
                
                
                526,597Dairy
      cows
                
                
                256,209
                
                
                
                253,439Office
      equipment
                
                
                77,639
                
                
                
                76,6167,897,589
                
                
                
                7,851,746Less:
      Accumulated depreciation
                
                
                (2,037,572
                )
                
                
                (1,905,416
                )$
                5,860,017
                
                
                $
                5,946,330
  Depreciation
expenses totaled $131,819 and $123,659 for the three months ended March 31, 2010
and 2009, respectively, of which $90,027 and $89,845 were included as a
component of cost of goods sold for the three months ended March 31, 2010 and
2009, respectively.
 
 8.
Construction-in-progress
 
 March
      31,
                  2010
                
                
                December 31,
                  2009Construction
      in progress
                
                $
                9,519,137
                
                
                $
                8,772,931
 
 Construction-in-progress
represents construction and installations of the new plant and machinery for the
production facility in Hailun City.
  10
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 9.
Intangible Assets
 
 March
      31,
                  2010
                
                
                December 31,
                  2009Land
      use rights
                
                $
                1,355,807
                
                
                $
                1,355,589Patents
                
                
                53,180
                
                
                
                53,1711,408,987
                
                
                
                1,408,760Less:
      Accumulated amortization
                
                
                (76,674
                )
                
                
                (67,226
                )$
                1,332,313
                
                
                $
                1,341,534
  For the
three months ended March 31, 2010 and 2009, amortization expenses totaled $9,436
and $9,424, respectively.
 
 Amortization
expense is estimated to be $37,744 for each of the next five years.
 
 10.
Income Taxes
 
 On May
30, 2005, AIDH executed a Share Transfer Agreement with XAL, a corporation
organized and existing under the laws of the PRC. XAL applied to be as a foreign
invested company right after the share transfer, which business license has been
approved as a foreign invested company on January 10, 2006. According to Chinese
taxation policy, there is income tax exemption for 2 years and half for 3 years
suitable to foreign invested company, advanced Technology Company or software
Development Company. XAL is considered an Advanced Technology Company. Therefore
the Company receives this income tax exemption policy from January 10, 2006 the
date approval as a foreign invested company. The Company received a 100% tax
holiday as of January 10, 2006. On January 10, 2008 the Company’s tax exemption
was reduced to 50% of the prevailing tax rate and will continue at this reduced
rate for three additional years.
 
 LvBao is
currently subject to the Enterprise income tax of 25%.
 
 A
reconciliation of the provision for income taxes with amounts determined by the
U.S. federal income tax rate to income before income taxes is as
follows.
 
 The
components of net income (loss) before provision for income tax consist of
following:
 
 Three Months
                  Ended March 31,2010
                
                2009U.S.
      Operations
                
                $
                (5,583,000
                )
                
                $
                (510,600
                )Chinese
      Operations
                
                
                3,708,000
                
                
                
                2,401,100$
                (1,875,000
                )
                
                $
                1,890,500
  The
components of the provision for income taxes are approximately as
follows:
  Three Months
                  Ended March 31,2010
                
                2009Federal,
      State and Local
                
                $
                -
                
                
                $
                -PRC -Federal
      and Local
                
                
                421,500
                
                
                
                337,800$
                421,500
                
                
                $
                337,800
  11
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
  10.
Income Taxes (Continued)
 
 The table
below approximately summarizes the reconciliation of the Company’s income tax
provision (benefit) computed at the statutory U.S. Federal rate and the actual
tax provision:
  Three Months
                  Ended March 31,2010
                
                
                2009Income
      tax provision at Federal statutory rate
                
                $
                (637,600
                )
                
                $
                642,800State
      income taxes, net of Federal benefit
                
                
                -0-
                
                
                
                113,500U.S.
      tax rate in excess of foreign tax rate
                
                
                (333,700
                )
                
                
                (168,100
                )Abatement
      of foreign income taxes
                
                
                (505,500
                )
                
                
                (452,600
                )Increase
      in valuation allowance
                
                
                1,898,300
                
                
                
                202,200Tax
      provision
                
                $
                421,500
                
                
                $
                337,800
  The
Company has a U.S. net operating loss carryforward of approximately $11,868,000
as of March 31, 2010, which expires in 2030. The deferred tax asset associated
with these net operating loss carryforwards was fully reserved as of March 31,
2010.
 
 The
change in the valuation allowance as of March 31, 2010 and 2009 was $1,898,300
and $202,200, respectively.
 
 The
effects of the tax exemption per share were as follows:
 
 Three
      Months
                  Ended March 31,2010
                
                
                2009Tax
      Saving
                
                $
                505,500
                
                
                $
                452,600Benefit
      per share:Basic
                
                $
                0.02
                
                
                $
                0.02Diluted
                
                $
                0.02
                
                
                $
                0.02
  Had the
tax exemption not been in place for the three months ended March 31, 2010 and
2009, the Company estimates the following proforma financial statement
impact:
  Three
      Months
                  Ended March 31,2010
                
                
                2009Net
      (loss) income before tax provisions, as reported
                
                $
                (1,875,100
                )
                
                $
                1,890,500Less
      tax provision not exempted
                
                
                421,500
                
                
                
                337,800Less
      tax provision exempted
                
                
                505,500
                
                
                
                452,600Proforma
      Net income (loss)
                
                $
                (2,802,100
                )
                
                $
                1,100,100Proforma
      Net income (loss) per shareBasic
                
                $
                (0.09
                )
                
                $
                0.04Diluted
                
                $
                (0.09
                )
                
                $
                0.04
  12
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 11.
Employee Retirement Benefits and Post Retirement Benefits
 
 According
to the Heilongjiang Provincial regulations on state pension program, both
employees and employers have to contribute toward pensions. The pension
contributions range from 2% to 8% that was contributed by individuals
(employees), and the Company is required to make contributions to the state
retirement plan based on 20% of the employees’ monthly basic salaries. Employees
in the PRC are entitled to retirement benefits calculated with reference to
their basic salaries on retirement and their length of service in accordance
with a government managed benefits plan. The PRC government is responsible for
the benefit liability to these retired employees. During the three months ended
March 31, 2010 and 2009, respectively, the Company contributed $32,668 and
$43,130 in pension contributions.
 
 12.
Accounts Payable and Accrued Expenses
  At March
31, 2010 and December 31, 2009 accounts payable and accrued expenses consisted
of:
 
 March
      31,
                  2010
                
                
                December 31,
                  2009Accounts
      payable
                
                $
                2,659,045
                
                
                $
                2,308,866Accrued
      payroll
                
                
                55,033
                
                
                
                306,011Accrued
      interest
                
                
                227,820
                
                
                
                71,570Economic
      development advance
                
                
                43,950
                
                
                
                43,943Accrued
      insurance
                
                
                40,990
                
                
                
                187,408$
                3,026,838
                
                
                $
                2,917,798
  13.
Notes Payable
 
 At March
31, 2010 and December 31, 2009 notes payable consisted of the
following:
 
 March
      31,
                  2010
                
                
                December 31,
                  2009Notes
      dated June, 2008, due December 31, 2010 with a interest rate of
      10%,
                
                $
                2,573,301
                
                
                $
                2,573,301Notes
      dated November, 2008 due May 10, 2010 with a interest rate of
      10%
                
                
                500,000
                
                
                
                500,000Note
      dated November, 2009 due November 30, 2010 with a interest rate of
      10%
                
                
                1,750,000
                
                
                
                1,750,000Notes
      dated December, 2009 due December 24, 2010 with a interest rate of 10%,
      net of debt discount of $543,805  and $729,830 at March 31, 2010
      and December 31, 2009, respectively
                
                
                1,206,196
                
                
                
                1,020,171$
                6,029,497
                
                
                $
                5,843,472
  13
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
  14.
Equity
 
 Warrants
 
 Information
with respect to stock warrants outstanding as of March 31, 2010 are as
follows:
  Exercise Price
                
                Outstanding
                  December31, 2009
                
                
                Granted
                
                
                Modified,
      Expired or
                  Exercised
                
                
                Outstanding
                  March31, 2010
                
                Expiration
                  Date$0.75
                
                
                -0-
                
                
                
                -0-
                
                
                
                373,334
                
                
                
                373,334
                
                4/6/2010$0.94
                
                
                373,334
                
                
                
                -0-
                
                
                
                (373,334
                )
                
                
                -0-
                
                10/09/2010$1.20
                
                
                -0-
                
                
                
                -0-
                
                
                
                499,522
                
                
                
                499,522
                
                4/6/2010$1.50*
                
                
                -0-
                
                
                
                -0-
                
                
                
                833,811
                
                
                
                833,811
                
                8/02/2011$2.04*
                
                
                578,884
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                578,884
                
                8/01/2012$2.04*
                
                
                327,306
                
                
                
                -0-
                
                
                
                (30,675
                )
                
                
                296,631
                
                8/11/2012$1.63*
                
                
                235,583
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                235,583
                
                8/11/2012$1.63*
                
                
                195,000
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                195,000
                
                6/12/2013$1.63*
                
                
                75,000
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                75,000
                
                6/20/2013$1.63
                
                
                97,500
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                97,500
                
                12/31/2011$1.63
                
                
                100,000
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                100,000
                
                11/10/2012$1.63
                
                
                120,000
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                120,000
                
                11/30/2012$1.63
                
                
                536,809
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                536,809
                
                12/24/2012$1.63
                
                
                789,536
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                789,536
                
                12/31/2012$1.63
                
                
                -0-
                
                
                
                -0-
                
                
                
                184,049
                
                
                
                184,049
                
                4/6/2010$3.26*
                
                
                -0-
                
                
                
                -0-
                
                
                
                981,747
                
                
                
                981,747
                
                8/02/2011$3.26*
                
                
                -0-
                
                
                
                -0-
                
                
                
                1,423,372
                
                
                
                1,423,372
                
                8/11/2011$2.61
                
                
                75,000
                
                
                
                -0-
                
                
                
                -0-
                
                
                
                75,000
                
                11/10/2011
  
 *
                  On
      January 28, 2010 the Company’s registration statement became effective
      which extended the expiration date of the
  warrants.
 
 As of
March 31, 2010 all outstanding warrants are exercisable.
 
 Extension
of Warrants
 
 Pursuant
to the provisions of Section 10 of the respective common stock purchase warrants
(the “Warrants”) previously issued by the Company to the investors and certain
finders and placement agents in connection with private offerings the Company
consummated in October 2007, the original expiration dates of the Warrants were
to be extended beyond their initial stated termination dates for certain
specified periods until the Company satisfied certain registration rights
provisions relating to the shares of the Company’s common stock underlying the
Warrants. As a result of the Company’s satisfaction on January 28, 2010 of
certain registration rights provisions relating to the warrants, the expiration
dates of the Warrants were adjusted to provide as follows:
 
 Ÿ
                373,334
      Warrants exercisable at $0.94 per share that would otherwise have expired
      on October 9, 2010 now expire on  August 1,
  2012;
  Ÿ
                1,333,333
      Warrants exercisable at $1.50 per share that would otherwise have expired
      on October 9, 2009 now expire on August 2,
2011;
 
 Ÿ
                190,245
      Warrants exercisable at $2.04 per share that would otherwise have expired
      on October 9, 2010 now expire on August 1,
2012;
  14
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
  14.
Equity (Continued)
 
 Ÿ
                981,747
      Warrants exercisable at  $3.26 per share that would otherwise
      have expired on October 9, 2009 now expire on August 2,
    2011;
 
 Ÿ
                235,583
      Warrants exercisable at $1.63 per share that would otherwise have expired
      on October 19, 2010 now expire on August 11,
  2012;
 
 Ÿ
                715,945
      Warrants exercisable at  $2.04 per share that would otherwise
      have expired on October 19, 2010 now expire on August 11, 2012;
      and
 
 Ÿ
                1,544,461
      Warrants exercisable at $3.26 per share that would otherwise have expired
      on October 19, 2009 now expire on August 12,
  2011.
  The
extended expiration dates have been noted on the Company’s records and it is not
necessary for the holders to exchange their original Warrants for amended
warrants.  No other terms of the Warrants were
changed.
 
 The fair
value of the warrants as of January 28, 2010 before modification of the terms
was calculated to be $759,035. The fair value of the warrants as of January 28,
2010 after modification of the terms was calculated to be
$5,780,704.  The incremental change in the value of the warrants is
$5,021,669, which was recorded to liquidated damages in the three months ended
March 31, 2010.
 
 Warrant
Tender Offer
 
 On
February 10, 2010 the Company commenced an offer (the “Third Offer”) to the
holders of the Warrants to voluntarily exchange any or all of the Warrants for
amended warrants exercisable at reduced exercise prices (“Amended
Warrants”).  The reduced exercise prices of the Amended Warrants
depended on the exercise prices applicable to the Warrants, as
follows:
 
 Ÿ
                373,334
      Original Warrants to purchase shares of Common Stock at an exercise price
      of $0.94 per share, were eligible to be exchanged for Amended Warrants
      exercisable at a reduced price of $0.75 per
  share,
 
 Ÿ
                1,333,333
      Original Warrants to purchase shares of Common Stock at an exercise price
      of $1.50 per share, were eligible to be exchanged for Amended Warrants
      exercisable at a reduced price of $1.20 per
  share,
 
 Ÿ
                235,583
      Original Warrants to purchase shares of Common Stock at an exercise price
      of $1.63 per share, were eligible to be exchanged for Amended Warrants
      exercisable at a reduced price of $1.30 per
  share,
 
 Ÿ
                906,190
      Original Warrants to purchase shares of Common Stock at an exercise price
      of $2.04 per share, were eligible to be exchanged for Amended Warrants
      exercisable at a reduced price of $1.63 per share,
  and
 
 Ÿ
                2,526,208
      Original Warrants to purchase shares of Common Stock at an exercise price
      of $3.26 per share, were eligible to be exchanged for Amended Warrants
      exercisable at a reduced price of $1.63 per
    share.
 
 The only
differences between the Warrants and the Amended Warrants that were offered,
related to (i) the lower exercise prices, (ii) the shortening of the exercise
period to twenty (20) days following the expiration of the Third Offer, (iii)
the deletion of the provision that holders may not exercise their Warrants if
the exercise will cause them and their affiliates to beneficially own an
aggregate of more than 9.9% of the outstanding shares of Common Stock of the
Company, and (iv) the requirement that the exercise price must be paid in cash,
as a cashless exercise of the Amended Warrants will not be
accepted.
 
  15
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 14.
Equity (Continued)
 
 On March
17, 2010 the Company closed the Third Offer with the following Warrants
exchanged:
 
 Ÿ
                a
      total of 373,334 Warrants with exercise prices of $0.94 per share were
      exchanged for Amended Warrants with reduced exercise prices of $0.75 per
      share;
 
 Ÿ
                a
      total of 499,522 Warrants with exercise prices of $1.50 per share were
      exchanged for Amended Warrants with reduced exercise prices of $1.20 per
      share;
 
 Ÿ
                no
      Warrants with exercise prices of $1.63 per share were exchanged for
      Amended Warrants with reduced exercise prices of $1.30 per
      share;
 
 Ÿ
                a
      total of 30,675 Warrants with exercise prices of $2.04 per share were
      exchanged for Amended Warrants with reduced exercise prices of $1.63 per
      share; and
  Ÿ
                a
      total of 153,374 Original Warrants with exercise prices of $3.26 per share
      were exchanged for Amended Warrants with reduced exercise prices of $1.63
      per share.
 
 As of
April 6, 2010 (a) one holder of Amended Warrants exercised all 184,049 of his
Amended Warrants, at an aggregate exercise price of approximately $300,000; and
(b) one holder of Amended Warrants applied $879,427 of principal and interest
due to him under a 10% promissory note in the principal amount of $856,890, due
on December 31, 2010, to the exercise of (i) 373,334 of his Amended Warrants, at
an exercise price of $0.75 per share, and (ii) 499,522 of his Amended Warrants,
at an exercise price of $1.20 per share.
 
 Shares
Issued For Services
 
 On March
18, 2010 the Company issued 180,000 shares of the Company’s common stock with a
fair value of $250,200 to an employee for services in 2009.  The
$250,200 was accrued as compensation expense for the year ended December 31,
2009, and was included in accrued payroll at December 31, 2009.
 
 Return
of Shares
 
 On March
18, 2010, Yang Yong Shan, the Company’s Chairman, Chief Executive Officer and
President, returned 180,000 shares of the Company’s common stock to the Company
as a capital contribution.  The 180,000 shares have been returned to
the Company’s number of authorized but unissued shares of common stock. The $180
par value of the shares was transferred from common stock to additional paid-in
capital as of March 18, 2010.
 
 15.
Common Welfare Reserves
 
 The
Company is required to transfer 10% of its net income, as determined in
accordance with PRC accounting rules and regulations, to the general reserve.
The balance of these reserves at March 31, 2010 and December 31, 2009, was
$3,191,614 and $1,834,742, respectively. These amounts are restricted and are
included in retained earnings.
 
 This fund
can only be utilized on capital items for the collective benefit of the
Company’s employees, such as construction of dormitories, cafeteria facilities,
and other staff welfare facilities. The fund is non-distributable other than
upon liquidation.
  16
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 16.
Earnings Per Share
 
 Accounting
guidance requires a reconciliation of the numerator and denominator of the basic
and diluted earnings per share (“EPS”) computations.
 
 For the
three months ended March 31, 2010 stock options of 1,463,200 and outstanding
warrants to purchase 7,395,598 shares of common stock were not included in
dilutive shares as the effect would have been anti-dilutive.
 
 For the
three months ended March 31, 2009, dilutive shares include outstanding warrants
to purchase 373,334 shares of common stock at an exercise price of $0.94 and
warrants to purchase 1,333,333 shares at an exercise price of $1.50. Warrants to
purchase 6,627,203 share of common stock were not included in dilutive shares as
the effect would have been anti-dilutive.
 
 The
following reconciles the components of the EPS computation:
 
 Income
                
                
                Shares
                
                
                Per Share(Numerator)
                
                
                (Denominator)
                
                
                AmountFor
      the three months ended March 31, 2010:Net
      income
                
                $
                (2,296,644
                )Basic
      EPS income available to common shareholders
                
                $
                (2,296,644
                )
                
                
                32,945,823
                
                
                $
                (0.07
                )Effect
      of dilutive securities:Warrants
                
                
                
                
                
                
                --Stock
      options
                
                
                —
                
                
                
                --Diluted
      EPS income available to common shareholders
                
                $
                (2,296,644
                )
                
                
                32,945,823
                
                
                $
                (0.07
                )For
      the three months ended March 31, 2009:Net
      income
                
                $
                1,552,706Basic
      EPS income available to common shareholders
                
                $
                1,552,706
                
                
                
                29,415,137
                
                
                $
                0.05Effect
      of dilutive securities:Warrants
                
                
                —
                
                
                
                95,714Diluted
      EPS income available to common shareholders
                
                $
                1,552,706
                
                
                
                29,510,851
                
                
                $
                0.05
  17.Equity
Incentive Plan
  
 On March
2, 2009, the Company’s board of directors and majority stockholders adopted the
Emerald Dairy Inc. 2009 Equity Incentive Plan (the “Plan”) to attract and retain
the best available personnel, provide additional incentives to employees,
directors and consultants and promote the success of the Company’s business.
1,500,000 shares of the Company’s common stock have been reserved for issuance
under the Plan.
 
 Eligibility
 
 The
Company may grant awards to its employees, directors and consultants, including
those of the Company’s subsidiaries. However, the Company may grant options that
are intended to qualify as incentive stock options (“ISOs”) only to its
employees and employees of its subsidiaries.
 
 Acceleration of Awards upon
Corporate Transactions.
 
 The
outstanding awards will terminate and/or accelerate upon occurrence of certain
significant corporate transactions, including amalgamations, consolidations,
liquidations or dissolutions, sales of substantially all or all of the Company’s
assets, reverse takeovers or acquisitions resulting in a change of
control.
  17
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 17.
Equity Incentive Plan (Continued)
 
 Exercise Price and Term of
Awards.
 
 In
general, the Plan administrator will determine the exercise price of an option
in the award agreement. The exercise price may be a fixed price, or it may be a
variable price related to the fair market value of the Company’s ordinary
shares. If the Company grants an ISO to an employee, the exercise price may not
be less than 100% of the fair market value of its common stock on the date of
the grant, except that if the grantee, at the time of that grant, owns shares
representing more than 10% of the voting power of all classes of the Company’s
shares of common stock, the exercise price may not be less than 110% of the fair
market value of its common stock on the date of that grant. If the Company
grants a non-qualified share option to a grantee, the exercise price may not be
less than 100% of the fair market value of its common stock on the date of
grant.
 
 The term
of each award under the Plan will be specified in the award agreement, but may
not exceed ten years from the earlier of the adoption or the approval of the
plan, unless sooner terminated.
 
 Total
share-based compensation costs included on the Condensed Consolidated Statements
of Income were $213,361 and $18,508 during the three months ended March 31, 2010
and 2009, respectively. All share-based compensation costs are included in
selling expenses and administrative expenses.
 
 The
Company estimates the fair value of stock options using a Black-Scholes option
pricing valuation model, consistent with accounting guidance. Key inputs and
assumptions used to estimate the fair value of stock options include the grant
price of the award, the expected option term, volatility of the Company’s stock,
the risk-free rate and the Company’s dividend yield. Estimates of fair value are
not intended to predict actual future events or the value ultimately realized by
grantees, and subsequent events are not indicative of the reasonableness of the
original estimates of fair value made by the Company.
 
 No
options were granted during the three months ended March 31, 2010.
 
 Share
Options
 
 A summary
of the Company’s outstanding share option award grants as of March 31, 2010 and
changes during the three months then ended are presented below:
 
 Shares
                
                Weighted-Average
      Exercise Price
                
                Weighted-Average
      Remaining Contractual Term
                
                Aggregate
      Intrinsic Value(in
      years)
                
                (in
      millions)Outstanding
      at December 31, 2009
                1,463,200
                
                $
                1.14Granted
                -0-
                
                
                --Exercised
                -0-
                
                
                --Expired
                -0-
                
                
                --Forfeited
                -0-
                
                
                --Outstanding
      at March 31, 2010
                1,463,200
                
                $
                1.14
                
                9.29
                
                $
                583,656Vested
      and expected to vest at March 31, 2010
                1,463,200
                
                $
                1.14
                
                9.29
                
                $
                583,656Exercisable
      at March 31, 2010
                351,600
                
                $
                0.42
                
                8.93
                
                $
                291,828
  18
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 17.
Equity Incentive Plan (Continued)
 
 As of
March 31, 2010, there was $608,593 of total unrecognized compensation costs
related to non-vested Company share options granted under Company share option
plans. The cost is expected to be recognized over a weighted-average period of
1.12 years.
 
 18.
Commitments and Contingencies
 
 The
Company has various purchase commitments for materials, supplies and services
incident to the ordinary conduct of business, generally for quantities required
for the Company’s business and at prevailing market prices. No material annual
loss is expected from these commitments.
 
 The
Company has contracted to purchase equipment from a supplier for the second
processing facility for $10,338,563 of which $8,787,779 has been
paid.  The remaining $1,550,784 will be paid on delivery and
completion of installation of the equipment in 2010.
 
 The
Company has advances to milk suppliers of $376,412 which will be offset against
future milk purchases from those suppliers (see Note 6, Other Current
Assets).
 
 In order
for the Company to conduct its current operations, an Infant & Baby Formula
Milk Powder Production Permit is required from the State General Administration
of Quality Supervision and Inspection and Quarantine of the People’s Republic of
China (the “Administration”). The Company’s current license will expire in May
2010. The Company is in the process of renewing this permit, and has no reason
to believe the permit will not be renewed.  Other than the foregoing,
no government approvals are required to conduct the Company’s principal
operations, and the Company is not aware of any probable governmental regulation
of our business sectors in the near future. 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 lead to a material adverse
effect on the Company’s financial position, results of operations, or cash
flows.
 
 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 it might involve in the future
are not expected to have a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
 
 19.
Operating Leases
 
 The
Company leases various distribution facilities. All leases are on an annual
basis and commence on January 1, of each year. The Company also leases office
space which expires September 2010.  For the three months ended March
31, 2010 and 2009, the Company incurred rental expense of $19,030 and $39,293,
respectively. As of March 31, 2010, the Company had outstanding lease
commitments totaling $328,878, all of which are $138,147 is due within the one
year and $190,731 in the second year.
  19
 
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2010 and 2009
 
 20.
Subsequent Events
 
 Management
has evaluated subsequent events from March 31, 2010 to May 17, 2010, the date
which our financial statements have been issued and were available to be issued,
and has concluded the following events should be reported during this
period.  Subsequent events that may occur after May 17, 2010 have not
been evaluated in the financial statements as of March 31, 2010.
 
 On April
6, 2010, the holder of the Company’s 10% promissory notes in the principal
amount of $856,890, due on December 31, 2010 (the “Note”), requested that the
Company apply the $879,427 balance due to him under the Note (which balance
included $19,537 of accrued and unpaid interest) to the holder’s exercise of (a)
373,334 of his Amended Warrants, at an exercise price of $0.75 per share, and
(b) 499,522 of his Amended Warrants, at an exercise price of $1.20 per
share.  The Company’s Board approved the request and, accordingly, on
April 6, 2010 the holder exercised the Amended Warrants, the Company issued
872,856 shares of its common stock to the holder, and the Note was
cancelled.
 
 On April
6, 2010 one holder of Amended Warrants exercised all 184,049 of his Amended
Warrants, at an exercise price of $1.63 per share, resulting in gross proceeds
to the Company of approximately $300,000.
 
 Following
the exercise of the Amended Warrants, the Company had 34,002,728 shares of
common stock issued and outstanding (not including an additional 1,944,444
shares of common stock of the Company currently being held in
treasury).
 
 21.
Segment reporting
 
 The
Company operates in one operating segment in accordance with the provisions
accounting guidance regarding segment reporting. Although the Company has key
product lines of milk, soybean milk, and rice powder, the Company’s chief
operating decision maker reviews and evaluates one set of combined financial
information deciding how to allocate resources and in assessing
performance.
 
 For the
three months ended March 31, 2010 and 2009, the Company’s sales revenues from
various products are as follows:
  Three Months
                  Ended March 31,2010
                
                
                2009Milk
      powder
                
                $
                12,424,193
                
                
                $
                9,270,354Soybean
      milk powder
                
                
                382,471
                
                
                
                287,039Rice
      powder
                
                
                444,587
                
                
                
                320,090Sub-contract
      processing
                
                
                1,001,605
                
                
                
                979,069$
                14,252,856
                
                
                $
                10,856,552
  20


Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





Forward
Looking Statements





This
Quarterly Report on Form 10-Q contains “forward-looking statements” that involve
substantial risks and uncertainties. You can identify such statements by forward
looking words such as “may,” “expect,” “plans,” “intends,” “anticipate,”
“believe,” “estimate,” and “continue” or similar words. Such statements involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements. The forward-looking statements included herein are
based on current expectations that involve numerous risks and uncertainties. Our
plans and objectives are based, in part, on assumptions involving the continued
growth and expansion of our business. Assumptions relating to the foregoing
involve judgments with respect to, among other things, future economic,
competitive and market conditions and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
our control. Although we believe the assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate and,
therefore, there can be no assurance the forward-looking statements included in
this Report will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by us or any other
person that our objectives and plans will be achieved.





Overview





We are a
producer of milk powder, rice powder and soybean milk powder, which currently
comprise approximately 94.2%, 3.1% and 2.7%of our sales,
respectively. Through our network of over 1,100 salespeople, our products are
distributed throughout 20 provinces in the People’s Republic of China (“PRC”),
and sold in over 6,000 retail outlets.





Our
products are marketed under two brand names:





·
            “Xing
      An Ling,” which is designed for high-end customers;
  and




·
            “Yi
      Bai,” which is designed for middle and low-end
  customers.




The
Chinese government has initiated programs to promote milk consumption and is
providing incentives to increase dairy production. The dairy market is one of
the fastest growing markets in the PRC. It has been growing at a rate of 16% per
year over the past six years, according to the National Bureau of Statistics of
China, and is expected to grow at a rate of 15% per year for the foreseeable
future. We focus on the infant formula segment of the market, which, according
to the Dairy Association of China, has grown even faster in recent years, at a
rate of 20%-30% per year. Currently, it is estimated that demand for infant
formula in the PRC outstrips supply by at least 2-to-1.





We have
received an Infant & Baby Formula Milk Powder Production Permit from the
State General Administration of Quality Supervision and Inspection and
Quarantine of the PRC. Only current license holders are permitted to produce
formula milk powder in the PRC.





Because
of our close proximity to our sources of fresh milk, we are able to complete the
production process in approximately 30-35 hours, which is faster than
competitors of ours that are not similarly situated. We produced approximately
7,000 tons of milk powder at our facility in Be’ian City, Heilongjiang Province,
PRC in fiscal 2007, up from approximately 5,000 tons in fiscal 2006. By adding a
third shift to the existing two shifts working schedule, we produced
approximately 9,000 tons of milk powder in each of fiscal 2008 and
2009.




21




We
believe that a lack of adequate production capacity has been a significant
impediment to our ability to increase our revenue in recent years. In July 2008,
through our wholly-owned subsidiary, HXD, we commenced construction of a new
production facility in Hailun City, Heilongjiang Province, PRC. Between our
existing production facility in Be’ian City and our new production facility in
Hailun City, we believe we will have the capacity to produce approximately
27,000 tons of milk powder per year by the end of fiscal 2011. It is expected
that our production of rice powder and soymilk powder will also increase in
volume over the same period, while continuing to comprise an aggregate of
approximately 5% of our overall sales.





Initially,
this new facility will have one production line, with the capacity to produce
9,000 tons of milk power annually. A second production line can be added at this
new facility, which, when completed, would enable us to produce an additional
9,000 tons of milk powder per year, giving us a total annual production capacity
of 27,000 tons of milk powder. We anticipate that production at this new
facility will commence on or around the end of the second quarter of fiscal
2010, provided we are able to raise the additional $1.0 million we believe will
be required to complete the equipping of the first production line in
satisfaction with proposed more stringent government manufacturing standards
expected to be adopted in the near future. We are currently in negotiations with
potential sources which may provide this financing. The cost to add a second
production line, would be an additional $15.0 million. We plan to raise the
funds needed for the second production line from the capital market through
private or public equity and/or debt offerings. There can be no assurance that
that any additional financing will become available to us, and if available, on
terms acceptable to us.





All of
our business is conducted through our wholly-owned Chinese
subsidiaries:





·
            Heilongjiang
      Xing An Ling Dairy, Co., a PRC company (“XAL”), which handles our
      promotion, sales and administrative
functions;




·
            Heilongjiang
      Be’ian Nongken Changxing Lvbao Dairy Limited Liability Company, a PRC
      company (“Lvbao”), which handles production of our products in Be’ian
      City, Heilongjiang Province, PRC;
and




·
            Hailun
      Xinganling Dairy Co., Ltd., a PRC company (“HXD”), which, upon completion
      of the first production line of our new facility, will handle additional
      production of our products in Hailun City, Heilongjiang Province,
      PRC.




Our
products have become increasing popular in mainland China due to our continued
sales and marketing efforts. As a result, we have experienced tremendous growth
well above the industry average during recent years. Sales increased from
approximately $7.9 million in 2005 to approximately $44.7 million in 2009, a
466% increase over four years. Net income increased from approximately $0.7
million in 2005 to approximately $4.2 million in 2009, a 500% increase over four
years.




22




Recent
Developments




Second
Amendment to November 2008 Promissory Note





As of May
10, 2010, we entered into a second amendment (the “Second Amendment to November
2008 Purchase Agreement”) to a purchase agreement we originally entered into in
connection with our November 2008 private placement (“November 2008 Offering”)
of a promissory note in the principal amount of $500,000, as previously amended
on November 10, 2009 (the “Amended November 2008 Note”), and warrants to
purchase 50,000 shares (the “November 2008 Investor
Warrants”).  Pursuant to the Second Amendment to November 2008
Purchase Agreement:





·
            On
      May 11, 2010, we paid the investor in the November 2008 Offering (the
      “November 2008 Investor”) $75,000, representing the full amount of accrued
      and unpaid interest due on the Amended November 2008 Note as of May 10,
      2010;





·
            We
      agreed that within thirty (30) days we will repay to the November 2008
      Investor the full $500,000 principal amount due under the Amended November
      2008 Note, plus additional interest, at a rate of 15% per annum, accrued
      from May 10, 2010 through the date of repayment;
  and





·
            As
      additional consideration, we agreed to issue to the November 2008 Investor
      a total of: (a) 5,000 restricted shares of our common stock, if the full
      amount due under the Amended November 2008 Note is repaid to the November
      2008 Investor on or before May 25, 2010, or (b) 10,000 restricted shares
      of our common stock, if the full amount due under the Amended November
      2008 Note is repaid to the November 2008 Investor after May 25, 2010, but
      on or before June 9, 2010.





The
rights and obligations under the Amended November 2008 Note is further described
in “-- Liquidity and Capital Resources -- Promissory Notes” below.





Third Warrant Tender Offer




On March
17, 2010, we closed our third offer (the “Third Warrant Tender Offer”) to
holders of an aggregate of 5,374,648 warrants to purchase shares of our common
stock (the “October 2007 Warrants”) we originally issued in connection with
private placements we consummated in October 2007 (the “October 2007 Private
Placements”), to exchange their October 2007 Warrants for warrants exercisable
at reduced exercise prices (“Amended Warrants”). In connection with the Third
Warrant Tender Offer we issued a total of 1,056,905 Amended Warrants with
reduced exercise prices.





As of
April 6, 2010: (a) one holder of Amended Warrants exercised all 184,049 of his
Amended Warrants, at an aggregate exercise price of approximately $300,000; and
(b) one holder of Amended Warrants applied $879,427 of principal and interest
due to him under a 10% promissory note in the principal amount of $856,890, due
on December 31, 2010, to the exercise of (i) 373,334 of his Amended Warrants, at
an exercise price of $0.75 per share, and (ii) 499,522 of his Amended Warrants,
at an exercise price of $1.20 per share.





See Note
14 of the Notes to our consolidated financial statements for additional
information concerning the Third Warrant Tender Offer.




23




Extension
of Expiration Dates of Warrants





Pursuant
to the provisions of the October 2007 Warrants, the original expiration dates
were to be extended beyond their initial stated termination dates for certain
specified periods until we satisfied certain registration rights provisions
relating to the shares of our common stock underlying the October 2007 Warrants.
As a result of our satisfaction of the registration rights provisions on January
28, 2010, the expiration dates of the October 2007 Warrants were
extended.





The fair
value of the October 2007 Warrants prior to modification of the terms was
calculated to be $759,035. The fair value of the October 2007 Warrants after
modification of the terms was calculated to be $5,780,704. The $5,021,669
incremental change in the fair value of the October 2007 Warrants has been
recorded as liquidated damages as of March 31, 2010.





See
Note 14 of the Notes to our consolidated financial statements for additional
information concerning the extension of the expiration dates of the October 2007
Warrants.





Second
Amendment to June 2008 Promissory Notes





As of
December 31, 2009, we entered into a second amendment (the “Second Amendment to
June 2008 Purchase Agreements”) to purchase agreements we originally entered
into in connection with our June 2008 private placement (“June 2008 Offering”)
of an aggregate principal amount of $2,250,000 promissory notes (the “June 2008
Notes”) and 225,000 warrants (the “June 2008 Investor Warrants”). Pursuant to
the Second Amendment to June 2008 Purchase Agreements:





·
            the
      Maturity Date of the indebtedness represented by the June 2008 Notes was
      extended from December 31, 2009 to December 31,
  2010;





·
            accrued
      and unpaid interest on the June 2008 Notes, in the aggregate amount of
      $323,301, was added to the principal amount outstanding (resulting in an
      aggregate principal balance of $2,573,301 immediately after the Second
      Amendment to June 2008 Purchase Agreements reflected in the Amended June
      2008 Notes defined below);





·
            amended
      and restated notes (the “Amended June 2008 Notes”) incorporating the
      changes set forth above were issued to the investors in the June 2008
      Offering (the “June 2008 Investors”) in exchange for the cancellation of
      the June 2008 Notes;





·
            the
      June 2008 Investors received additional three-year warrants to purchase an
      aggregate of 789,356 shares of our common stock, at an exercise price of
      $1.63 per share (the “Additional June 2008 Investor Warrants”);
      and





·
            Our
      repayment of amounts due under the Amended June 2008 Notes is secured by a
      pledge of an aggregate of 3,157,425 shares of our common stock
      beneficially owned by Yang Yong Shan, our Chairman, Chief Executive
      Officer and President.





In
consideration for its services in connection with the Second Amendment, we
issued 200,000 shares of our common stock to the entity that had acted as
placement agent for the June 2008 Offering.





On April
6, 2010, at the request of the holder of our Amended June 2008 Note in the
principal amount of $856,890, we applied the $879,427 balance due to him under
this (which balance included $22,537 of accrued and unpaid interest) to the
holder’s exercise of (a) 373,334 of his Amended Warrants, at an exercise price
of $0.75 per share, and (b) 499,522 of his Amended Warrants, at an exercise
price of $1.20 per share.




24




The
rights and obligations under the remaining Amended June 2008 Note are further
described in “-- Liquidity and Capital Resources -- Promissory Notes”
below.





December
2009 Note Offering





On December 24, 2009, we sold to three
“accredited investors” (the “December 2009 Noteholders”) for an aggregate
purchase price of $1,750,000, (i) promissory notes in the aggregate principal
amount of $1,750,000, with an interest rate of 10% per annum (the “December 2009
Notes”) and (ii) three-year warrants to purchase an aggregate of 536,809 shares
of our common stock, at an exercise price of $1.63 per share (the “December 2009
Warrants”) (the “December 2009 Note Offering”).





At the
closing of the December 2009 Note Offering, we paid the December 2009
Noteholders a closing fee in the aggregate amount of $35,000, and prepaid
interest on the December 2009 Notes in the aggregate amount of $175,000. As a
result, we received net proceeds of $1,540,000. We have applied the net proceeds
primarily toward (i) the cost of equipping the first production line of our
newly-constructed milk powder processing facility located in Hailun City,
Heilongjiang Province, PRC, (ii) the payment of expenses incurred in connection
with the December 2009 Note Offering, and (iii) general working capital
purposes.





Our
repayment of amounts due under the December 2009 Notes is secured by a pledge of
5,883,329 shares of our common stock beneficially owned by Yang Yong Shan, our
Chairman, Chief Executive Officer and President.





The
rights and obligations under the December 2009 Notes are further described in
“-- Liquidity and Capital Resources -- Promissory Notes” below.





November
2009 Term Loan





On
November 30, 2009, we entered into a Loan Agreement with an unrelated third
party (the “Lender”), pursuant to which we borrowed $1,750,000 from the Lender
(the “November 2009 Term Loan”), in consideration for which we issued the Lender
a promissory note (the “Term Loan Note”). We have applied the gross proceeds
from the Term Loan primarily toward (i) the cost of equipping the first
production line of our newly-constructed milk powder processing facility located
in Hailun City, Heilongjiang Province, PRC, (ii) the payment of expenses
incurred in connection with the November 2009 Term Loan, and (iii) general
working capital purposes.





The
rights and obligations under the Term Loan Note are further described in “--
Liquidity and Capital Resources -- Promissory Notes” below.





Payment
of Liquidated Damages





We
entered into registration rights agreements (the “Registration Rights
Agreements”) with the investors in our October 2007 Private Placements (the
“October 2007 Investors”). Pursuant to the Registration Rights Agreements, we
were required to pay liquidated damages to the investors, if we failed to
satisfy certain registration requirements, as further described in “-- Liquidity
and Capital Resources -- Registration Rights and Liquidated Damages”
below.




25




As a
result of our failure to satisfy the registration requirements, we accrued a
total of $1,201,998 in liquidated damages through October 19, 2008, the date the
shares purchased in the October 2007 Private Placements became eligible for sale
pursuant to Rule 144 under the Securities Act. Pursuant to the Registration
Rights Agreements, the liquidated damages were payable in cash or shares of our
common stock, at our discretion. As of October 5, 2009, in full payment of the
liquidated damages, we issued an aggregate of 667,777shares of our common
stock to the October 2007 Investors, valued at $1.80 per share, the closing
price on the OTCBB on October 20, 2008.





In
addition, pursuant to the Registration Rights Agreements, if we failed to pay
any liquidated damages in full within seven days after the date payable, we were
required to pay interest thereon at a rate of 15% per annum until such amounts,
plus all such interest thereon, were paid in full. Therefore, as of October 5,
2009, we paid interest to the October 2007 Investors in the aggregate amount of
approximately $172,900, by issuing an aggregate of 108,056 additional shares of
our common stock, valued at $1.60 per share, the closing price of our common
stock on the OTCBB on October 2, 2009.





Trends
and Uncertainties





Economic
Downturn





The
worldwide economic downturn and market instability, which began in 2008, have
made the business climate more volatile and more costly. Although all of our
business operations are currently conducted in the PRC, our general business
strategy, as well as our results of operations and financial condition, may be
adversely affected by unpredictable and unstable market conditions. If the
current equity and credit markets deteriorate, or do not improve from current
levels, it may make it difficult, if not impossible, for us to obtain debt or
equity financing on acceptable terms at a time when we wish to do so. Failure to
secure any necessary financing in a timely manner and on favorable terms could
have a material adverse effect on our growth strategy, financial performance and
stock price and could require us to delay or abandon our expansion plans. We do
not expect this economic downturn to have a significant effect on our business
or operations in the near future.





Narrowing
of Gap in Milk Consumption





The
Chinese government has initiated programs to promote milk consumption and is
providing incentives to increase dairy production. In addition to improving the
overall health of its populous, the government views increased dairy production
as a means of improving employment in rural areas thus improving social
stability. The programs are designed to narrow the significant gap between the
PRC’s per capita milk consumption of 15 kg per person and the global average of
100 kg per person. We believe this initiative will continue to provide us with
growth opportunities.





Industry
Growth





The dairy
market is one of the fastest growing markets in the PRC. It has been growing at
a rate of 16% per year over the past six years, according to the National Bureau
of Statistics of China, and is expected to grow at a rate of 15% per year for
the foreseeable future. On its website, the Dairy Association of China estimates
that the infant formula market segment, which is the market segment we target,
has grown even faster in recent years, at a rate of 20%-30% per year. We believe
the following three factors are the main drivers of the infant formula
market:





·
            Increased
      household income made infant formula more affordable in the
      PRC;




26




·
            Increased
      number of working mothers or busy mothers created more demands for infant
      formula products; and





·
            Increased
      popularity and acceptance of infant formula
  products.





Based on
these factors, we expect to see significant growth in our business and
operations when we commence production at our new production facility in Hailun
City.





Supply
of Infant Formula





It is
estimated that the demand for infant formula in the PRC outstrips supply by at
least 2-to-1.  In recent years, our production capabilities have not
been able to keep up with demand for our products. We have commenced
construction of a new production facility in Hailun City with an initial annual
production capacity of 9,000 tons of milk powder, which is expected to start
production by the end of the second quarter of 2010, provided we are able to
raise the additional $1.0 million we believe will be required to complete the
equipping of the first production line in satisfaction with proposed more
stringent government manufacturing standards expected to be adopted in the near
future. We are currently in negotiations with potential sources which may
provide this financing. We expect that this increase in production capacity of
approximately 100% will result in the doubling of our sales revenues, with a
corresponding increase in cost of goods sold and sales and administrative
expenses.





Product
Pricing and Raw Material Supply





Historically
we have been able to obtain sufficient raw milk and other raw materials to meet
our production needs. The price of raw milk is affected by regional market in
Heilongjiang Province, PRC, while other raw materials are affected by global
markets. We expect that the raw materials we require to produce our products
will continue to be available to us for the foreseeable future. In fiscal 2009,
the price of certain raw materials we use declined. However, we believe that the
prices will start to increase again in fiscal 2010. To some extent, we believe
we will be able to increase the prices for our products to pass on any higher
raw material costs to consumers. However, there is no guarantee that we will be
able to raise prices to the full extent necessary to cover rises in costs for
raw materials, which could have a negative material impact on our financial
condition and results of operations.





Brand
Name and Product Quality





There are
more than 30 brand names of infant formula products sold in the PRC. Most of our
international and larger competitors have been concentrating in the first tier
cities, or well-known urban centers such as Beijing and Shanghai. The rest of
the Chinese domestic companies in the industry, including us, have been focusing
on less developed second and third tier cities where competition is less severe
than the top tier cities. As consumers have many options for infant formula
products, infant formula producers with better quality and safety images have
the advantages to sell their product at higher price. Brand image and
recognition are increasingly important in gaining customer loyalty. We plan to
continue to focus on penetrating less-competitive second and third tier
cities.





Label
Milk Products





Currently,
there are no organic label milk powder products in the mainland China market. In
February 2008, we obtained organic label certification from Guangdong Zhongjian
Certification Co., Ltd.  We plan to create an organic label product
line by the end of fiscal 2010. We will need to test the market to determine
demand for organic milk products. Initially, we expect sales of organic milk
powder to be insignificant. However, over the long term, we believe that,
similar to the growth of the organic milk market in the U.S., organic milk
products will become increasingly popular in the PRC. Over time, this should
help increase our revenues.




27




Factors
Affecting Raw Milk Production





Raw milk
production is influenced by a number of factors that are beyond our control
including, but not limited to, the following:





·
            Seasonal factors: dairy
      cows generally produce more milk in temperate weather than in cold or hot
      weather and extended unseasonably cold or hot weather could lead to lower
      than expected production;




·
            Environmental factors:
      the volume and quality of milk produced by dairy cows is closely linked to
      the quality of the nourishment provided by the environment around them, if
      environmental factors cause the quality of nourishment to decline, milk
      production could decline and we may have difficulty finding sufficient raw
      milk; and




·
            Governmental agricultural and
      environmental policy: declines in government grants, subsidies,
      provision of land, technical assistance and other changes in agricultural
      and environmental policies may have a negative effect on the viability of
      individual dairy farms, and the numbers of dairy cows and quantities of
      milk they are able to produce.




Contamination
of Milk Powder Products Produced in the PRC





In
mid-2008, a number of milk powder products produced within the PRC were found to
contain unsafe levels of tripolycyanamide, also known as melamine, sickening
thousands of infants. This prompted the Chinese government to conduct a
nationwide investigation into how the milk powder was contaminated, and caused a
worldwide recall of certain milk powder products produced within the
PRC.  On September 16, 2008, China’s Administration of Quality
Supervision, Inspection and Quarantine (AQSIQ) revealed that it had tested
samples from 175 dairy manufacturers, and published a list of 22 companies whose
products contained melamine. We passed the emergency inspection and were not
included on AQSIQ’s list. The contraction in the Chinese milk powder industry
caused by this crisis has lead to increased demand for our products. However, we
can not be certain that the illnesses caused by contamination in the milk powder
industry, whether or not related to our products, will not lead to decreased
demand for milk powder products produced within the PRC, thereby having a
material adverse effect on our business.





Results
of Operations





Three-Month
Period Ended March 31, 2010 Compared to Three-Month Period Ended March 31,
2009





The
following summarizes changes in our operations for the three months ended March
31, 2010 and 2009. Net income decreased by $3,849,350, from $1,552,706 in
the three months ended March 31, 2009, to a loss of $2,296,644 for the three
months ended March 31, 2010. The decrease in net income during the three months
ended March 31, 2010, as compared to the same time period in the prior year, was
due to liquidated damages during the current year, which were paid through our
issuance of shares of our common stock, which offset an increase in our gross
profit as further described below.




28




Sales
and Cost of Goods Sold




For the Three
      Months
              Ended March
      31,2010
            
            2009Sales
            
            $
            14,252,856
            
            
            $
            10,856,552Cost of Goods
      Sold
            
            
            7,153,772
            
            
            
            5,848,675Gross
      Profit
            
            $
            7,099,084
            
            
            $
            5,007,877





Sales. Sales volume increased
by 499 metric tons, or 23.8%, to 2,599 metric tons for the three months ended
March 31, 2010, from 2,100 metric tons for the three months ended March 31,
2009. Sales revenues increased by $3,396,304, or 31.3%, from $10,856,552 in the
three months ended March 31, 2009, to $14,252,856 for the three months ended
March 31, 2010. This increase was due to an increase in the quantity of products
we sold, as well as an increase in the average selling price for our products,
by $314 per metric ton, as compared to the three months ended March 31, 2009,
resulting from our increased production of our high end product line in the
first quarter of 2010.





Sales by product
line.A break-down of our sales by product line for the three
months ended March 31, 2010 and 2009 is as follows:





Three
      Months Ended March 31,
            
            
            Period-on-period2010
            
            
            2009Product category
            
            Quantity
              (tons)
            
            
            $ Amount
            
            
            % of sales
            
            
            Quantity
              (tons)
            
            
            $ Amount
            
            
            % of
              sales
            
            
            Qty.
              VarianceMilk
      powder
            
            
            1,958
            
            
            
            12,424,193
            
            
            
            87.2
            
            
            
            1,529
            
            
            
            9,270,354
            
            
            
            85.4
            
            
            
            429Rice
      powder
            
            
            78
            
            
            
            444,587
            
            
            
            3.1
            
            
            
            56
            
            
            
            320,090
            
            
            
            2.9
            
            
            
            22Soybean
      powder
            
            
            233
            
            
            
            382,471
            
            
            
            2.7
            
            
            
            153
            
            
            
            287,039
            
            
            
            2.7
            
            
            
            80Subcontracting
            
            
            330
            
            
            
            1,001,605
            
            
            
            7.0
            
            
            
            362
            
            
            
            979,069
            
            
            
            9.0
            
            
            
            (32
            )Total
            
            
            2,599
            
            
            
            14,252,856
            
            
            
            100.0
            
            
            
            2,100
            
            
            
            10,856,552
            
            
            
            100.0
            
            
            
            499




There
were various changes to the break-down of sales among our product lines over the
three months ended March 31, 2010, as we increased production in most all lines,
but attempted to adjust our sales mix to higher margin products, and away from
subcontracting. Milk powder accounted for 87.2% of first quarter 2010 sales mix,
at an average selling price of $6,345 per metric ton, as compared to 85.4% of
first quarter 2009, at an average selling price of $6,063 per metric ton. The
increase in sales price per metric ton for milk powder resulted from our
continued shift to increase production of our high end product line in the first
quarter of 2010. Rice powder accounted for 3.1% of our sales mix for the three
months ended March 31, 2010, at an average selling price of $5,700 per metric
ton, as compared to 2.9% of our sales mix in the three months ended March 31,
2009, at an average selling price of $5,716 per metric ton. Soybean powder
accounted for 2.7% of our sales mix for the three months ended March 31, 2010,
at an average selling price of $1,642 per metric ton, as compared to 2.7% of our
sales mix in the three months ended March 31, 2009, at an average selling price
of $1,876 per metric ton. The decrease in sales price per metric ton for
soybean powder resulted from our reduction in price of soybean powder to stay
competitive in the first quarter of 2010. We decreased our subcontract
production during the three months ended March 31, 2010 to 7.0% of the sales
mix, at an average selling price of $3,035 per metric ton, as compared to 9.0%
of the sales mix in the three months ended March 31, 2009, at an average sales
price of $2,705 per metric ton.




29




A
breakdown of our average selling price by product line for the three months
ended March 31, 2010 and 2009 is as follows:




Three
      Months Ended
              March
      31,Average selling prices
            
            2010
            
            
            2009
            
            
            Variance$
            
            
            $
            
            
            $
            
            
            
            %Milk
      powder
            
            
            6,345
            
            
            
            6,063
            
            
            
            282
            
            
            
            4.7Rice
      powder
            
            
            5,700
            
            
            
            5,716
            
            
            
            (16
            )
            
            
            (0.3
            )Soybean
      powder
            
            
            1,642
            
            
            
            1,876
            
            
            
            (234
            )
            
            
            (12.5
            )Subcontracting
            
            
            3,035
            
            
            
            2,705
            
            
            
            330
            
            
            
            12.2Total
            
            
            5,484
            
            
            
            5,170
            
            
            
            314
            
            
            
            6.1




Cost of Goods
Sold.  Cost of goods sold increased by $1,305,097, or 22.3%,
from $5,848,675 in the three months ended March 31, 2009, to $7,153,772 for the
three months ended March 31, 2010. This increase was directly related to our
increased production during the three months ended March 31, 2010. Overall our
cost per metric ton decreased by $32, or 1.1%, to $2,753 per metric ton in the
three months ended March 31, 2010, as compared to $2,785 per metric ton in three
months ended March 31, 2009, due to decreases in the price of raw materials we
use to produce our products.





A
breakdown of cost of sales by product line for the years ended March 31, 2010
and 2009 is as follows:




Three
      Months Ended March 31,2010
            
            
            2009
            
            
            Variance$
            
            
            $
            
            
            $
            
            
            
            %Cost of salesMilk
      powder
            
            
            5,821,847
            
            
            
            4,632,692
            
            
            
            1,189,155
            
            
            
            25.7Rice
      powder
            
            
            174,348
            
            
            
            125,525
            
            
            
            48,823
            
            
            
            38.9Soybean
      powder
            
            
            265,605
            
            
            
            215,280
            
            
            
            50,325
            
            
            
            23.4Subcontracting
            
            
            891,972
            
            
            
            875,178
            
            
            
            16,794
            
            
            
            1.9Total
            
            
            7,153,772
            
            
            
            5,848,675
            
            
            
            1,305,097
            
            
            
            22.3Cost per units sold(per
      ton)Milk
      powder
            
            
            2,973
            
            
            
            3,030
            
            
            
            (57
            )
            
            
            (1.9
            )Rice
      powder
            
            
            2,235
            
            
            
            2,242
            
            
            
            (7
            )
            
            
            (0.3
            )Soybean
      powder
            
            
            1,140
            
            
            
            1,407
            
            
            
            (267
            )
            
            
            (19.0
            )Subcontracting
            
            
            2,703
            
            
            
            2,418
            
            
            
            285
            
            
            
            11.8Average
      cost per unit sold
            
            
            2,753
            
            
            
            2,785
            
            
            
            (32
            )
            
            
            (1.1
            )




Gross Profit. Gross profit was
$7,099,084, or 49.8% of our sales for the three months ended March 31, 2010, as
compared to gross profit of $5,007,877, or 46.1%, for the three months ended
March 31, 2009. During the three months ended March 31, 2010, our gross margin
on milk powder increased to 53.1%, from 50.0% in the same period of the prior
year, due to an increase in the average sales price of 4.7%, while there was a
1.9% decrease in the cost per metric ton from the three months ended March 31,
2009. The gross margin for soybean powder increased 5.6% to 30.6% in the
three months ended March 31, 2010, as compared to 25.0% in the three months
ended March 31, 2009, due to an decrease in the average cost per ton of 19.0% in
the three months ended March 31, 2010 as compared to the same period in
2009.




30




A
breakdown of gross margin by product line for the years March 31, 2010 and 2009
is as follows:




Three
      Months Ended March 31,
            
            
            Period-on-period2010
            
            
            2009Product category
            
            $ Amount
            
            
            Gross
              Margin %
            
            
            $ Amount
            
            
            Gross
              Margin %
            
            
            Margin
              VarianceMilk
      powder
            
            
            6,602,346
            
            
            
            53.1
            
            
            
            4,637,662
            
            
            
            50.0
            
            
            
            3.1Rice
      powder
            
            
            270,239
            
            
            
            60.8
            
            
            
            71,759
            
            
            
            60.8
            
            
            
            --Soybean
      powder
            
            
            116,866
            
            
            
            30.6
            
            
            
            194,565
            
            
            
            25.0
            
            
            
            5.6Subcontracting
            
            
            109,633
            
            
            
            10.9
            
            
            
            103,891
            
            
            
            10.6
            
            
            
            0.3Total
            
            
            7,099,084
            
            
            
            49.8
            
            
            
            5,007,877
            
            
            
            46.1
            
            
            
            3.7




Operating
Expenses





For the Three
      Months
              Ended March
      31,2010
            
            
            2009Operating
    ExpensesSelling
      and administrative expenses
            
            $
            3,902,390
            
            
            $
            3,026,704Liquidated
      damages
            
            
            5,021,669
            
            
            
            -Depreciation
      and amortization
            
            
            51,228
            
            
            
            43,238Total
      operating expenses
            
            $
            8,975,287
            
            
            $
            3,069,942





Selling Expenses. Selling
expenses overall increased by $805,383, or 34.4%, from $2,340,654 in the three
months ended March 31, 2009, to $3,146,037 for the three months ended March 31,
2010. The major factors in the decrease in selling expenses are as
follows:





·
            Advertising
      expenses increased by $108,984, or 44.3%, to $354,742 in 2010, from
      $245,758 in 2009, due to an increased marketing campaign in
      2010.





·
            Promotion
      expenses increased by $586,635, or 633.3%, to $679,270 in 2010, from
      $92,635 in 2009, as we increased our marketing as compared to
      2009.





·
            Outdoor
      promotion expenses increased by $113,065, or 70.1%, to $274,385 in 2010,
      from $161,320 in 2009, as a result of our increased marketing campaign in
      2010.





·
            Selling
      salary expenses increased by $115,526, or 21.1%, to $662,497 in 2010, from
      $546,971 in 2009, as a result of our increased marketing campaign in
      2010.





These
increases were partially offset by a decrease in entertainment expenses of
$42,150, or 28.4%, to $106,312 in 2010, from $148,462 in 2009, as part of
readjusting our marketing campaign to increase brand awareness and
sales.





Rather
than using a wholesaler, our sales people deal directly with the retail
outlets. This business model has higher sales expenses compared to the
traditional business model, but creates better profit margins for
us.




31




Administrative Expenses.
Administrative expenses increased by $70,303, or 10.2%, from $686,050 in three
months ended March 31, 2009, to $756,353 for the three months ended March 31,
2010. The major factors in the increase in administrative expenses are as
follows:





·
            Increase
      of salary and stock option expenses of $238,297, or 178.4%, to $371,879 in
      2010, from $133,582 in 2009, as a result additional stock options granted
      in late 2009.





·
            Increase
      in travel expenses of $10,197, or 20.4%, to $60,118 in 2010, from $49,921
      in 2009, as a result of increase in cost of travel during
      2010.





These
increases were partially offset by a decrease of $126,848 in legal and
accounting expense as compared with 2009 and a decrease in consultation expenses
of $48,750 as compared with 2009. We required less time in preparation of our
regulatory filings in the current year and did not use the services of the
consultant that was used in the 2009.





Liquidated Damages.The
company recorded $5,021,669 in liquidated damages during the three months ended
March 31, 2010 from the extension of warrants previously issued by the Company
to satisfy certain registration rights provisions. There was no similar expense
in the first fiscal quarter of 2009. See Note 14 of the Footnotes to Condensed
Consolidated Financial Statements.




Provision
for Income Taxes





For the Three
      Months
              Ended March
      31,2010
            
            
            2009Provision
      for Income TaxesCurrent
            
            $
            421,499
            
            
            $
            337,830Deferred
            
            
            —
            
            
            
            —$
            421,499
            
            
            $
            337,830





Provision for Income Taxes.
Income taxes increased by $83,669, or 24.8%, from $337,830 for the three months
ended March 31, 2009, to $421,499 for the three months ended March 31, 2010.
This increase was due to the increase in our taxable income in our operating
subsidiaries.





Liquidity
and Capital Resources





Uses
of Capital





For the Three
      Months Ended
              March
      31,2010
            
            
            2009Net
      cash provided by operating activities
            
            $
            2,560,421
            
            
            $
            70,044Net
      cash used in investing activities
            
            
            (9,569,697
            )
            
            
            (4,933
            )Net
      cash provided (used in) by financing activities
            
            $
            -
            
            
            $
            758,230




32




Net Cash Provided By Operating
Activities.For the three months ended March 31, 2010,
$2,560,421 was provided by operating activities, compared with $70,044 provided
by operating activities for the three months ended March 31, 2009. Our net cash
flows provided from operating activities during 2010 increased due to the
following factors:





·
            Operations
      provided $2,634,748 of net cash during the three months ended March 31,
      2010.





·
            Trade
      accounts receivable decreased by $298,933, due to the increased
      collections during the period.





·
            Inventory
      increased by $622,331, due to adjustments from increased sales of our
      products during the current period.





·
            Other
      current assets decreased by $171,145, due the increase in our level of
      production during 2010.





·
            Accounts
      payable and accrued expenses increased by $358,770 at March 31, 2010 due
      to increases in production of products and
  expenses.





Net Cash Used In Investing
Activities.For the three months ended March 31, 2010, we used
$9,569,697 in investing activities, compared with $4,933 used in investing
activities for the three months ended March 31, 2009. The $9,569,697 was
primarily for the construction and equipping of our new production
facility.




Net Cash Provided By Financing
Activities.For the three months ended March 31, 2010 there
was no cash provided by financing activities, compared with $758,230 provided by
financing activities for the three months ended March 31, 2009. We raised
$758,230 through the exercise of warrants during the three months ended March
31, 2009, in connection with the consummation of warrant tender
offers.





General





Cash and
cash equivalents at March 31, 2010 decreased by approximately 51.9% to
$6,482,593, from $13,486,429 at December 31, 2009. Working capital increased
from approximately $17.3 million at December 31, 2009, to approximately $19.9
million at March 31, 2010, including cash generated from operations, as well as
funds raised from private offerings of promissory notes and warrants we
consummated in fiscal 2009. Based upon our short term liabilities, we believe
our cash and cash equivalents are adequate to satisfy our working capital needs
and sustain our ongoing operations for the next twelve months.





We
believe that a lack of adequate production capacity has been a significant
impediment to our ability to increase our revenue in recent years. Our growth
strategy for the next three years will be primarily focused on expanding
production capacity and strengthening sales efforts. Management plans to achieve
this strategy by increasing our production capacity with introduction of our new
production facility, sales staff, and advertising expenditures.





In July
2008, we commenced construction of a new production facility in Hailun City,
Heilongjiang Province, PRC. The first phase of this project has cost an
aggregate of approximately $20.0 million, including land use rights,
construction expenses and equipment costs. Upon completion of the first phase,
the new facility will have one production line, which will have the capacity to
produce 9,000 tons of milk power annually. We anticipate that production at this
new facility will commence on or around the end of the second quarter of fiscal
2010, provided we are able to raise the additional $1.0 million we believe will
be required to complete the equipping of the first production line in
satisfaction with proposed more stringent government manufacturing standards
expected to be adopted in the near future.  We are currently in
negotiations with potential sources which may provide this financing. In the
second phase, a second production line may be added at this new facility, which,
when completed, would enable us to produce an additional 9,000 tons of milk
powder per year, giving us a total annual production capacity of 27,000 tons of
milk powder. We believe the cost to add a second production line would be an
additional $15.0 million.




33




Historically
we relied on investments by our Chief Executive Officer and shareholders, and
bank loans, to meet our cash and capital expenditures. However, as the amount of
our capital expenditures increases, we will depend more on the capital markets
to raise funds through private and public offerings of equity and/or debt. There
can be no assurance that any future financing will be available to us when
needed, and on commercially reasonable terms.





In fiscal
2009, we raised approximately $3.3 million through the sale of promissory notes
payable and warrants, and approximately $4.4 million from the exercise of
warrants, as follows.





·
            On
      March 2, 2009, we closed our offer, pursuant to which the holders of the
      October 2007 Warrants had the opportunity to tender their October 2007
      Warrants for shares of our common stock at a reduced exercise prices (the
      “First Warrant Tender Offer”). In connection with the First Warrant Tender
      Offer, we received gross proceeds of approximately
    $758,000.





·
            On
      August 13, 2009, we closed our second offer, pursuant to which the holders
      of the October 2007 Warrants had the opportunity to tender their October
      2007 Warrants for shares of our common stock at a reduced exercise prices
      (the “Second Warrant Tender Offer”). On August 14, 2009, the warrant
      holders that participated in the Second Warrant Tender Offer exercised all
      of the amended warrants they received in connection therewith, at an
      exercise price of $1.63 per share. As a result, we received gross proceeds
      of $3,675,000.





·
            On
      November 30, 2009, we borrowed $1,750,000 through the November 2009 Term
      Loan from the Lender.





·
            On
      December 24, 2009, we consummated the December 2009 Note Offering pursuant
      to which we received net proceeds of
$1,540,000.





We used
the proceeds we received from the First Warrant Tender Offer, Second Warrant
Tender Offer, November 2009 Term Loan and December 2009 Note Offering for the
construction and equipping of our new production facility, to pay expenses
related to these transactions, and for general working capital purposes. We
anticipate that production at this new facility will commence on or around the
second quarter of fiscal 2010, provided we are able to raise the additional $1.0
million we believe will be required to complete the equipping of the first
production line in satisfaction with proposed more stringent government
manufacturing standards expected to be adopted in the near future. We are
currently in negotiations with potential sources which may provide this
financing.





Following
the completion of the first production line of our new facility, we plan to add
a second production line, which, when completed, would enable us to produce an
additional 9,000 tons of milk powder per year, giving us a total annual
production capacity of 27,000 tons of milk powder. We believe it will cost
approximately $15.0 million to add a second production line. We currently have
no sources for the additional financing we may need to add a second production
line at our new processing facility. There can be no assurance that that any
additional financing will become available to us, and if available, on terms
acceptable to us.




34




In
addition to constructing our new production facility, we have purchased an
office building located in Heilongjiang Province, PRC, for approximately $1.8
million, which serves as our corporate headquarters. The purchase price of this
building was paid out of our retained earnings.





Currently,
we spend approximately 8%-12% of total revenues on advertising and promotional
efforts through out the year. We spent approximately $4.5 million, $5.4 million
and $3.0 million on advertising and promotion in fiscal 2009, 2008 and 2007,
respectively. We currently expect to spend an aggregate of approximately $6.0
million on advertising and promotion in fiscal 2010. This will still fall within
our standard budget for advertising and promotion of 8%-12% of total revenues.
The funds for advertising and promotion will generally come out of our
earnings.





Management
will also consider making strategic acquisitions if there are good opportunities
in the marketplace. However, revenue from acquisitions has not been included in
our planned growth.





Registration
Rights and Liquidated Damages





In
connection with the October 2007 Private Placements, we entered into
Registration Rights Agreements with the October 2007 Investors, pursuant to
which we agreed that within thirty (30) business days of the respective closing
date (the “Filing Date”), we would file a registration statement with the SEC
(the “Registration Statement”) covering the resale of (i) the shares of common
stock purchased in the October 2007 Private Placements (the “Purchased Shares”),
and (ii) the common stock issuable upon exercise of the October 2007 Warrants
(collectively (i) and (ii), the “Registrable Securities”). Further, we agreed to
use our best efforts to (i) cause the Registration Statement to be declared
effective within ninety (90) calendar days from the Filing Date, or, if reviewed
by the SEC, within one hundred eighty (180) calendar days after the Filing Date,
and (ii) keep the Registration Statement continuously effective until all of the
Registrable Securities have been sold, or may be sold without volume
restrictions pursuant to Rule 144.





Pursuant
to the Registration Rights Agreements, we were required to pay liquidated
damages to the holders of the Purchased Shares if (i) we failed to file the
Registration Statement on or before the Filing Date, (ii) the SEC did not
declare the Registration Statement effective within ninety (90) days of the
Filing Date (or one hundred eighty (180) days in the event of a review by the
SEC) (the “Effectiveness Date”), (iii) we failed to request acceleration of
effectiveness within five (5) business days of a notice of no further review
from the SEC, (iv) we failed to respond to the SEC within ten (10) business days
of receipt by us of any comments on the Registration Statement, or (v) after it
has been declared effective, the Registration Statement ceases to be effective
or available or if we suspend the use of the prospectus forming a part of the
Registration Statement (A) for more than thirty (30) days in any period of 365
consecutive days if we suspend in reliance on its ability to do so due to the
existence of a development that, in the good faith discretion of its board of
directors, makes it appropriate to so suspend or which renders us unable to
comply with SEC requirements, or (B) for more than ninety (60) days in any
period of 365 consecutive days for any reason. The liquidated damages accumulate
at the rate of one and one-half percent (1.5%) of the purchase price paid by the
October 2007 Investors for units of our securities purchase in the October 2007
Private Placements for each thirty (30) day period during which a registration
default is continuing; provided, however, that (i) we would not be liable for
liquidated damages with respect to any warrants or shares of common stock
underlying the warrants, and (ii) in no event would we be liable for liquidated
damages in excess of 1.5% of the aggregate purchase price of the securities
purchased in the October Offerings in any 30 day period, and (iii) the maximum
aggregate liquidated damages payable to any of the October 2007 Investors shall
be 20% of the aggregate purchase price paid by such purchaser. The Registration
Rights Agreements further required that if we failed to pay any partial
liquidated damages in full within seven days after the date payable, we will pay
interest thereon at a rate of 15% per annum, until such amounts, plus all such
interest thereon, are paid in full.




35




We did
not satisfy these registration requirements and, as a result, accrued a total of
$1,201,998 in liquidated damages and $172,900 in interest. As of October 5,
2009, we issued an aggregate of 775,833 shares in full payment of the liquidated
damages and interest, as further described in “-- Recent Developments -- Payment
of Liquidated Damages” above.





On
January 28, 2010, a Registration Statement we filed to register the Registrable
Securities for resale was declared effective by the SEC.





Put/Call
Agreements





In
October 2007, we entered into agreements (the “Put/Call Agreements”) with
certain shareholders of ours (the “Put/Call Shareholders”). Pursuant to the
Put/Call Agreements, we had an option to repurchase an aggregate of 1,944,444
shares of our common stock (the “Put/Call Shares”) from the Put/Call
Shareholders (the “Call Option”), for an exercise price of $1.63 per share (the
“Call Option Price”), if the following conditions were met (the “Call Option
Conditions”):





·
            either
      (a) a registration statement (“Registration Statement”) covering the
      resale of the Put/Call Shares had been declared effective by the SEC, and
      had been kept continuously effective by us, or (b) all of the Put/Call
      Shares were available for sale without registration pursuant to Rule 144;
      and




·
            the
      closing price of a share of our common stock as traded on the OTCBB (or
      such other exchange or stock market on which the common stock may be
      listed or quoted) equaled or exceeded $4.08 (appropriately adjusted for
      any stock split, reverse stock split, stock dividend or other
      reclassification or combination of the common stock occurring after the
      date hereof) for at least ten (10) consecutive trading days immediately
      preceding the date notice of exercise of a Call Option was given by
      us.




In
addition, pursuant to the Put/Call Agreements, the Put/Call Shareholders had the
right to cause us to repurchase the Put/Call Shares (the “Put Right”), for a
price of $1.63 per share (the “Put Purchase Price”), if:





·
            we
      failed to exercise our Call Option within ten (10) days of a date on which
      all of the Call Option Conditions had been met;
  or




·
            we
      consummated a private offering of our securities of $5,000,000 or greater
      (a “Qualified Offering”); or




·
            we
      failed to consummate a Qualified Offering on or prior to October 9, 2009
      (each of the aforementioned conditions, a “Put Right
      Trigger”).




Initially,
our failure to (i) file the Registration Statement within thirty (30) business
days of October 9, 2007 (the “Filing Date”), (ii) have the Registration
Statement declared effective within ninety (90) calendar days from the Filing
Date, or, if reviewed by the SEC, within one hundred eighty (180) calendar days
after the Filing Date, or (iii) keep the Registration Statement continuously
effective until all of the “Registrable Securities” were available for sale
without registration pursuant to Rule 144, would also have served as a Put Right
Trigger. However, as of April 9, 2008, the Put/Call Shareholders agreed to amend
the Put/Call Agreements to delete this provision. We did not pay any
consideration to the Put/Call Shareholders in connection with their waiver of
this provision.




36




We had
recorded the value of the Put/Call Agreements as a liability in the aggregate
amount of $3,169,444 as of October 9, 2007, based on the fair market value of
the underlying common stock of $1.63 as of such date. The parties mutually
agreed that it was in the best interests of the Company and its stockholders for
the Put/Call Agreements to be terminated. Therefore, as of March 3, 2009, the
Put/Call Agreements were terminated.





Changes
in foreign exchange regulations in the PRC and ability to pay dividends in
foreign currency or conduct other foreign exchange business





The
Renminbi is currently not a freely convertible currency, and the restrictions on
currency exchange may limit our ability to use revenues generated in RMB to fund
our business activities outside the PRC, or to make dividends or other payments
in United States dollars. The PRC government strictly regulates conversion of
RMB into foreign currencies. Over the years, foreign exchange regulations in the
PRC have significantly reduced the government’s control over routine foreign
exchange transactions under current accounts. In the PRC, SAFE, regulates the
conversion of the RMB into foreign currencies. Pursuant to applicable PRC laws
and regulations, foreign invested enterprises incorporated in the PRC are
required to apply for “Foreign Exchange Registration Certificates.” Currently,
conversion within the scope of the “current account” (e.g. remittance of foreign
currencies for payment of dividends, etc.) can be effected without requiring the
approval of SAFE. However, conversion of currency in the “capital account” (e.g.
for capital items such as direct investments, loans, securities, etc.) still
requires the approval of SAFE.  See the discussion in Risk Factors
commencing on page 14 of Amendment No. 1 to our Annual Report on Form 10-K for
the fiscal year ended December 31, 2009 (the “Form 10-K/A”) for more
information.





Warrants





As of the
date hereof, we have outstanding exercisable warrants to purchase an aggregate
of 6,383,336 shares of our common stock, of which:




·
            833,811
      are exercisable at a price of $1.50 per
share;




·
            2,149,248
      are exercisable at a price of $1.63 per
share;




·
            44,643
      are exercisable at a price of $1.68 per
share;




·
            875,515
      are exercisable at a price of $2.04 per
share;




·
            75,000
      are exercisable at a price of $2.61 per share;
  and




·
            2,405,119
      are exercisable at a price of $3.26 per
share.




If all of
the warrants are exercised at their reduced exercise prices, we will receive
gross proceeds of approximately $14.7 million, although there can be no
assurance that any of these warrants will be exercised.




We also
have an additional:




·
            160,000
      warrants, whichvestas to 25% of the underlying shares on each of June 30, 2010,
      September 30, 2010, December 31, 2010 and March 31, 2011;
    and




·
            714,286
      warrants, which may become exercisable at a price of $1.68 per share if
      certain conditions are met by June 30,
2010.




37




Promissory
Notes





The Amended June 2008
Note





The
remaining Amended June 2008 Note has a principal balance of $1,716,411, which
bears interest at a rate of 10% until Amended June 2008 Note becomes due and
payable on December 31, 2010. Any amount of principal or interest which is not
paid when due will bear interest at a rate of 12%. We may prepay the entire
amount due under the Amended June 2008 Note at any time without penalty, upon 15
days prior written notice. The holder of the Amended June 2008 Note has the
right to be prepaid any amounts due under the Amended June 2008 Note from the
proceeds of any future offering we consummate resulting in gross proceeds of
$4,500,000 or more. So long as we have any obligation under the Amended June
2008 Note, there are limitations on our ability to: (a) pay dividends or make
other distributions on our capital stock; (b) redeem, repurchase or otherwise
acquire any of our securities; (c) create, incur or assume any liability for
borrowed money (except as is related to the completion of the construction of
our new production facility); (d) sell, lease or otherwise dispose of any
significant portion of its assets; (e) lend money, give credit or make advances;
or (f) assume, guarantee, endorse, contingently agree to purchase or otherwise
become liable upon the obligation of any other person or entity. It shall be
deemed an “Event of Default” under the Amended June 2008 Note if: (a) we fail to
pay principal or interest when due on the Amended June 2008 Note; (b) we breach
any material covenant or other material term or condition contained in the
Amended June 2008 Note or securities purchase agreement entered into in
connection with the June 2008 Offering, as amended (the “June Purchase
Agreement”), and such breach continues for a period of thirty (30) days after
written notice thereof; (c) any representation or warranty we made under the
Amended June 2008 Note or the June Purchase Agreement shall be false or
misleading in any material respect; (d) we, or any subsidiary of ours, shall
make an assignment for the benefit of creditors, or apply for or consent to the
appointment of a receiver or trustee, or such a receiver or trustee shall
otherwise be appointed; (e) a money judgment shall be entered against us, or any
subsidiary of ours, for more than $250,000, that remains in effect for a period
of twenty (20) days; (f) bankruptcy, insolvency, reorganization or liquidation
proceedings or other similar proceedings shall be instituted by or against us,
or any subsidiary of ours, which are not dismissed within sixty (60) days; or
(g) we fail to maintain the listing of our common stock on at least one of the
OTCBB, the Nasdaq National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the NYSE Amex Equities. Upon the occurrence of any Event of
Default under the Amended June 2008 Note, unless such Event of Default shall
have been waived in writing by the holder, the holder may consider the Amended
June 2008 Note immediately due and payable, without presentment, demand, protest
or notice of any kind, and the holder may immediately enforce any and all of its
rights and remedies provided in the Amended June 2008 Note or any other right or
remedy afforded by law. Our repayment of amounts due under the Amended June 2008
Note is secured by a pledge of an aggregate of 2,104,950 shares of our common
stock beneficially owned by Yang Yong Shan, our Chairman, Chief Executive
Officer and President.





The Amended November 2008
Note





The
Amended November 2008 Note has a principal balance of $500,000, and bears
interest at a rate of 10% until it becomes due and payable on June 9, 2010. The
holder of the Amended November 2008 Note has the right to be prepaid any amounts
due under his Amended November 2008 Note from the proceeds of any future
offering we consummate resulting in gross proceeds of $6,500,000 or more.
Otherwise, the terms and conditions of the Amended November 2008 Note are
substantially similar to those of the Amended June 2008 Notes.




38




The Term Loan
Note





The Term
Loan Note has a principal balance of $1,750,000. The interest rate on the Term
Loan Note is 10% per annum and is payable on maturity. The Term Loan Note has a
stated maturity date of November 30, 2010. Upon the maturity of the Term Loan
Note, by acceleration or otherwise, interest on unpaid amounts shall thereafter
be payable at the rate of 12% per annum (“Default Interest”), until the
obligation is paid in full. Any regular interest or Default Interest not paid
when due under the Term Loan Note shall be added to the principal of the Term
Loan Note. We may from time-to-time prepay any amount due under the Term Loan
Note, in whole or in part, without penalty. The entire unpaid principal balance,
together with accrued interest, shall become due and payable, without
presentment, demand, protest, notice of protest or other notice of dishonor of
any kind upon the occurrence of an “Event of Default,” as defined in our Loan
Agreement with the Lender.





The December 2009
Notes





The
December 2009 Notes have an aggregate principal balance of $1,750,000. The
December 2009 Notes bear interest at a rate of 10% until due and payable on
December 24, 2010. Any amount of principal or interest which is not paid when
due will bear interest at a rate of 15% per annum. We may prepay the entire
amount due under the December 2009 Notes at any time without penalty, upon 15
days prior written notice; provided, however, in such event the December 2009
Noteholders will be entitled to retain an amount of prepaid interest equal to
the greater of (i) the amount accrued as of the prepayment date, and (ii) an
aggregate of $105,000. The December 2009 Noteholders have the right to be
prepaid any amounts due under the December 2009 Notes should we consummate
certain additional offerings of equity or debt securities. So long as we have
any obligation under the December 2009 Notes, there are limitations on our
ability to: (a) pay dividends or make other distributions on our capital stock;
(b) redeem, repurchase or otherwise acquire any of our securities; (c) create,
incur or assume any liability for borrowed money; (d) sell, lease or otherwise
dispose of any significant portion of our assets; (e) lend money, give credit or
make advances; or (f) assume, guarantee, endorse, contingently agree to purchase
or otherwise become liable upon the obligation of any other person or entity.
The entire unpaid principal balance, together with accrued interest, shall
become due and payable, without presentment, demand, protest, notice of protest
or other notice of dishonor of any kind upon the occurrence of an “Event of
Default,” as defined in the December 2009 Notes. Our repayment of amounts due
under the December 2009 Notes is secured by a pledge of an aggregate of
5,883,329 shares of our common stock beneficially owned by Yang Yong Shan, our
Chairman, Chief Executive Officer and President.





Dividends





We have
not paid any dividends. In all likelihood, we will use our earnings to develop
our business and do not intend to declare dividends for the foreseeable future.
Any decision to pay dividends on our common stock in the future will be made by
our board of directors on the basis of earnings, financial requirements and
other such conditions that may exist at that time. In addition, the Notes we
issued in the Note Offering, further described in “-- Recent Developments --
Sale of Notes and Warrants” above, contain restrictive covenants on our payment
of dividends, as further described in “Description of Securities -- Promissory
Notes” above.





39


Contractual
Obligations and Commercial Commitments





Our
contractual obligations, as of March 31, 2010, were as follows:




Payments Due By PeriodContractual
      obligations
            
            Total
            
            
            Less than
              1 year
            
            
            1-3 years
            
            
            After
              3-5 years
            
            
            More than
              5 yearsEquipment
      purchase
            
            $
            1,550,785
            
            
            $
            1,550,785
            
            
            
            —
            
            
            
            —
            
            
            
            —Construction
      contract
            
            
            497,300
            
            
            
            497,300
            
            
            
            —
            
            
            
            —
            
            
            
            —Debt
      Obligations
            
            
            7,264,952
            
            
            
            7,264,952
            
            
            
            —
            
            
            
            —
            
            
            
            —Advertising
      contract
            
            
            1,429,564
            
            
            
            1,429,564
            
            
            
            —
            
            
            
            —
            
            
            
            —Operating
      leases
            
            
            328,878
            
            
            
            138,147
            
            
            
            190,731
            
            
            
            —
            
            
            
            —Total:
            
            $
            11,071,479
            
            
            $
            10,880,748
            
            
            
            190,731
            
            
            
            —
            
            
            
            —





Critical
Accounting Policies and Estimates





Our
consolidated financial statements are prepared in accordance with U.S. generally
accepted accounting principles (“GAAP”). These accounting principles require us
to make certain estimates, judgments and assumptions. We believe that the
estimates, judgments and assumptions upon which we rely are reasonable based
upon information available to us at the time that these estimates, judgments and
assumptions are made. These estimates, judgments and assumptions can affect the
reported amounts of assets and liabilities as of the date of the financial
statements as well as the reported amounts of revenues and expenses during the
periods presented. To the extent there are material differences between these
estimates, judgments or assumptions and actual results, our financial statements
will be affected. The accounting policies that reflect our more significant
estimates, judgments and assumptions and which we believe are the most critical
to aid in fully understanding and evaluating our reported financial results
include the following:





·
                Inventory





·
              Property
      and equipment





·
              Intangible
      Assets





·
              Revenue
      recognition





·
              Earnings
      per share





·
              Taxation





·
              Warrants





·
              Freestanding
      Financial Instruments with Characteristics of Both Liabilities and
      Equity





·
              Retirement
      benefit costs





·
              Stock
      Based Compensation





·
              Fair
      value of financial
instruments





·
              Fair
      Value Measurements




40




In many
cases, the accounting treatment of a particular transaction is specifically
dictated by GAAP and does not require management’s judgment in its application.
There are also areas in which management’s judgment in selecting among available
alternatives would not produce a materially different result. Our senior
management has reviewed these critical accounting policies and related
disclosures with the Board of Directors.





During
the first three months of fiscal 2010, there were no significant changes in our
critical accounting policies and estimates. You should refer to Management’s
Discussion and Analysis of Financial Condition and Results of Operations
contained in Part II, Item 7 of our Form 10-K/A for the fiscal year ended
December 31, 2009 for a more complete discussion of our critical accounting
policies and estimates.





Recently
Enacted Accounting Standards





Refer to
Note 3 to the Financial Statements included in Part I, Item 1 of this Quarterly
Report on Form 10-Q, which discusses new accounting pronouncements we recently
adopted, as well as accounting pronouncements recently issued or proposed but
not yet required to be adopted.





Off-Balance
Sheet Arrangements





We are
not a party to any off-balance sheet arrangements.




41




Item
3. Quantitative and Qualitative Disclosures about Market Risk





We are a
smaller reporting company as defined by Rule 12b-2 of the Securities Exchange
Act of 1934 (“Exchange Act”) and are not required to provide the information
under this item.





Item
4.  Controls and Procedures.





Disclosure
Controls and Procedures





Our
management maintains disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide
reasonable assurance that the material information required to be disclosed by
us in our periodic reports filed or submitted under the Exchange Act is
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 us in the reports that we file or submit under the
Exchange Act is accumulated and communicated our management, including our Chief
Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure.





As of
March 31, 2010, our management, under the supervision of and with the
participation of our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of our disclosure controls and procedures as
required by Rules 13a-15(b) and 15d-15(b) under the Exchange Act. Based upon
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were not effective as of
March 31, 2010 as a result of the material weaknesses identified in our internal
control over financial reporting. These material weaknesses are discussed in
“Management’s Report on Internal Control over Financial Reporting” contained in
our Form 10-K/A. Our management considers our internal control over financial
reporting to be an integral part of our disclosure controls and
procedures.





Our
management has taken and is continuing to take the following actions to improve
our internal controls over financial reporting, including actions to remediate
the identified material weaknesses:







●
              As
      financial conditions permit, our management will recruit an independent
      financial expert to the Board of Directors to chair the Audit Committee
      and formalize roles and responsibilities over our internal controls over
      financial reporting for the Board and our management. Our management also
      intends to develop and implement a formal corporate internal audit
      capability, eventually reporting directly to an independent Audit
      Committee, to provide more effective oversight of our internal control
      over financial reporting.
 
 ●
              Our
      management will implement a Code of Conduct specifically designed for
      public company applicability across all corporate entities. Company
      directors, management and staff will be required to certify receipt of the
      Code by signature. Thereafter, our management will periodically require
      employees to acknowledge that they understand the contents of the Code,
      and disclose whether they are aware of anyone in the Company that might
      have violated some part of the
Code.
 
 ●
              Our
      management will formalize finance-related job descriptions for all staff
      levels that specifically identify required financial reporting roles,
      responsibilities, and competencies, and clarify responsibility for
      maintaining our internal controls over financial reporting.  Our
      management will implement these revised policies and procedures across all
      of its corporate entities with appropriate staff training to ensure that
      financial reporting competencies are
  strengthened.
  42
  ●
              Our
      management will hire additional, qualified accounting personnel at the
      Chinese operating unit level to enhance our financial reporting
      competencies. Our management will also continue to provide training to
      existing accounting personnel regarding our significant accounting
      policies and procedures.
 
 ●
              Our
      management will continue to engage the services of qualified consultants
      with China GAAP, U.S. GAAP and SEC reporting experience to assist with and
      support our financial reporting and SOX compliance requirements in 2010,
      including assistance with the
following:
 
 o
              Remediating
      identified material weaknesses;
 
 o
              Monitoring
      our internal controls over financial reporting on an ongoing
      basis;
 
 o
              Managing
      our period-end financial closing and reporting processes;
    and
 
 o
              Identifying
      and resolving non-routine or complex accounting
  matters.
 
 ●
              Our
      management will determine and hire the staff competencies required to
      ensure that essential IT general controls are maintained over our
      accounting system. In addition, our management will formalize its policies
      and procedures over core IT functions, including access, change, data, and
      security management, to ensure that all relevant financial information is
      secure, identified, captured, processed, and reported within the
      accounting system.





Our
management will continue to monitor and evaluate the effectiveness of its
disclosure controls and procedures, as well as its internal controls over
financial reporting, on an ongoing basis, and is committed to taking further
action and implementing additional improvements, as necessary and as funds
allow. However, our management cannot guarantee that the measures taken or any
future measures will remediate the material weaknesses identified or that any
additional material weaknesses or significant deficiencies will not arise in the
future due to a failure to implement and maintain adequate internal controls
over financial reporting.





Notwithstanding
the material weaknesses described above, our management believes that there are
no material inaccuracies or omissions of material fact and, to the best of its
knowledge, believes that the consolidated financial statements included in this
annual report present fairly, in all material respects, our financial position,
results of operations, and cash flows for the periods presented in conformity
with accounting principles generally accepted in the United States.





Changes
in Internal Control Over Financial Reporting





There
were no changes in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the
interim period ended March 31, 2010, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




43




PART
II - OTHER INFORMATION





Item
1.  Legal Proceedings.





We are
not a party to any pending legal proceedings.





Item
1A.  Risk Factors.





We are a smaller reporting company as
defined by Rule 12b-2 of the Exchange Act and are not required to provide the
information under this item.





Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds.





Issuance
of Shares to Investor Relations Firm





As of
January 1, 2009, we entered into an Investor Relations Consulting Agreement (the
“IR Agreement”) with a consultant. Pursuant to the IR Agreement, in
consideration for investor relations services to be provided to us by the
consultant, the Company agreed to pay a monthly retainer of $9,000, consisting
of (i) $4,500 in cash, and (ii) such number of shares of our restricted stock to
be determined by dividing $4,500 by 85% of the average closing trading price of
our common stock for the first ten trading days of the applicable month, capped
at 10,588 shares per month. On January 15, 2010, we issued 18,632 restricted
shares of common stock to the consultant for services provided to us between
July 1, 2009 and December 31, 2009.





We
believe the issuance of the 18,632 shares pursuant to the IR Agreement is exempt
from registration under the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereof, as a transaction by an issuer not involving a public
offering.





Issuance
of Shares to Vice President of Sales





As of
March 18, 2010, we issued of 180,000 restricted shares of our common stock to
Niu Wan Chen, our Vice President of Sales, as additional compensation for
services he rendered to us in fiscal 2009.





We
believe the issuance of these shares is exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof, as
transactions by an issuer not involving a public offering.





Item
3.  Defaults Upon Senior Securities.





Not
Applicable





Item
4.  (Removed and Reserved).





Item
5.  Other Information.





None




44




Item
6.  Exhibits







Exhibit
              No.
            
            Description of Exhibit31.1
            
            Certification
      of principal executive officer pursuant to Section 13a-14(a) -- filed
      herewith31.2
            
            Certification
      of principal financial and accounting officer pursuant to Section
      13a-14(a) -- filed herewith32.1
            
            Certification
      of principal executive officer pursuant to Section 1350 -- filed
      herewith32.2
            
            Certification
      of principal financial and accounting officer pursuant to Section 1350 --
      filed herewith





45




SIGNATURES




Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly
authorized.




EMERALD
      DAIRY INC.Dated:
      May 17, 2010
              By:
              /s/
      Yang Yong ShanYang
      Yong ShanChairman,
      Chief Executive Officer and President




Dated:
      May 17, 2010
              By:
              /s/
      Shu KanekoShu
      KanekoChief
      Financial Officer and Secretary




46