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
                
                June
      30, 2009





or





 ̈
            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      ̈No





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).


oYes      ̈No




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.





Large
      accelerated filer  ̈
            Accelerated
      filer  ̈Non-accelerated
      filer  ̈
            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).


 ̈Yes     x No





The
registrant had 29,696,530 shares of common stock issued and outstanding as of
July 31, 2009 (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 JUNE 30, 2009




TABLE
OF CONTENTS





PAGEPART I
                      -
                      FINANCIAL
      INFORMATIONItem
      1.
                      
                      Financial
      Statements
                      1Condensed
      Consolidated Balance Sheets as of June 30, 2009 (unaudited) and December
      31, 2008
                      1Condensed
      Consolidated Statements of Income for the Three and Six Months Ended June
      30, 2009 and 2008 (unaudited)
                      2Condensed
      Consolidated Statements of Cash Flows for the Six Months Ended June 30,
      2009 and 2008 (unaudited)
                      3Notes
      to Condensed Consolidated Financial Statements (unaudited)
                      4Item
      2.
                      
                      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                      27Item
      3.
                      
                      Quantitative
      and Qualitative Disclosures About Market Risk
                      57Item
      4.
                      
                      Controls
      and Procedures
                      57PART II
                      -
                      OTHER
      INFORMATIONItem
      1.
                      
                      Legal
      Proceedings
                      60Item
      1A.
                      
                      Risk
      Factors
                      60Item
      2.
                      
                      Unregistered
      Sales of Equity Securities and Use of Proceeds
                      60Item
      3.
                      
                      Defaults
      Upon Senior Securities
                      62Item
      4.
                      
                      Submission
      of Matters to a Vote of Security Holders
                      62Item
      5.
                      
                      Other
      Information
                      62Item
      6.
                      
                      Exhibits
                      63Signatures
                      64




i


PART
I. FINANCIAL INFORMATION





Item
1.  Financial Statements





Emerald
Dairy Inc. and Subsidiaries
 Condensed
Consolidated Balance Sheets
 June
30, 2009 and December 31, 2008


June 30,
                            
                            
                            December 31,2009
                            
                            
                            2008(Unaudited)
                            
                            
                            (Audited)ASSETSCurrent
      AssetsCash
      and cash equivalents
                            
                            $
                            4,752,255
                            
                            
                            $
                            7,343,588Trade
      accounts receivable,net
                            
                            
                            6,702,945
                            
                            
                            
                            6,146,228Inventory,
      net
                            
                            
                            1,629,834
                            
                            
                            
                            883,233Other
      current assets
                            
                            
                            4,398,896
                            
                            
                            
                            4,337,332Total
      current assets
                            
                            
                            17,483,930
                            
                            
                            
                            18,710,381Property,
      plant and equipmentProperty,
      plant and equipment, net
                            
                            
                            5,861,988
                            
                            
                            
                            6,101,566Contruction
      in progress
                            
                            
                            6,875,312
                            
                            
                            
                            2,482,33912,737,300
                            
                            
                            
                            8,583,905Intangible
      assets, net
                            
                            
                            1,359,671
                            
                            
                            
                            1,380,089$
                            31,580,901
                            
                            
                            $
                            28,674,375LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
                            
                            $
                            4,163,034
                            
                            
                            $
                            4,651,947Notes
      payable, net of debt discount of $43,944 and $87,888 atJune
      30, 2009 and December 31, 2008, respectively
                            
                            
                            2,706,056
                            
                            
                            
                            2,662,112Other
      current liabilites
                            
                            
                            419,397
                            
                            
                            
                            728,859Loan
      from shareholder
                            
                            
                            210,028
                            
                            
                            
                            210,265Total
      current liabilities
                            
                            
                            7,498,515
                            
                            
                            
                            8,253,183Commitments
      and Contingencies (Note 19)Stockholders'
      EquityPreferred
      stock ($0.001 par value, 10,000,000 shares authorized,
noneissued
      and outstanding at June 30, 2009 and December 31, 2008)
                            
                            
                            -
                            
                            
                            
                            -Common
      stock ($0.001 par value, 100,000,000 shares authorized, 31,640,974 and
      31,243,776 issued and outstanding at June 30, 2009 and December 31, 2008,
      respectively)
                            
                            
                            31,641
                            
                            
                            
                            31,244Treasury
      Stock (1,944,444 shares at June 30, 2009 andDecember
      31, 2008, respectively)
                            
                            
                            (1,944
                            )
                            
                            
                            (1,944
                            )Additional
      paid-in capital
                            
                            
                            9,096,894
                            
                            
                            
                            8,225,922Retained
      earnings (of which $2,062,907 and $1,314,861 are restricted at June 30,
      2009 and December 31, 2008, respectively, for common welfare
      reserves)
                            
                            
                            12,922,244
                            
                            
                            
                            10,106,402Accumulated
      other comprehensive income
                            
                            
                            2,033,551
                            
                            
                            
                            2,059,568Total
      stockholders' equity
                            
                            
                            24,082,386
                            
                            
                            
                            20,421,192$
                            31,580,901
                            
                            
                            $
                            28,674,375





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 and Six Months Ended June 30, 2009 and 2008


Three months ended
                
                
                Six months endedJune 30,
                
                
                June 30,
                
                
                June 30,
                
                
                June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Sales
                
                $
                10,246,935
                
                
                $
                10,904,778
                
                
                $
                21,103,487
                
                
                $
                21,339,237Cost
      of Goods Sold
                
                
                5,639,310
                
                
                
                7,281,163
                
                
                
                11,487,985
                
                
                
                13,292,397Gross
      Profit
                
                
                4,607,625
                
                
                
                3,623,615
                
                
                
                9,615,502
                
                
                
                8,046,840Operating
      ExpensesSelling
      expenses and adminstrative expenses
                
                
                3,073,694
                
                
                
                2,634,812
                
                
                
                6,100,398
                
                
                
                6,964,150Depreciation
      and amortization
                
                
                43,274
                
                
                
                15,570
                
                
                
                86,512
                
                
                
                30,431Total
      operating expenses
                
                
                3,116,968
                
                
                
                2,650,382
                
                
                
                6,186,910
                
                
                
                6,994,581Other
      Income (Expense)Interest
      income
                
                
                2,191
                
                
                
                3,978
                
                
                
                3,144
                
                
                
                9,606Interest
      expense
                
                
                48,352
                
                
                
                (42,150
                )
                
                
                -
                
                
                
                (43,406
                )Total
      other income (expense)
                
                
                50,543
                
                
                
                (38,172
                )
                
                
                3,144
                
                
                
                (33,800
                )Net
      Income Before Provision for Income Tax
                
                
                1,541,200
                
                
                
                935,061
                
                
                
                3,431,736
                
                
                
                1,018,459Provision
      for Income TaxesCurrent
                
                
                278,064
                
                
                
                236,711
                
                
                
                615,894
                
                
                
                317,291278,064
                
                
                
                236,711
                
                
                
                615,894
                
                
                
                317,291Net
      Income
                
                $
                1,263,136
                
                
                $
                698,350
                
                
                $
                2,815,842
                
                
                $
                701,168Basic
      Earnings Per Share
                
                $
                0.04
                
                
                $
                0.02
                
                
                $
                0.10
                
                
                $
                0.02Basic
      Weighted Average Shares Outstanding
                
                
                29,658,726
                
                
                
                29,299,332
                
                
                
                29,537,604
                
                
                
                29,299,332Diluted
      Earnings Per Share
                
                $
                0.04
                
                
                $
                0.02
                
                
                $
                0.09
                
                
                $
                0.02Diluted
      Weighted Average Shares Outstanding
                
                
                30,105,880
                
                
                
                29,563,708
                
                
                
                29,648,643
                
                
                
                29,563,708The
      Components of Other Comprehensive IncomeNet
      Income
                
                $
                1,263,136
                
                
                $
                698,350
                
                
                $
                2,815,842
                
                
                $
                701,168Foreign
      currency translation adjustment
                
                
                16,406
                
                
                
                440,717
                
                
                
                (39,420
                )
                
                
                1,375,312Income
      tax related to other comprehensive income
                
                
                (5,578
                )
                
                
                (149,844
                )
                
                
                13,403
                
                
                
                (467,606
                )Comprehensive
      Income
                
                $
                1,273,964
                
                
                $
                989,223
                
                
                $
                2,789,825
                
                
                $
                1,608,874




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 Six Months Ended June 30, 2009 and 2008


2009
                  
                  
                  2008Cash
      flows from operating activitiesNet
      Income
                  
                  $
                  2,815,842
                  
                  
                  $
                  701,168Adjustments
      to reconcile net cash provided by operating activitiesDepreciation
      and amortization
                  
                  
                  266,374
                  
                  
                  
                  193,559Amortization
      of loan discount
                  
                  
                  43,944
                  
                  
                  
                  18,766Capitalized
      interest
                  
                  
                  (220,727
                  )
                  
                  
                  -Stock
      issued for services
                  
                  
                  33,475
                  
                  
                  
                  -Warrants
      modified for services
                  
                  
                  3,975
                  
                  
                  
                  -Incentive
      stock options
                  
                  
                  75,688
                  
                  
                  
                  -Net
      change in assets and liabilitiesTrade
      accounts receivable
                  
                  
                  (563,653
                  )
                  
                  
                  (1,565,617
                  )Inventory
                  
                  
                  (747,598
                  )
                  
                  
                  (1,212,775
                  )Other
      current assets
                  
                  
                  (66,459
                  )
                  
                  
                  604,913Accounts
      payable and accrued expenses
                  
                  
                  (483,663
                  )
                  
                  
                  1,440,003Other
      current liabilities
                  
                  
                  (308,639
                  )
                  
                  
                  34,914Net
      cash provided by operating activities
                  
                  
                  848,559
                  
                  
                  
                  214,931Cash
      flows from investing activitiesDeposit
      on equipment purchase
                  
                  
                  
                  
                  
                  
                  (3,695,928
                  )Purchases
      of fixed assets and intangibles includingconstruction
      in progress
                  
                  
                  (4,189,873
                  )
                  
                  
                  (1,656,200
                  )Net
      cash used in investing activities
                  
                  
                  (4,189,873
                  )
                  
                  
                  (5,352,128
                  )Cash
      flows from financing activities-
                  
                  
                  
                  -Exercise
      of warrants
                  
                  
                  758,231
                  
                  
                  
                  -Repayments
      of notes payable
                  
                  
                  -
                  
                  
                  
                  (290,713
                  )Advances
      on notes payable
                  
                  
                  -
                  
                  
                  
                  2,250,000Net
      cash provided by financing activities
                  
                  
                  758,231
                  
                  
                  
                  1,959,287Effect
      of exchange rate
                  
                  
                  (8,250
                  )
                  
                  
                  438,090Net
      increase in cash
                  
                  
                  (2,591,333
                  )
                  
                  
                  (2,739,820
                  )Cash
      and cash equivalents at beginning of period
                  
                  
                  7,343,588
                  
                  
                  
                  6,560,931Cash
      and cash equivalents at end of period
                  
                  $
                  4,752,255
                  
                  
                  $
                  3,821,111





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
 June
30, 2009 and 2008
 
 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.
 
 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 Province, pursuant to the laws of the PRC. 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.
  XAL is a
dairy company engaged in manufacturing of milk powder, soybean powder and rice
powder. Through the Company’s network of over 800 salespeople, the its products
are distributed throughout 20 provinces in the PRC, and sold in over 5,800
retail outlets.
 
 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
fourth quarter of 2009. 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 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 generally
accepted accounting principles 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, 2008 which are included in the Company’s Form 10-K for the year
ended December 31, 2008 filed with the SEC on April 9, 2009.
 
 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 balance sheets of Emerald
Dairy Inc. and subsidiaries as of June 30, 2009 and the results of their
operations for the three and six months ended June 30, 2009 and 2008, and cash
flows for the six months ended June 30, 2009 and 2008. The results of operations
for the six months ended June 30, 2009 and 2008 are not necessarily indicative
of the results to be expected for the entire year.
 
 The
financial statements have been prepared in order to present the consolidated
financial position and consolidated results of operations in accordance with
accounting principles generally accepted in the United States of America (“US
GAAP”) and are expressed in terms of US dollars (see paragraph “Foreign
Currency” below).
 
 The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries, 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
 June
30, 2009 and 2008
 
 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 affected 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 the 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 June 30, 2009, no U.S. deposit 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.
 
 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
December 31, 2008 and 2007, there were no allowances for doubtful accounts based
on the review of the above factors. There were no write-off’s for the three and
six months ended June 30, 2009 and 2008. 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 June 30, 2009, the
Company has incurred and capitalized into construction-in-progress $6,564,717 of
construction costs from the construction contract and $310,595 of capitalized
interest for a balance of $6,875,312.  The estimated cost to be
incurred in 2009 to complete the project is approximately
$1,866,942.
 
 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 June 30, 2009 and 2008 is as follows:
 
 Three Months
                                                                                      Ended June 30,
                                                                                    
                                                                                    
                                                                                    Six Months
                                                                                      Ended June 30,2009
                                                                                    
                                                                                    
                                                                                    2008
                                                                                    
                                                                                    
                                                                                    2009
                                                                                    
                                                                                    
                                                                                    2008Interest
      cost capitalized
                                                                                    
                                                                                    $
                                                                                    158,715
                                                                                    
                                                                                    
                                                                                    $
                                                                                    —
                                                                                    
                                                                                    
                                                                                    $
                                                                                    220,727
                                                                                    
                                                                                    
                                                                                    $
                                                                                    —Interest
      cost charged to income
                                                                                    
                                                                                    
                                                                                    (48,352
                                                                                    )
                                                                                    
                                                                                    
                                                                                    42,150
                                                                                    
                                                                                    
                                                                                    
                                                                                    -0-
                                                                                    
                                                                                    
                                                                                    
                                                                                    43,406$
                                                                                    110,363
                                                                                    
                                                                                    
                                                                                    $
                                                                                    42,150
                                                                                    
                                                                                    
                                                                                    $
                                                                                    220,727
                                                                                    
                                                                                    
                                                                                    $
                                                                                    43,406
  5
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 3.      Summary
of Significant Accounting Policies (Continued)
 
 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,
RMB, as the functional currency. The results of operations denominated in
foreign currency are translated at the average rate of exchange during the
reporting period.
  Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the 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 (“US Dollars”) are dealt with as a
separate component within stockholders’ equity. Translation adjustments net of
tax totaled $10,828 and $290,873, for the three months ended June 30, 2009 and
2008, respectively and ($26,017) and $907,706 for the six months ended June 30,
2009 and 2008, respectively.
 
 As of
June 30, 2009 and 2008, the exchange rate was 6.8307 RMB and 6.8543 RMB per
U.S. Dollar, respectively.
 
 Revenue recognition - Revenue
is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, which
states that revenue should be 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
June 30, 2009, the Company has no sales or contracts that included multiple
deliverables that would fall under the scope of Emerging Issues Task Force
(EITF) 00-21, Revenue
Arrangements with Multiple Deliverables.
 
 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 the provisions of Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes,
which 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.
 
 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.
  6
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 3.     Summary
of Significant Accounting Policies (Continued)
 
 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 Enterprise” 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 -In accordance with
SFAS No. 150, Accounting for
Certain 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 -On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123(R), Share-Based Payment, 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. The Company has adopted the requirements of SFAS
No. 123(R) for the fiscal year beginning on January 1, 2006.
 
 Fair value of financial instruments -The Company applies the provisions of SFAS No. 107, Disclosures about Fair Value of
Financial Instruments. SFAS No. 107 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.  SFAS No. 107 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  June 30, 2009
and December 31, 2008 the fair value of cash, 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- In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS
No. 157 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. SFAS No. 157 applies to fair value measurements required by
existing accounting pronouncements and does not require any new fair value
measurements. The Company adopted SFAS No. 157 on January 1,
2008.
 
 On
January 1, 2009 the Company  adopted FASB Staff Position (FSP) No. FAS
157-2 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 standard 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
 June
30, 2009 and 2008
 
 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 June 30, 2009.
  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
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement
No. 133 (SFAS 161). SFAS 161 changes the disclosure requirements for
derivative instruments and hedging activities. Entities are required to provide
enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.. On January 1, 2009
the Company adopted SFAS 161, the adoption of this standard did not have a
material impact on the Company’s financial position, results of operations, or
cash flows.
 
 In June
2008, the EITF reached final consensuses on EITF Issue 08-4, Transition Guidance for Conforming
Changes to Issue No. 98-5. Certain conclusions reached in EITF Issue No.
98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, were nullified in EITF Issue No. 00-27,
Application of EITF Issue No.
98-5 to Certain Convertible Instruments. Moreover, some of the
conclusions in EITF Issue No. 98-5 and EITF Issue No. 00-27 were superseded by
SFAS No. 150 , Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. While the conclusions reached in EITF Issue No. 98-5 were
subsequently updated to reflect the issuance of EITF Issue No. 00-27 and SFAS
No. 150, the transition guidance in EITF Issue No. 98-5 was not revised. On
January 1, 2009 the Company adopted EITF 08-4, the adoption of this standard did
not have a material impact on the Company’s financial condition, results of
operations or cash flows.
 
 In June
2008, the EITF reached final consensuses on EITF Issue 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity's Own Stock.  In
EITF Issue 07-5, the EITF reached the consensus that evaluation of whether an
equity-linked financial instrument (or embedded feature) is indexed to the
company's own stock should be based on a two-step approach. Under the two-step
approach, an equity-linked financial instrument (or embedded feature) is not
deemed indexed to the entity's own stock if the strike price is denominated in a
currency other than the issuer's functional currency (but the determination of
whether the instrument is indexed to the company's own stock is not affected by
the currency in which the underlying shares are traded). Also, market-based
employee stock valuation instruments are not considered to be indexed to the
entity's own stock (presumably because they are influenced by, among other
factors, employee behavior, which is not an input used to estimate the fair
value of the forward contract or option). An exercise contingency is a provision
entitling the entity (or the counterparty) to exercise an equity-linked
financial instrument or embedded feature based on changes in an underlying,
which includes the occurrence (or nonoccurrence) of a specified event.
Provisions that accelerate the timing of the entity's (or counterparty's)
ability to exercise an instrument or that extend the length of time that an
instrument is exercisable are exercise contingencies. On January 1, 2009 the
Company adopted EITF  07-5, the adoption of this standard did not have
a material impact on the Company’s financial condition, results of operations or
cash flows.
  8
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 3.      Summary
of Significant Accounting Policies (Continued)
 
 In July
2008, the FASB issued FSP No. EITF 03-6-1, Unvested Share-Based Awards as
Participating Securities for EPS Purposes.  FSP No. EITF 03-6-1
clarifies the circumstances under which unvested share-based payment awards
should be considered participating securities for purposes of determining basic
earnings per share (EPS). On January 1, 2009 the Company adopted FSP No.
EITF  03-6-1, the adoption of this standard did not have a material
impact on the Company’s financial condition, results of operations or cash
flows.
 
 In
December 2008, the FASB issued FSP no. FAS 132(R)-1, Employers’ Disclosures about
Postretirement Benefit Plan Assets. The FSP amends SFAS No. 132 (revised
2003), Employers’ Disclosures
about Pensions and Other Postretirement Benefits, to provide guidance on
an employer's disclosures about plan assets of a defined benefit pension or
other postretirement plan. The disclosures about plan assets required by FSP No.
FAS 123(R)-1 are to be provided for fiscal years beginning after December 15,
2009. The Company is currently assessing the impact of FSP No.
FAS123(R)-1.
 
 In
April 2009, the FASB issued FSP SFAS No. 107-1, Interim Disclosures about Fair Value
of Financial Instruments, which amends SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, and Accounting Principles Board (APB) Opinion
No. 28, Interim Financial
Reporting. FSP SFAS No. 107-1 will require disclosures about fair
value of financial instruments in financial statements for interim reporting
periods and in annual financial statements of publicly-traded companies. This
FSP also will require entities to disclose the method(s) and significant
assumptions used to estimate the fair value of financial instruments in
financial statements on an interim and annual basis and to highlight any changes
from prior periods. On June 30, 2009 the Company adopted FSP SFAS No. 107-1, the
adoption of this standard did not have a material impact on our financial
condition, results of operations or cash flows.
 
 In April
2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. The FSP amends the other-than-temporary
impairment guidance for debt securities to make the guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments on debt and equity securities. On June 30, 2009 the Company adopted
FSP No. FAS 115-2 and FSP No. FAS 124-2, the adoption of this standard did not
have a material impact on the Company’s financial condition, results of
operations or cash flows.
  In April
2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly” The FSP
provides additional guidance for estimating fair value when the market activity
for an asset or liability has declined significantly. On June 30, 2009 the
Company adopted FSP  No. FAS 157-4, the adoption of this standard did
not have a material impact on the Company’s financial condition, results of
operations or cash flows.
 
 In May
2009, the FASB issued SFAS No. 165, Subsequent Events, which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. We have adopted the provisions of
SFAS No. 165, which became effective for interim and annual reporting
periods ending after June 15, 2009. Subsequent events have been evaluated
through the date and time the financial statements were issued on
August 14, 2009. No material subsequent events have occurred since
June 30, 2009 that required recognition or disclosure in the Company’s
current period financial statements.
 
 In
June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation
No. 46(R), which amends FASB Interpretation No. 46 (revised
December 2003) to address the elimination of the concept of a qualifying
special purpose entity. SFAS 167 also 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. Additionally, SFAS No. 167 provides more timely and
useful information about an enterprise’s involvement with a variable interest
entity. SFAS No. 167 will become effective in the first quarter of 2010. The
Company is currently evaluating whether this standard will have an impact on the
Company’s consolidated financial statements.
  9
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 3.      Summary
of Significant Accounting Policies (Continued)
 
 In
June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles. SFAS No. 168 will become the single source of authoritative
nongovernmental GAAP, superseding existing FASB, American Institute of Certified
Public Accountants (AICPA), EITF, and related accounting literature. SFAS No.
168 reorganizes the thousands of GAAP pronouncements into roughly 90 accounting
topics and displays them using a consistent structure. Also included is relevant
SEC guidance organized using the same topical structure in separate sections.
SFAS No. 168 will be effective for financial statements issued for reporting
periods that end after September 15, 2009. This will have an impact on the
Company’s financial statement disclosures since all future references to
authoritative accounting literature will be referenced in accordance with SFAS
No. 168.
 
 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. Because the Company is dependant on
foreign trade in the 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 June 30, 2009 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 the Company’s 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 the Company’s products in particular.  There is
substantial risk that the market may not accept or be receptive to our
products.  Market acceptance of the Company’s current and proposed
products will depend, in large part, upon its 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 our 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 RMB.
 
 In 2008,
a number of milk powder products produced within China 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 China. 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. The Company
passed the emergency inspection and were not included on AQSIQ’s list. Although
the Company believes that the inevitable contraction in the Chinese milk powder
industry caused by this crisis will lead to increased demand for its products,
the Company can’t be certain that the illnesses caused by contamination in the
milk powder industry, whether or not related to its products, won’t lead to
decreased demand for milk powder products produced within China, thereby having
a material adverse effect on the Company’s business.
  10
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 4.      Concentrations
of Business and Credit Risk (Continued)
 
 Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash and trade receivables, the balances of which are
stated on the balance sheet. Concentration of credit risk with respect to trade
receivables is limited due to the Company's large number of diverse customers in
different locations in China. The Company does not require collateral or other
security to support financial instruments subject to credit risk.
 
 For the
three and six months ended June 30, 2009 and 2008, no single customer accounted
for 10% or more of sales.
 
 As of
June 30, 2009 and December 31, 2008, the Company had no insurance coverage of
any kind. Accrual for losses is not recognized until such time as an uninsured
loss has occurred.
 
 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
June 30, 2009 and December 31, 2008 inventory consisted of the
following:
 
 2009
                                
                                
                                2008Raw
      materials
                                
                                $
                                1,096,659
                                
                                
                                $
                                557,128Work-in-process
                                
                                
                                464,847
                                
                                
                                
                                299,931Finished
      goods
                                
                                
                                59,546
                                
                                
                                
                                17,305Repair
      parts
                                
                                
                                8,782
                                
                                
                                
                                8,869$
                                1,629,834
                                
                                
                                $
                                883,233
  6.      Other
Current Assets
 
 As of
June 30, 2009 and December 31, 2008, other current assets consisted of the
following:
 
 2009
                        
                        
                        2008Advances
      to milk suppliers
                        
                        $
                        353,565
                        
                        
                        $
                        388,406Advances
      to equipment supplier
                        
                        
                        3,708,698
                        
                        
                        
                        3,712,883Advances
      to staff
                        
                        
                        221,071
                        
                        
                        
                        76,712Deposit
      on contract
                        
                        
                        81,983
                        
                        
                        
                        74,614Prepaid
      expenses
                        
                        
                        33,579
                        
                        
                        
                        84,717$
                        4,398,896
                        
                        
                        $
                        4,337,332
  11
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 7.      Property,
Plant, and Equipment
 
 As of
June 30, 2009 and December 31, 2008, Property, Plant, and Equipment consisted of
the following:
 
 2009
                            
                            
                            2008Building
                            
                            $
                            3,700,796
                            
                            
                            $
                            3,704,971Plant
      and Machinery
                            
                            
                            2,969,532
                            
                            
                            
                            2,972,883Motor
      vehicles
                            
                            
                            526,312
                            
                            
                            
                            526,906Dairy
      cows
                            
                            
                            248,118
                            
                            
                            
                            242,102Office
      equipment
                            
                            
                            68,361
                            
                            
                            
                            59,7397,513,119
                            
                            
                            
                            7,506,601Less:
      Accumulated depreciation
                            
                            
                            (1,651,131
                            )
                            
                            
                            (1,405,035
                            )$
                            5,861,988
                            
                            
                            $
                            6,101,566
  Depreciation
expenses totaled $123,859 and $247,518 for the three and six months ended June
30, 2009, respectively, and $94,396 and $183,302 for the three and six months
ended June 30, 2008, respectively. $90,017 and $179,862 were included as a
component of cost of goods sold for the three and six months ended June 30,
2009, respectively and $78,826 and $152,871 for the three and six months ended
June 30, 2008, respectively.
 
 8.      Construction-in-progress
 
 June
      30,
                        2009
                      
                      
                      December 31,
                        2008Construction
      in progress
                      
                      $
                      6,875,312
                      
                      
                      $
                      2,482,339
 
 Construction-in-progress
represents construction and installations of the new plant and machinery for the
production facility in Hailun City.
 
 9.      Intangible
Assets
 
 June 30,
                              2009
                            
                            
                            December 31,
                              2008Land
      use rights
                            
                            $
                            1,354,855
                            
                            
                            $
                            1,356,384Patents
                            
                            
                            53,142
                            
                            
                            
                            53,2021,407,997
                            
                            
                            
                            1,409,586Less:
      Accumulated amortization
                            
                            
                            (48,326
                            )
                            
                            
                            (29,497
                            )$
                            1,359,671
                            
                            
                            $
                            1,380,089
  Amortization
expense totaled $9,432 and $18,856 for the three and six months ended June 30,
2009, respectively, and $5,813 and $8,187 the three and six months ended June
30, 2008, respectively.
 
 Amortization
expense is estimated to be $37,712 for each of the next five
years.
  12
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 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 June 30,
                                                        
                                                        
                                                        Six Months
                                                          Ended June 30,2009
                                                        
                                                        
                                                        2008
                                                        
                                                        
                                                        2009
                                                        
                                                        
                                                        2008U.S.
      Operations
                                                        
                                                        $
                                                        (319,000
                                                        )
                                                        
                                                        $
                                                        (815,000
                                                        )
                                                        
                                                        $
                                                        (830,000
                                                        )
                                                        
                                                        $
                                                        (1,189,000
                                                        )Chinese
      Operations
                                                        
                                                        
                                                        1,860,000
                                                        
                                                        
                                                        
                                                        1,751,000
                                                        
                                                        
                                                        
                                                        4,262,000
                                                        
                                                        
                                                        
                                                        2,208,000$
                                                        1,541,000
                                                        
                                                        
                                                        $
                                                        936,000
                                                        
                                                        
                                                        $
                                                        3,432,000
                                                        
                                                        
                                                        $
                                                        1,019,000
  The
components of the provision for income taxes are approximately as
follows:
  Three Months
                                                          Ended June 30,
                                                        
                                                        
                                                        Six Months
                                                          Ended June 30,2009
                                                        
                                                        
                                                        2008
                                                        
                                                        
                                                        2009
                                                        
                                                        
                                                        2008Federal,
      State and Local
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        -Peoples
      Republic of China -Federal and Local
                                                        
                                                        
                                                        278,000
                                                        
                                                        
                                                        
                                                        236,700
                                                        
                                                        
                                                        
                                                        615,900
                                                        
                                                        
                                                        
                                                        317,000$
                                                        278,000
                                                        
                                                        
                                                        $
                                                        236,700
                                                        
                                                        
                                                        $
                                                        615,900
                                                        
                                                        
                                                        $
                                                        317,000
  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 June 30,
                            
                            
                            Six Months
                              Ended June 30,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Income
      tax provision at Federal statutory rate
                            
                            $
                            524,000
                            
                            
                            $
                            319,000
                            
                            
                            $
                            1,166,800
                            
                            
                            $
                            347,000State
      income taxes, net of Federal benefit
                            
                            
                            -0-
                            
                            
                            
                            57,000
                            
                            
                            
                            -0-
                            
                            
                            
                            62,000U.S.
      tax rate in excess of foreign tax rate
                            
                            
                            (167,400
                            )
                            
                            
                            (123,000
                            )
                            
                            
                            (383,500
                            )
                            
                            
                            (155,000
                            )Abatement
      of foreign income taxes
                            
                            
                            (187,100
                            )
                            
                            
                            (339,300
                            )
                            
                            
                            (449,500
                            )
                            
                            
                            (408,000
                            )Increase
      in valuation allowance
                            
                            
                            108,500
                            
                            
                            
                            323,000
                            
                            
                            
                            282,100
                            
                            
                            
                            471,000Tax
      provision
                            
                            $
                            278,000
                            
                            
                            $
                            236,700
                            
                            
                            $
                            615,900
                            
                            
                            $
                            317,000
  13
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
  10.    Income
Taxes (Continued)
 
 The
Company has a U.S net operating loss carryforward of approximately $3,779,000 as
of December 31, 2008 which expires in 2027. The deferred tax asset associated
with these net operating loss carryforwards was fully reserved as of June 30,
2009.
 
 The
change in the valuation allowance as of June 30, 2009 and 2008 was $349,600 and
$471,000, respectively.
 
 The
effects of the tax exemption per share were as follows:
 
 Three
      Months
                                    Ended June 30,
                                  
                                  
                                  Six
      Months
                                    Ended June 30,2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009
                                  
                                  
                                  2008Tax
      Saving
                                  
                                  $
                                  187,100
                                  
                                  
                                  $
                                  339,300
                                  
                                  
                                  $
                                  449,500
                                  
                                  
                                  $
                                  408,000Benefit
      per share:Basic
                                  
                                  $
                                  0.01
                                  
                                  
                                  $
                                  0.01
                                  
                                  
                                  $
                                  0.02
                                  
                                  
                                  $
                                  0.01Diluted
                                  
                                  $
                                  0.01
                                  
                                  
                                  $
                                  0.01
                                  
                                  
                                  $
                                  0.02
                                  
                                  
                                  $
                                  0.01
  Had the
tax exemption not been in place for the three and six months ended June 30, 2009
and 2008, the Company estimates the following proforma financial statement
impact:
 
 Three Months
                                Ended June 30,
                              
                              
                              Six Months
                                Ended June 30,2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Net
      income before tax provision, as reported
                              
                              $
                              1,541,000
                              
                              
                              $
                              936,000
                              
                              
                              $
                              3,432,000
                              
                              
                              $
                              1,019,000Less
      Tax provision not exempted
                              
                              
                              278,000
                              
                              
                              
                              236,700
                              
                              
                              
                              615,900
                              
                              
                              
                              317,000Less
      Tax provision exempted
                              
                              
                              187,100
                              
                              
                              
                              339,300
                              
                              
                              
                              449,500
                              
                              
                              
                              408,000$
                              1,075,900
                              
                              
                              $
                              360,000
                              
                              
                              $
                              2,366,600
                              
                              
                              $
                              294,000
  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 and six
months ended June 30, 2009, respectively, the Company contributed $102,054 and
$145,184 in pension contributions. For the three and six months ended June 30,
2008 the Company contributed $27,910 and $54,813, respectively.
  14
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 12.    Accounts
Payable and Accrued Expenses
  At June
30, 2009 and 2008 accrued expenses consisted of:
 
 June
      30,
                        2009
                      
                      
                      December 31,
                        2008Accounts
      payable
                      
                      $
                      2,637,261
                      
                      
                      $
                      3,264,066Liquidated
      damages
                      
                      $
                      1,201,998
                      
                      
                      
                      1,201,998Accrued
      payroll
                      
                      
                      50,796
                      
                      
                      
                      56,404Accrued
      interest
                      
                      
                      242,787
                      
                      
                      
                      105,287Accrued
      insurance
                      
                      
                      30,192
                      
                      
                      
                      24,192$
                      4,163,034
                      
                      
                      $
                      4,651,947
  13.    Notes
Payable
  At June
30, 2009 and December 31, 2008 notes payable consisted of the
following:
 
 June
      30,
                            2009
                          
                          
                          December 31,
                            2008Notes
      dated June, 2008, due December 31, 2009 with a interest rate of 10%, net
      of debt discount of $20,057 and $40,113 at June 30, 2009 and December 31,
      2008, respectively
                          
                          $
                          2,229,943
                          
                          
                          $
                          2,209,887Notes
      dated November, 2008 due November 10, 2009 with a interest rate of 10%,
      net of debt discount of $23,887 and $47,775 at June 30, 2009 and December
      31, 2008, respectively
                          
                          $
                          476,113
                          
                          
                          
                          452,225$
                          2,706,056
                          
                          
                          $
                          2,662,112
 
 14.    Put/Call
Liability
 
 On
October 9, 2007, the Company entered into Put/Call Agreements with two (2) of
its stockholders (the “Put/Call Stockholders”), pursuant to which the Put/Call
Shareholders granted the Company an option to repurchase an aggregate of
1,944,444 shares (the “Put/Call Shares”) from the Put/Call Stockholders (the
“Call Option”), for an exercise price of $1.63 per share (the “Call Option
Price”), if the following conditions have been met (the “Call Option
Conditions”):
 
 ·
                Either
      (i) a registration statement (“Registration Statement”) covering the
      resale of the Put/Call Shares has been declared effective by the
      Commission, and has been kept continuously effective by the Company, or
      (B) all of the Put/Call Shares are available for sale without registration
      pursuant to Rule 144(k); and
 
 ·
                The
      closing price of a share of Common Stock of the Company as traded on the
      Over-the-Counter Bulletin Board (or such other exchange or stock market on
      which the Common Stock may then be listed or quoted) equals or exceeds
      $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 that the Call Option Exercise
      Notice is given by the Company.
 
 Term of the Call Option - The
Company may only exercise its Call Option by delivering a written notice (a
“Call Option Exercise Notice”) to the Put/Call Stockholders within thirty (30)
days of such time as all of the Call Option Conditions have been met. The Call
Option may be exercised for all, but not less than all, of the Put/Call Shares.
The repurchase shall be consummated within ninety (90) days following the date
of the Call Option Exercise Notice.
  15
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
  14.    Put/Call
Liability (Continued)
 
 In
addition, the Put/Call Stockholders shall have the right to cause the Company to
repurchase the Put/Call Shares from the Put/Call Stockholders (the “Put Right”),
for a price of $1.63 per share (the “Put Purchase Price”), if:
 
 ·
                the
      Company fails to exercise its Call Option within ten (10) days of a date
      on which all of the Call Option Conditions have been met;
    or
 
 ·
                the
      Company consummates a private offering of not less than $5,000,000 of its
      securities (a “Qualified Offering”);
or
 
 ·
                the
      Company fails to (i) file the Registration Statement within thirty (30)
      business days of the Closing Date (the “Filing Date”), (B) have the
      Registration Statement declared effective within ninety (90) calendar days
      from the Filing Date, or, if reviewed by the Commission, within one
      hundred eighty (180) calendar days after the Filing Date, or (C) keep the
      Registration Statement continuously effective until all of the Shares are
      available for sale without registration pursuant to Rule 144(k);
      or
 
 ·
                the
      Company fails to consummate a Qualified Offering within two (2) years of
      the date hereof (each of the aforementioned conditions, a “Put Right
      Trigger”).
  Term of the Put Option - The
Put/Call Stockholders shall exercise their Put Right by giving written notice
(“Put Exercise Notice”) of their exercise of the Put Right to the Company within
thirty (30) days of a Put Right Trigger. The Put/Call Stockholders may only
exercise their Put Right as to all, but not less than all, of the Put/Call
Shares. Upon exercise of the Put Right by the Shareholder, the repurchase of the
Put/Call Shares by the Company shall be consummated within ninety (90) days
following the date of the Put Exercise Notice.
  In
accordance with SFAS No. 150 Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity the
Company recorded the value of the Put/Call agreement of $3,169,444 as a
liability as of October 9, 2007. The value of the Put/Call agreement was based
on the fair market value of the underlying common stock of $1.63 at October 9,
2007.
 
 On April
9, 2008 the company and the Put/Call Stockholders executed a waiver and
amendment to the Put/Call Agreement reaffirming that the Put/Call Agreement is
still in full force and removing the following provision as a Put Right
Trigger:
 
 ·
                The
      Company fails to (i) file the Registration Statement within thirty (30)
      business days of the Closing Date (the “Filing Date”), (B) have the
      Registration Statement declared effective within ninety (90) calendar days
      from the Filing Date, or, if reviewed by the Commission, within one
      hundred eighty (180) calendar days after the Filing Date, or (C) keep the
      Registration Statement continuously effective until all of the Shares are
      available for sale without registration pursuant to Rule
      144(k).
 
 On March
3, 2009 the Company and the Put/Call Stockholders terminated the Put/Call
Agreements.
 
 The
termination of the Put/Call Agreements was considered a type 1 event due to the
culmination of events that started with the waiver executed on April, 9, 2008
and ending with the termination of the Put/Call Agreement on March 3,
2009.  As a type 1 event, the termination provided additional evidence
with respect to the valuation of the Put/Call agreement as of December 31, 2008.
As of December 31, 2008, Company reclassified the $3,169,444 value previous
recorded from liabilities to additional paid-in capital.
  16
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 15.    Equity
 
 Registration
Rights Agreement
 
 On
October 9, 2007 and October 19, 2007, the Company entered into Registration
Rights Agreements with certain accredited investors (“Investors”), in connection
with private offerings (the “Offerings”) it consummated on such dates. Pursuant
to the Registration Rights Agreements, the Company agreed to register the shares
of common stock, and shares underlying warrants, purchased in the
Offerings.  Further, if the Company did not satisfy its registration
requirements, liquidated damages would accumulate at the rate of 1.5% of the
purchase price paid by the Investors  for each thirty (30) day period
during which a registration default continued.
 
 The
Company did not satisfy the registration requirements.  However, as of
October 20, 2008, the liquidated damages stopped accruing because the shares
covered by the Registration Rights Agreements could then be sold under Rule
144.
 
 There are
accrued liquidated damages of $1,201,998 at June 30, 2009 and December 31,
2008,  Liquidated damages of $359,299 and $552,799 were accrued in the
three and six months ended June 30, 2008, respectively.
 
 Per the
Registration Rights Agreements the Company can pay the $1,201,998 in liquidated
damages in cash or Company common stock.  The Company plans to issue
667,777 shares of the Company’s common stock for the based on the closing price
of the Company’s common stock on October 20, 2008 of $1.80.
 
 Warrants
 
 Information
with respect to stock warrants outstanding as of June 30, 2009 are as
follows:
  Exercise Price
                            
                            Outstanding
                              December
                              31, 2008
                            
                            
                            Granted
                            
                            
                            Modified,
                              Expired or
                              Exercised
                            
                            
                            Outstanding
                              June
                              30, 2009
                            
                            Expiration
                              Date$0.94
                            
                            
                            373,334
                            
                            
                            
                            -0-
                            
                            
                            
                            -0-
                            
                            
                            
                            373,334
                            
                            10/09/2010$1.50
                            
                            
                            1,333,333
                            
                            
                            
                            -0-
                            
                            
                            
                            -0-
                            
                            
                            
                            1,333,333
                            
                            10/09/2009$2.04
                            
                            
                            804,884
                            
                            
                            
                            -0-
                            
                            
                            
                            (177,000
                            )
                            
                            
                            627,884
                            
                            10/09/2010$2.04
                            
                            
                            569,346
                            
                            
                            
                            -0-
                            
                            
                            
                            (242,040
                            )
                            
                            
                            327,306
                            
                            10/19/2010$1.63
                            
                            
                            195,000
                            
                            
                            
                            -0-
                            
                            
                            
                            -0-
                            
                            
                            
                            195,000
                            
                            6/12/2011$1.63
                            
                            
                            75,000
                            
                            
                            
                            -0-
                            
                            
                            
                            -0-
                            
                            
                            
                            75,000
                            
                            6/20/2011$1.63
                            
                            
                            -0-
                            
                            
                            
                            -0-
                            
                            
                            
                            235,583
                            
                            
                            
                            235,583
                            
                            10/19/2010$3.26
                            
                            
                            2,061,227
                            
                            
                            
                            -0-
                            
                            
                            
                            (169,480
                            )
                            
                            
                            1,891,747
                            
                            10/09/2009$3.26
                            
                            
                            2,846,746
                            
                            
                            
                            -0-
                            
                            
                            
                            (6,457
                            )
                            
                            
                            2,840,289
                            
                            10/19/2009$2.61
                            
                            
                            75,000
                            
                            
                            
                            -0-
                            
                            
                            
                            -0-
                            
                            
                            
                            75,000
                            
                            11/10/2011
 
 As of
June 30, 2009 all outstanding warrants are exercisable.
 
 Modification
of Warrants
 
 On March
2, 2009, the Company entered into a Consulting Agreement with a placement agent
holding $2.04 warrants, pursuant to which, in consideration for certain
consulting services to be provided to the Company by the placement agent, the
Company agreed (i) to pay the placement agent a one-time consulting fee of
$38,000, and (ii) to reduce the per share exercise price of 235,583 warrants
received by the placement agent and its designees  in connection with
the private offerings consummated by the Corporation in October 2007, from $2.04
to $1.63. Pursuant
to FAS 123(R) Share Based
Payments (as amended),the Company evaluated the value of the warrants
before and after the modification to determine the incremental change in the
value of the warrants.
  17
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 15.    Equity
(Continued)
 
 The fair
value of the warrants as of March 2, 2009 before modification of the terms was
calculated to be $18,625.  The following assumptions were used to
calculate the fair value of the warrants:
 
 Dividend
      yield
                    
                    
                    0
                    %Expected
      volatility
                    
                    
                    114.83
                    %Risk-free
      interest rate
                    
                    
                    0.75
                    %Expected
      life
                    
                    1.58
      yearsStock
      price
                    
                    $
                    0.42Exercise
      price
                    
                    $
                    2.04
 
 The fair
value of the warrants as of March 2, 2009 after modification of the terms was
calculated to be $22,600.  The following assumptions were used to
calculate the fair value of the warrants:
 
 Dividend
      yield
                    
                    
                    0
                    %Expected
      volatility
                    
                    
                    114.83
                    %Risk-free
      interest rate
                    
                    
                    0.75
                    %Expected
      life
                    
                    1.58
      yearsStock
      price
                    
                    $
                    0.42Exercise
      price
                    
                    $
                    1.63
 
 The
incremental change in the value of the warrants is $22,600 less $18,625 or
$3,975, which was recorded to consulting expense.
 
 Warrant
Tender Offers
 
 As of
April 24, 2008, the Company commenced an offer (the “First Offer”) to the
holders (“Warrantholders”) of its then outstanding warrants, pursuant to which
the Warrantholders were able to tender their warrants for shares of the
Company’s Common Stock at a reduced exercise price as follows:
 
 ·
                With
      respect to warrants having an exercise price of $0.94 per share, a holder
      accepting the First Offer was able to exercise some or all of such
      warrants at $0.75 per share of Common
Stock;
  ·
                With
      respect to warrants having an exercise price of $1.50 per share, a holder
      accepting the First Offer was able to exercise some or all of such
      warrants at $1.20 per share of Common
Stock;
  ·
                With
      respect to warrants having an exercise price of $2.04 per share, a holder
      accepting the First Offer was able to exercise some or all of such
      warrants at $1.63 per share of Common Stock;
and
 
 ·
                With
      respect to warrants having an exercise price of $3.26 per share, a holder
      accepting the First Offer was able to exercise some or all of such
      warrants at $2.61 per share of Common
Stock.
  On March
2, 2009, the Company closed on the First Offer. In connection with the First
Offer:
  ·
                A
      total of 183,457 warrants were tendered at the reduced exercise price of
      $1.63 per share (originally $2.04 per share), for an aggregate exercise
      price of $299,034; and
  ·
                A
      total of 175,937 warrants were tendered at the reduced exercise price of
      $2.61 per share (originally $3.26 per share), for an aggregate exercise
      price of $459,196.
 18
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 15.    Equity
(Continued)
 
 As a
result, (a) a total of 359,394 shares of the Company’s common stock were issued
in connection with the exercise of such warrants and (b) the Company received
gross proceeds of $758,230 as payment of the exercise prices.
 
 As of
June 19, 2009, the Company commenced an offer (the “Second Offer”) to all
holders of warrants to purchase shares of its Common Stock, having exercise
prices of either $0.94, $1.50, $1.63, $2.04 or $3.26 per share, originally
issued in connection with the Offerings (the “Original Warrants”), the
opportunity to voluntarily exchange any or all of the Original Warrants for
amended warrants exercisable at reduced exercise prices (“Amended Warrants”),
for a limited period of time.
 
 The terms
of the Amended Warrants, include the following:
 
 ·
                With
      respect to the 373,344 warrants having an exercise price of $0.94 per
      share, a holder accepting the Second Offer may exchange some or all of the
      warrants for amended warrants exercisable at $0.75 per
    share;
 
 ·
                With
      respect to the 1,333,333 warrants having an exercise price of $1.50 per
      share, a holder accepting the Second Offer may exchange some or all of the
      warrants for amended warrants exercisable at $1.20 per
    share;
 
 ·
                With
      respect to the 235,583 warrants having an exercise price of $1.63 per
      share, a holder accepting the Second Offer may exchange some or all of the
      warrants for amended warrants exercisable at $1.30 per
    share;
 
 ·
                With
      respect to the 955,190 warrants having an exercise price of $2.04 per
      share, a holder accepting the Second Offer may exchange some or all of the
      warrants for amended warrants exercisable at $1.63 per share;
      and
 
 ·
                With
      respect to the 4,732,036 warrants having an exercise price of $3.26 per
      share, a holder accepting the Second Offer may exchange some or all of the
      warrants for amended warrants exercisable at $1.63 per
    share.
 
 The only
differences between the Original Warrants and the Amended Warrants to be issued
in connection with the Second Offer, are that the Amended Warrants:
 
 ·
                have
      the lower exercise prices described
above;
 
 ·
                will
      expire on August 28, 2009, and the expiration date will not be extended
      for the Company’s failure to register the underlying
    shares;
 
 ·
                will
      not be subject to the limitation contained in the Original Warrants, which
      provides that the Original Warrants may not be exercised if the exercise
      would cause the holder and its affiliates to hold an aggregate of more
      than 9.9% of the outstanding shares of the Company’s Common Stock;
      and
 
 ·
                must
      be exercised for cash, as a cashless exercise of the Amended Warrants will
      not be permitted.
  19
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 15.    Equity
(Continued)
 
 Stock
Issued for Consulting
 
 The
Company entered into an Investor Relations Consulting Agreement (the “IR
Agreement”) with a consultant, as of January 1, 2009.  Pursuant to the
IR Agreement, in consideration for investor relations services to be provided to
the Company 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
restricted stock of the Company to be determined by dividing $4,500 by 85% of
the average closing trading price of the Company’s common stock for the first
ten trading days of the applicable month, capped at 10,588 shares per
month.
 
 On June
30, 2009, the Company issued 37,804 shares of common stock with a fair value of
$33,475 pursuant to the agreement.  The fair value of the stock was
determined by the closing price of the stock on the 10th day of
each month, which is the day the number of shares is determined.
  16.    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 June 30, 2009 and December 31, 2008, was
$2,062,907 and $1,314,861, 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.
  17.    Earnings
Per Share
 
 SFAS No.
128 requires a reconciliation of the numerator and denominator of the basic and
diluted earnings per share (EPS) computations.
 
 For the
three and six months ended June 30, 2009, dilutive shares include stock options
of 703,200 and outstanding warrants to purchase 373,334 shares of common stock
at an exercise price of $0.94. Warrants to purchase 7,960,536 share of common
stock were not included in dilutive shares as the effect would have been
anti-dilutive.
 
 For the
three and six months ended June 30, 2008, 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 $2.04.
Warrants to purchase 6,552,193 share of common stock were not included in
dilutive shares as the effect would have been
anti-dilutive.
  20
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 15.    Earnings
Per Share (Continued)
 
 The
following reconciles the components of the EPS computation:
 
 Income
                                  
                                  
                                  Shares
                                  
                                  
                                  Per Share(Numerator)
                                  
                                  
                                  (Denominator)
                                  
                                  
                                  AmountFor
      the three months ended June 30, 2009:Net
      income
                                  
                                  $
                                  1,263,136Basic
      EPS income available to common shareholders
                                  
                                  $
                                  1,263,136
                                  
                                  
                                  
                                  29,658,726
                                  
                                  
                                  $
                                  0.04Effect
      of dilutive securities:Warrants
                                  
                                  
                                  
                                  
                                  
                                  
                                  109,474Stock
      options
                                  
                                  
                                  —
                                  
                                  
                                  
                                  337,680Diluted
      EPS income available to common shareholders
                                  
                                  $
                                  1,263,136
                                  
                                  
                                  
                                  30,105,880
                                  
                                  
                                  $
                                  0.04For
      the three months ended June 30, 2008:Net
      income
                                  
                                  $
                                  698,350Basic
      EPS income available to common shareholders
                                  
                                  $
                                  698,350
                                  
                                  
                                  
                                  29,299,332
                                  
                                  
                                  $
                                  0.02Effect
      of dilutive securities:Warrants
                                  
                                  
                                  —
                                  
                                  
                                  
                                  264,376Diluted
      EPS income available to common shareholders
                                  
                                  $
                                  698,350
                                  
                                  
                                  
                                  29,563,708
                                  
                                  
                                  $
                                  0.02
 
 Income
                                  
                                  
                                  Shares
                                  
                                  
                                  Per Share(Numerator)
                                  
                                  
                                  (Denominator)
                                  
                                  
                                  AmountFor
      the six months ended June 30, 2009:Net
      income
                                  
                                  $
                                  2,815,842Basic
      EPS income available to common shareholders
                                  
                                  $
                                  2,815,842
                                  
                                  
                                  
                                  29,537,604
                                  
                                  
                                  $
                                  0.09Effect
      of dilutive securities:Warrants
                                  
                                  
                                  
                                  
                                  
                                  
                                  29,281Stock
      options
                                  
                                  
                                  —
                                  
                                  
                                  
                                  81,758Diluted
      EPS income available to common shareholders
                                  
                                  $
                                  2,815,842
                                  
                                  
                                  
                                  29,648,643
                                  
                                  
                                  $
                                  0.09For
      the six months ended June 30, 2008:Net
      income
                                  
                                  $
                                  701,168Basic
      EPS income available to common shareholders
                                  
                                  $
                                  701,168
                                  
                                  
                                  
                                  29,299,332
                                  
                                  
                                  $
                                  0.02Effect
      of dilutive securities:Warrants
                                  
                                  
                                  —
                                  
                                  
                                  
                                  264,376Diluted
      EPS income available to common shareholders
                                  
                                  $
                                  701,168
                                  
                                  
                                  
                                  29,563,708
                                  
                                  
                                  $
                                  0.02
  18.    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.
  21
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 18.    Equity
Incentive Plan (Continued)
 
 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.
 
 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.
 
 The
Company follows the provisions of SFAS No. 123(R). Total share-based
compensation costs included on the Condensed Consolidated Statements of
Operations were $57,180 and none during the three months ended June 30, 2009 and
2008, respectively, and $75,688 and none during the six months ended June 30,
2009 and 2008, 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 the provisions of SFAS 123(R) and SEC
Staff Accounting Bulletin No. 107 (SAB "107"). 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.
  The fair
value of each stock option is estimated on the date of the grant using the
Black-Scholes option pricing model. No dividends were assumed due to the nature
of the Company’s current business strategy. The following table presents the
weighted average assumptions used for options granted:
  Number
      of options
                        
                        
                        703,200Risk
      free interest rate
                        
                        
                        .67
                        %Expected
      life (year)
                        
                        
                        2Expected
      volatility
                        
                        
                        252.69
                        %Weighted
      average fair value per option
                        
                        $
                        0.34
 22
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 18.    Equity
Incentive Plan (Continued)
 
 The risk
free interest rate was determined from the daily interest rate of United State
Treasury securities for the expected life on the date of grant.  The
expected volatility was based on the Company’s common stock past trading
history.
 
 Share
Options
 
 A summary
of the Company’s outstanding share option award grants as of June 30, 2009 and
changes during the six 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, 2008
                                        
                                        
                                        -0-
                                        
                                        
                                        $
                                        —Granted
                                        
                                        
                                        703,200
                                        
                                        
                                        
                                        0.42Exercised
                                        
                                        
                                        -0-
                                        
                                        
                                        
                                        —Expired
                                        
                                        
                                        -0-
                                        
                                        
                                        
                                        —Forfeited
                                        
                                        
                                        -0-
                                        
                                        
                                        
                                        —Outstanding
      at June 30, 2009
                                        
                                        
                                        703,200
                                        
                                        
                                        $
                                        0.42
                                        
                                        
                                        
                                        9.68
                                        
                                        
                                        $
                                        864,936Non-vested
      and expected to vest at June 30, 2009
                                        
                                        
                                        703,200
                                        
                                        
                                        $
                                        0.42
                                        
                                        
                                        
                                        9.68
                                        
                                        
                                        $
                                        —Exercisable
      at June 30, 2009
                                        
                                        
                                        -0-
                                        
                                        
                                        $
                                        —
                                        
                                        
                                        
                                        3.2
                                        
                                        
                                        $
                                        —
 
 As of
June 30, 2009, there was $162,699 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
1.13 years.
 
 19.    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 for construction of a second production facility in
Hailun City, Heilongjiang Province, PRC.  The contract is for
$8,431,659 of which $6,564,717 has been paid.  The remaining
$1,866,942 is to be paid in 2009 for completion of the facility.
 
 The
Company has contracted to purchase equipment from a supplier for the second
processing facility for $5,298,139 of which $3,708,698 has been
paid.  The remaining $1,589,441 will be paid on delivery of the
equipment in 2009.
 
 The
Company has advances to milk suppliers of $353,565 which will be offset against
future milk purchases from those suppliers (see Note 6, Other current
assets).
 
  23
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 19.    Commitments
and Contingencies (Continued)
 
 In order
for the Company to conduct its current operations, a milk powder production
license 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 expired in December 2008. The
Administration will inspect the quality of the Company’s production process in
2009. Depending on the results of this inspection, the State General
Administration will either (i) grant the Company a license renewal, or (ii)
advise the Company of material deficiencies it has discovered and schedule
another inspection for 2010. The Company expects that it will pass the
inspection. If it does not, it will have an opportunity to cure any deficiencies
prior to the follow up inspection that would have been scheduled for 2010. 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 and its subsidiaries are self-insured, and they do not carry any
property insurance, general liability insurance, or any other insurance that
covers the risks of their business operations. As a result any material loss or
damage to its properties or other assets, or personal injuries arising from its
business operations would have a material adverse effect on the Company’s
financial condition and operations.
 
 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.
 
 The
Company’s employees were required to pay an employee deposit upon commencement
of employment, which was standard in the PRC. As of January 1, 2009 these
deposits are no longer allowed in the PRC and all amounts were returned to the
employees. As of December 31, 2008, the Company held employee deposits in the
aggregate amount of  $248,424 which were reflected in advances from
employees in the financials statements.
 
 20.    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 2009.  For the three months ended June
30, 2009 and 2008, the Company incurred rental expense of $39,116 and $32,440,
respectively. For the six months ended June 30, 2009 and 2008, the Company
incurred rental expense of $78,409 and $63,960, respectively. As of June 30,
2009, the Company had outstanding lease commitments totaling $108,310, all of
which are due within the next year.
  24
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
  21.    Subsequent
Events
 
 Management
has evaluated subsequent events from June 30, 2009 to August 14, 2009, 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 August 14, 2009 have
not been evaluated in the financial statements as of June 30, 2009.
 
 Placement
Agent Warrants
 
 On July
4, 2009 the Company agreed to issue 97,500 warrants to purchase the Company’s
common stock at $1.63 per share expiring December 31, 2011 to a placement agent
for assistance in the extension of promissory notes originally issued in June
2008. The fair value of the warrants as of July 4, 2009 was calculated to be
$117,155.  The following assumptions were used to calculate the fair
value of the warrants:
 
 Dividend
      yield
                    
                    
                    0
                    %Expected
      volatility
                    
                    
                    136.86
                    %Risk-free
      interest rate
                    
                    
                    1.68
                    %Expected
      life
                    
                    2.5
      yearsStock
      price
                    
                    $
                    1.65Exercise
      price
                    
                    $
                    1.63
 
 The
$117,155 fair value of the warrants will be treated as loan costs to be
amortized over the life of the loan, therefore, $58,577 of the cost will be
recorded in interest expense and the remaining $58,578 will be recorded in
prepaid loan costs to be amortized over the remaining life of the
loan.
 
 Second
Warrant Tender Offer
 
 On August
13, 2009, the Company closed the Second Offer. In connection with the Second
Offer:
 
 ·
                a
      total of 49,000 Original Warrants with an exercise price of $2.04 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share; and
  ·
                a
      total of 2,205,828 Original Warrants with an exercise price of $3.26 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share.
  In
addition to the reduced exercise prices, the Amended Warrants have exercise
periods shortened to fifteen (15) days following the expiration of the Second
Offer. Therefore, any warrant holder that exchanged its Original Warrants for
Amended Warrants in the Second Warrant Tender Offer who wishes to
exercise the Amended Warrants received in connection therewith must do
so on or before August 28, 2009. If all of the 2,254,828 Amended Warrants
are exercised at the reduced exercise price of $1.63, the Company will receive
gross proceeds of $3,675,370.
  22.    Segment
Reporting
 
 The
Company operates in one operating segment in accordance with the provisions of
SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information. 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.
 
  25
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June
30, 2009 and 2008
 
 22.    Segment
Reporting (Continued)
 
 For the
three and six months ended June 30, 2009 and 2008, the Company’s sales revenue
from various products are as follows:
 
 Three Months
                              Ended June 30,
                            
                            
                            Six Months
                              Ended June 30,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Milk
      powder
                            
                            $
                            9,126,262
                            
                            
                            $
                            8,529,387
                            
                            
                            $
                            18,395,943
                            
                            
                            $
                            16,828,825Soybean
      milk powder
                            
                            
                            267,662
                            
                            
                            
                            204,917
                            
                            
                            
                            554,823
                            
                            
                            
                            418,715Rice
      powder
                            
                            
                            314,240
                            
                            
                            
                            261,835
                            
                            
                            
                            634,465
                            
                            
                            
                            532,338Sub-contract
      processing
                            
                            
                            538,771
                            
                            
                            
                            1,908,639
                            
                            
                            
                            1,518,256
                            
                            
                            
                            3,559,359$
                            10,246,935
                            
                            
                            $
                            10,904,778
                            
                            
                            $
                            21,103,487
                            
                            
                            $
                            21,339,237
  26


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 95%, 3%
and 2%of our
sales, respectively. Through our network of over 800 salespeople, our products
are distributed throughout 20 provinces in the People’s Republic of China
(“PRC”), and sold in over 5,800 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 today in the PRC is over $13.0 billion 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 is expected to grow even
faster, at an annual rate of approximately 23% through 2011. 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 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. In 2008, by adding a
third shift to the existing two shifts working schedule, we produced
approximately 9,000 tons of milk powder.


27




In
addition, in July 2008, through our wholly-owned subsidiary, Hailun Xinganling
Dairy Co., Ltd. (“HXD”), we commenced construction of a new production facility
in Hailun City, Heilongjiang Province, PRC, which we expect will enable us to
produce an additional 9,000 tons of milk powder in 2010 and a total of 18,000
tons of milk powder annually in 2011. As a result, 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 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.





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





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




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




·
            HXD,
      which will handle additional production of our products in Hailun City,
      Heilongjiang Province, PRC.




Recent
Developments




Reverse Merger, Private Placements and
Related Transactions





Prior to October 9, 2007, we were a
public shell company, as defined by Rule 405 of the Securities Act of 1933 and
Rule 12b-2 of the Securities Exchange Act of 1934, without material assets or
activities. On October 9, 2007, we completed a reverse merger (the “Reverse
Merger”), pursuant to which our wholly-owned subsidiary merged with and into a
private company, American International Dairy Holding Co., Inc. (“AIDH”), with
such private company being the surviving company. In connection with this
Reverse Merger, we discontinued our former business and succeeded to the
business of AIDH as our sole line of business. For financial reporting purposes,
AIDH is considered to be the accounting acquirer. Accordingly, the historical
financial statements presented and the discussion of financial condition and
results of operations herein are those of AIDH and do not include our historical
financial results.





Simultaneously with the Reverse Merger,
we sold 1,333,333 units of our securities to John V. Winfield, consisting of:
(i) 1,333,333 shares of our common stock, (ii) warrants to purchase 266,667
shares of our common stock, at an exercise price of $0.94 per share (“Warrant
W-1”), and (iii) warrants to purchase 1,333,333 shares of our common stock, at
an exercise price of $1.50 per share (“Warrant W-2”), for an aggregate purchase
price of $1,000,000 (the “First Offering”). In addition, we sold 2,061,227 units
of our securities to certain additional “accredited investors” (the “Initial
Purchasers”), consisting of (i) 2,061,227 shares of our common stock,
(ii) warrants to purchase 412,245 of our common stock, at an exercise price
of $2.04 per share (the “Class A Warrants”), and (iii) warrants to purchase
2,061,227 shares of our common stock, at an exercise price of $3.26 per share
(the “Class B Warrants”), for an aggregate purchase price of $3,359,800 (the
“Initial Placement of the Second Offering”). The rights and obligations under
Warrant W-1, Warrant W-2, the Class A Warrants, and the Class B Warrants are
further described in “- Liquidity and Capital Resources - Warrants”
below.


28




Upon the consummation of the Reverse
Merger, and the closing of the First Offering and Initial Placement of the
Second Offering, we entered into a Share Repurchase Agreement with Grand Orient
Fortune Investment, Ltd. (“Grand Orient”), a PRC company controlled by Mingwen
Song, pursuant to which we repurchased 1,944,444 shares (the “Repurchased
Shares”) of our issued and outstanding common stock from Grand Orient for an
aggregate purchase price of $3,169,444 (the “Repurchase Transaction”). We
determined to repurchase these shares, to reduce the overall dilution created by
the First Offering and Second Offering. The Repurchased Shares are currently
being held in treasury.





Immediately following the closing of
the Repurchase Transaction, we entered into Put/Call Agreements with each of
Grand Orient and Fortune Land Holding, Ltd., a PRC company controlled by Dexuan
Yu (jointly, the “Put/Call Shareholders). Prior to the termination of the
Put/Call Agreements on March 3, 2009, we had the right to repurchase an
aggregate of 1,944,444 shares of our common stock from the Put/Call Shareholders
under certain circumstances, and the Put/Call Shareholders had the right to
cause us to repurchase such shares at $1.63 per share if certain events occur.
The Put/Call Agreements are further described in “- Liquidity and Capital
Resources - Put/Call Agreements” below.





On October 19, 2007, we sold 2,846,746
units of our securities to additional “accredited investors” (the “Additional
Purchasers”), consisting of (i) 2,846,746 shares of our common stock, (ii)
569,346 Class A Warrants, and (iii) 2,846,746 Class B Warrants, for an
aggregate purchase price of $4,640,200 (the “Additional Placement of the Second
Offering,” and together with the Initial Placement of the Second Offering, the
“Second Offering”).





As of March 2, 2009, an aggregate of
183,457 of the Class A Warrants and 175,937 of the Class B Warrants were
tendered at reduced exercise prices, as further described in “- Recent
Developments – First Warrant Tender Offer” below.





In connection with the First Offering
and Second Offering (collectively, the “October Offerings”), we engaged finders
and placement agents to whom we paid fees in the aggregate of $700,452, and
granted (i) warrants to purchase an aggregate of 106,667 shares of our common
stock, at an exercise price of $0.94 per share, the terms and conditions of
which are identical to the those of Warrant W-1, and (ii) warrants to purchase
392,639 shares of our common stock, at an exercise price of $2.04, the terms and
conditions of which are identical to the those of the Class A Warrants. On March
2, 2009, the exercise prices of 235,583 of these warrants were reduced from
$2.04 to $1.63, as partial consideration for services rendered in connection
with a consulting agreement we entered into with one of these
parties.





Construction of New Production
Facility





On May 22, 2008, we organized our
wholly-owned subsidiary, HXD, under the laws of the PRC. In July 2008, HXD
commenced construction of a production facility to be located in Hailun City,
Heilongjiang Province, PRC. Initially, the new facility will have one production
line, which will have the capacity to produce 9,000 tons of milk power annually.
The new facility will have the capacity to accommodate a second production line,
which, if and when completed, would enable us to produce an additional 9,000
tons of milk powder per year, giving us a total annual production capacity at
all of our production facilities of 27,000 tons of milk powder. We anticipate
that production at this new facility will commence in the fourth quarter of
fiscal 2009, assuming we obtain the $6.0 million we require to complete
construction and fully equip the first production line. We believe that the cost
to add the second production line would be approximately an additional $15.0
million. We plan to raise the funds needed for the new facility 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.




29


Sale
of Notes and Warrants





June
Note Offering





In June
2008, we conducted a private offering of up to a maximum of (i) $3,000,000 of
our 8% promissory notes (the “June Notes”) and (ii) warrants to purchase 300,000
shares of our common stock, at an exercise price of $2.61 per share (the “June
Warrants”) (the “June Note Offering”). On June 12, 2008, one “accredited
investor” purchased, for a purchase price of $1,500,000, a June Note in the
principal amount of $1,500,000, and June Warrants to purchase 150,000 shares of
our common stock. On June 20, 2008, an additional “accredited investor”
purchased, for a purchase price of $750,000, a June Note in the principal amount
of $750,000, and June Warrants to purchase 75,000 shares of our common stock. As
of December 31, 2008, certain of the terms of the June Notes and June Warrants
were amended. The rights and obligations under the June Notes, as amended, are
further described in “- Liquidity and Capital Resources - Promissory Notes”
below. The rights and obligations under the June Warrants, as amended as of
December 31, 2008, are further described in “- Liquidity and Capital Resources -
Warrants” below.





In
connection with the June Note Offering, we engaged a placement agent to whom we
paid a non-refundable retainer of $25,000, and a placement fee in the amount of
$97,500, and granted warrants to purchase an aggregate of 45,000 shares of our
common stock, the terms and conditions of which are identical to the those of
the June Warrants, as amended as of December 31, 2008.





In
addition, as of July 4, 2009, we granted the same placement agent warrants to
purchase an additional 97,500 shares of our common stock in consideration for
its services in connection with the amendment of the June Notes and June
Warrants as of December 31, 2008. The rights and obligations under these
additional warrants are further described in “- Liquidity and Capital Resources
- Warrants” below.





November
Note Offering





On
November 10, 2008, we sold to one “accredited investor,” for a purchase price of
$500,000, a 10% promissory note (the “November Note”) in the principal amount of
$500,000, and warrants to purchase 50,000 shares of our common stock, at an
exercise price of $2.61 per share (the “November Warrants”) (the “November Note
Offering”). The rights and obligations under the November Note are further
described in “- Liquidity and Capital Resources - Promissory Notes”
below.  The rights and obligations under the November Warrants are
further described in “- Liquidity and Capital Resources - Warrants”
below.





In
connection with the November Note Offering, we engaged a placement agent to whom
we paid a placement fee in the amount of $40,000, and granted warrants to
purchase an aggregate of 25,000 shares of our common stock, the terms and
conditions of which are identical to the those of the November
Warrants.





First
Warrant Tender Offer





As of
April 24, 2008, we commenced an offer (the “First Warrant Tender Offer”) to the
holders of our then outstanding warrants, pursuant to which the holders had the
opportunity to exchange their existing warrants for amended warrants to be
exercised at reduced exercise prices as follows:





·
            With
      respect to eligible warrants having an exercise price of $0.94 per share,
      a holder accepting the First Warrant Tender Offer could exercise some or
      all of the amended warrants at $0.75 per share of common
      stock;




30




·
            With
      respect to eligible warrants having an exercise price of $1.50 per share,
      a holder accepting the First Warrant Tender Offer could exercise some or
      all of the amended warrants at $1.20 per share of common
      stock;




·
            With
      respect to eligible warrants having an exercise price of $2.04 per share,
      a holder accepting the First Warrant Tender Offer could exercise some or
      all of the amended warrants at $1.63 per share of common stock;
      and




·
            With
      respect to eligible warrants having an exercise price of $3.26 per share,
      a holder accepting the First Warrant Tender Offer could exercise some or
      all of the amended warrants at $2.61 per share of common
      stock.




On March
2, 2009, we closed the First Warrant Tender Offer. In connection with the First
Warrant Tender Offer:





·
            a
      total of 183,457 warrants were tendered at the reduced exercise price of
      $1.63 per share (originally $2.04 per share), for an aggregate exercise
      price of $299,035; and




·
            a
      total of 175,937 warrants were tendered at the reduced exercise price of
      $2.61 per share (originally $3.26 per share) for an aggregate exercise
      price of $459,196.




As a
result, we received gross proceeds of $758,231 and issued an aggregate of
359,394 shares of our common stock.





Second
Warrant Tender Offer





As of
June 19, 2009, we commenced an offer (the “Second Warrant Tender Offer”) to all
holders of warrants to purchase shares of our common stock, having exercise
prices of either $0.94, $1.50, $1.63, $2.04 or $3.26 per share, originally
issued in connection with the October Offerings (the “Original Warrants”), the
opportunity to voluntarily exchange any or all of the Original Warrants for
amended warrants exercisable at reduced exercise prices (“Amended Warrants”),
for a limited period of time.





The terms
of the Amended Warrants, include the following:





·
            With
      respect to the 373,344 warrants having an exercise price of $0.94 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $0.75 per
      share;





·
            With
      respect to the 1,333,333 warrants having an exercise price of $1.50 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.20 per
      share;





·
            With
      respect to the 235,583 warrants having an exercise price of $1.63 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.30 per
      share;





·
            With
      respect to the 955,190 warrants having an exercise price of $2.04 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.63 per
      share; and


31





·
            With
      respect to the 4,732,036 warrants having an exercise price of $3.26 per
      share, a holder accepting the Second Warrants Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.63 per
      share.





On August
13, 2009, we closed the Second Warrant Tender Offer. In connection with the
Second Warrant Tender Offer:





·
            a
      total of 49,000 Original Warrants with an exercise price of $2.04 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share; and




·
            a
      total of 2,205,828 Original Warrants with an exercise price of $3.26 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share.




The
rights and obligations under the Amended Warrants are further described in “-
Liquidity and Capital Resources - Warrants” below.





Trends
and Uncertainties





Economic Downturn





The recent worldwide economic downturn
and market instability 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 may be adversely affected by unpredictable
and unstable market conditions. If the current equity and credit markets
deteriorate further, or do not improve, it may make any necessary debt or equity
financing more difficult, more costly, and more dilutive. 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.





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.





Industry Growth





The dairy market today in the PRC is
over $13.0 billion. According to the website of China National Bureau of
Statistics, between 2000 and 2007 the dairy industry in the PRC experienced an
average growth of 16% per year. English-language copies of the reports of the
China National Bureau of Statistics are available on its website, free of
charge, at www.stats.gov.cn/english. The dairy industry in the PRC is projected
to grow at rate of 15% per year from 2008 to 2012, to reach $32 billion by
2012.





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;


32





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





·
            Increased
      popularity and acceptance of infant formula
  products.





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 in the fourth quarter of 2009. 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.





This
project is expected to cost an aggregate of approximately $20.0 million,
including land use rights, construction expenses and equipment costs. We have
applied the net proceeds we received from the June Note Offering and November
Note Offering, further described in “— Recent Developments — Sale of Notes and
Warrants” above, and from the First Warrant Tender Offer, further described in
“— Recent Developments – First Warrant Tender Offer” above, toward the
construction of this new production facility. We have no additional commitments
for the additional $6.0 million we expect to need to complete the construction
and equipping of the first production line at our new production facility. There
can be no assurance that that any additional financing will become available to
us, and if available, on terms acceptable to us.





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. However, we believe the recent
worldwide increases in the cost and availability of commodities, such as rice
and oil, will lead to increases in prices for such commodities. To some extent,
we believe we will be able to increase the prices for our products to pass on
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.





33




Organic
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 beginning in 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 minor. 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 be very popular in the PRC. Over time, this
will help increase our revenues.





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





Recently,
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. Although we
believe that the inevitable contraction in the Chinese milk powder industry
caused by this crisis will lead to increased demand for our products, 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 June 30, 2009 Compared to Three-Month Period Ended June 30,
2008





Net
income increased by $564,786, from $698,350 in the three months ended June 30,
2008, to $1,263,136 for the three months ended June 30, 2009. The increase in
net income during the three months ended June 30, 2009, as compared to the same
time period in the prior year, was due to an increase in gross profit, which
offset an increase in our operating expenses as further described
below.




34


Sales
and Cost of Goods Sold





For the Three Months
                    Ended June 30,2009
                  
                  
                  2008Sales
                  
                  $
                  10,246,935
                  
                  
                  $
                  10,904,778Cost
      of Goods Sold
                  
                  
                  5,639,310
                  
                  
                  
                  7,281,163Gross
      Profit
                  
                  $
                  4,607,625
                  
                  
                  $
                  3,623,615





Sales. Sales volume decreased
by 307 metric tons, or 14.2%, period on period, to 1,861 metric tons for the
three months ended June 30, 2009, from 2,168 metric tons for the three months
ended June 30, 2008. Sales revenues decreased by $657,843, or 6.0%, from
$10,904,778 in the three months ended June 30, 2008, to $10,246,935 for the
three months ended June 30, 2009. This decrease was primarily due to the
decrease in subcontracting during three months ended June 30, 2009, as we
produced more of our high end product line in fiscal 2009.





Sales by product
line.A break-down of our sales by product line for the three
months ended June 30, 2009 and 2008 is as follows:





Three Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  Period-on-periodProduct category
                  
                  Quantity
                    (tons)
                  
                  
                  $ Amount
                  
                  
                  % of sales
                  
                  
                  Quantity
                    (tons)
                  
                  
                  $ Amount
                  
                  
                  % of
                    sales
                  
                  
                  Qty.
                    VarianceMilk
      powder
                  
                  
                  1,433
                  
                  
                  
                  9,126,262
                  
                  
                  
                  89.0
                  
                  
                  
                  1,426
                  
                  
                  
                  8,529,387
                  
                  
                  
                  78.2
                  
                  
                  
                  7Rice
      powder
                  
                  
                  55
                  
                  
                  
                  314,240
                  
                  
                  
                  3.1
                  
                  
                  
                  48
                  
                  
                  
                  261,835
                  
                  
                  
                  2.4
                  
                  
                  
                  7Soybean
      powder
                  
                  
                  156
                  
                  
                  
                  267,662
                  
                  
                  
                  2.6
                  
                  
                  
                  113
                  
                  
                  
                  204,917
                  
                  
                  
                  1.9
                  
                  
                  
                  43Subcontracting
                  
                  
                  217
                  
                  
                  
                  538,771
                  
                  
                  
                  5.3
                  
                  
                  
                  581
                  
                  
                  
                  1,908,639
                  
                  
                  
                  17.5
                  
                  
                  
                  (364
                  )Total
                  
                  
                  1,861
                  
                  
                  
                  10,246,935
                  
                  
                  
                  100.0
                  
                  
                  
                  2,168
                  
                  
                  
                  10,904,778
                  
                  
                  
                  100.0
                  
                  
                  
                  (307
                  )




There
were various changes to the break-down of sales among our product lines over the
three months ended June 30, 2009, as we increased production in most lines, but
attempted to adjust our sales mix to higher margin products, and away from
subcontracting. Rice powder accounted for 3.1% of our sales mix for the
three months ended June 30, 2009, at an average selling price of $5,713 per
metric ton, as compared to 2.4% of our sales mix in the three months ended June
30, 2008, at an average selling price of $5,455 per metric ton. Milk powder
accounted for 89.0% of the second quarter 2009 sales mix, at an average selling
price of $6,369 per metric ton, as compared to 78.2% of second quarter 2008, at
an average selling price of $5,981 per metric ton. We decreased our subcontract
production during the three months ended June 30, 2009 to 5.3% of the sales mix,
at an average selling price of $2,483 per metric ton, as compared to 17.5% of
the sales mix in the three months ended June 30, 2008, at an average sales price
of $3,285 per metric ton.




35


A
breakdown of our average selling price by product line for the three months
ended June 30, 2009 and 2008 is as follows:




Three Months Ended
                    June 30,Average selling prices
                  
                  2009
                  
                  
                  2008
                  
                  
                  Variance$
                  
                  
                  $
                  
                  
                  $
                  
                  
                  %Milk
      powder
                  
                  
                  6,369
                  
                  
                  
                  5,981
                  
                  
                  
                  388
                  
                  
                  
                  6.5Rice
      powder
                  
                  
                  5,713
                  
                  
                  
                  5,455
                  
                  
                  
                  258
                  
                  
                  
                  4.7Soybean
      powder
                  
                  
                  1,716
                  
                  
                  
                  1,813
                  
                  
                  
                  (97
                  )
                  
                  
                  (5.3
                  )Subcontracting
                  
                  
                  2,483
                  
                  
                  
                  3,285
                  
                  
                  
                  (802
                  )
                  
                  
                  (24.4
                  )Total
                  
                  
                  5,506
                  
                  
                  
                  5,030
                  
                  
                  
                  476
                  
                  
                  
                  9.5




Cost of Goods
Sold.  Cost of goods sold decreased by $1,641,853, or 22.5%,
from $7,281,163 in the three months ended June 30, 2008, to $5,639,310 for the
three months ended June 30, 2009. This decrease was directly related to our
reduction in subcontracting work during the three months ended June 30, 2009.
Overall our cost per metric ton decreased by $328, or 9.8%, to $3,030 per metric
ton in the three months ended June 30, 2009, as compared to $3,358 per metric
ton in three months ended June 30, 2008, 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 three months ended June 30,
2009 and 2008 is as follows:




Three Months Ended June 30,2009
                
                
                2008
                
                
                Variance$
                
                
                $
                
                
                $
                
                
                %Cost
      of salesMilk
      powder
                
                
                4,744,236
                
                
                
                5,397,268
                
                
                
                (653,032
                )
                
                
                (12.1
                )Rice
      powder
                
                
                123,231
                
                
                
                110,345
                
                
                
                12,886
                
                
                
                11.7Soybean
      powder
                
                
                215,192
                
                
                
                128,073
                
                
                
                87,119
                
                
                
                68.0Subcontracting
                
                
                556,651
                
                
                
                1,645,477
                
                
                
                (1,088,826
                )
                
                
                (66.2
                )Total
                
                
                5,639,310
                
                
                
                7,281,163
                
                
                
                (1,641,853
                )
                
                
                (22.5
                )Cost
      per units sold(per ton)Milk
      powder
                
                
                3,311
                
                
                
                3,785
                
                
                
                (474
                )
                
                
                (12.5
                )Rice
      powder
                
                
                2,241
                
                
                
                2,298
                
                
                
                (57
                )
                
                
                2.5Soybean
      powder
                
                
                1,379
                
                
                
                1,133
                
                
                
                246
                
                
                
                21.7Subcontracting
                
                
                2,565
                
                
                
                2,832
                
                
                
                (267
                )
                
                
                (9.4
                )Average
      cost per unit sold
                
                
                3,030
                
                
                
                3,358
                
                
                
                (328
                )
                
                
                (9.8
                )




Gross Profit. Gross profit was
$4,607,625, or 45.0% of our sales for the three months ended June 30, 2009, as
compared to gross profit of $3,623,615, or 33.2%, for the three months ended
June 30, 2008. During the three months ended June 30, 2009, our gross margin on
milk powder increased to 48.0%, from 36.7% in the same period of the prior year,
due to an increase in the average sales price of 6.5%, while there was a 12.5%
decrease in the cost per metric ton from the three months ended June 30,
2008. The gross margin for soybean powder declined 17.9% to 19.6% in the
three months ended June 30, 2009, as compared to 37.5% in the three months ended
June 30, 2008, due to an increase in the average cost per ton of 21.7% in the
three months ended June 30, 2009 as compared to the same period in
2008.




36


A
breakdown of gross margin by product line for the three months ended June 30,
2009 and 2008 is as follows:




Three Months Ended June 30,2009
                    
                    
                    2008
                    
                    
                    Period-on-periodProduct category
                    
                    $ Amount
                    
                    
                    Gross
                      Margin %
                    
                    
                    $ Amount
                    
                    
                    Gross
                      Margin %
                    
                    
                    Margin
                      VarianceMilk
      powder
                    
                    
                    4,382,026
                    
                    
                    
                    48.0
                    
                    
                    
                    3,132,119
                    
                    
                    
                    36.7
                    
                    
                    
                    11.3Rice
      powder
                    
                    
                    191,009
                    
                    
                    
                    60.8
                    
                    
                    
                    151,490
                    
                    
                    
                    57.9
                    
                    
                    
                    2.9Soybean
      powder
                    
                    
                    52,470
                    
                    
                    
                    19.6
                    
                    
                    
                    76,844
                    
                    
                    
                    37.5
                    
                    
                    
                    (17.9
                    )Subcontracting
                    
                    
                    (17,880
                    )
                    
                    
                    (3.3
                    )
                    
                    
                    263,192
                    
                    
                    
                    13.8
                    
                    
                    
                    (17.1
                    )Total
                    
                    
                    4,607,625
                    
                    
                    
                    45.0
                    
                    
                    
                    3,623,615
                    
                    
                    
                    33.2
                    
                    
                    
                    11.8




Operating
Expenses





For the Three Months
                  Ended June 30,2009
                
                
                2008Operating
      ExpensesSelling
      and administrative expenses
                
                $
                3,073,694
                
                
                $
                2,634,812Depreciation
      and amortization
                
                
                43,274
                
                
                
                15,570Total
      operating expenses
                
                $
                3,116,968
                
                
                $
                2,650,382





Selling Expenses. Selling
expenses overall increased by $813,172, or 49.3%, from $1,650,538 in the three
months ended June 30, 2008, to $2,463,710 for the three months ended June 30,
2009. The major factors in the increase in selling expenses are as
follows:





·
            Promotion
      expenses increased by $865,460, or 201.3%, to $435,621 in 2009, from
      ($429,954) in 2008, as we received a credit in 2008 that was not present
      in 2009.





·
            Shop
      decoration expenses increased by $162,509, or 243.9%, to $229,149 in 2009,
      from $66,640 in 2008, as a result of additional shop promotions in 2009 as
      compared to 2008.





These
increases were partially offset by advertising decreasing by $305,646, or 55.4%,
to $245,966 in 2009, from $551,612 in 2008, due to a change in the marketing
campaign in 2009 to spreading spending over the entire year rather than the
first half of the year in 2008.





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.





Administrative Expenses.
Administrative expenses decreased by $374,293, or 38.0%, from $984,274 in three
months ended June 30, 2008, to $609,984 for the three months ended June 30,
2009. The major factors in the decrease in administrative expenses are as
follows:





·
            Decrease
      in legal and accounting expenses of $142,581, or 54.5%, to $119,242 in
      2009, from $261,821 in 2008, due to decreased costs related to public
      company reporting requirements as compared to
  2008.


37





·
            Liquidated
      damages of $359,299 were incurred in the three months ended June 30, 2008,
      as a result of our failure to satisfy certain registration requirements.
      No liquidated damages were incurred in the comparable period in
      2009.





Provision
for Income Taxes





For the Three Months
                      Ended June 30,2009
                    
                    
                    2008Provision
      for Income TaxesCurrent
                    
                    $
                    278,064
                    
                    
                    $
                    236,711Deferred
                    
                    
                    —
                    
                    
                    
                    —$
                    278,064
                    
                    
                    $
                    236,711





Provision for Income Taxes.
Income taxes increased by $41,353, or 17.5%, from $236,711 for the three months
ended June 30, 2008, to $278,064 for the three months ended June 30, 2009. This
increase was due to the increase in our taxable income in our operating
subsidiaries.





Six-Month
Period Ended June 30, 2009 Compared to Six-Month Period Ended June 30,
2008





The
following summarizes changes in our operations for the six months ended June 30,
2009 and 2008.  Net income increased by $2,114,674, from $701,168 in
the six months ended June 30, 2008, to $2,815,842 for the six months ended June
30, 2009. The increase in net income during the six months ended June 30, 2009,
as compared to the same time period in the prior year, was due an increase in
gross profit as further described below.




Sales
and Cost of Goods Sold





For the Six Months
                      Ended June 30,2009
                    
                    
                    2008Sales
                    
                    $
                    21,103,487
                    
                    
                    $
                    21,339,237Cost
      of Goods Sold
                    
                    
                    11,487,985
                    
                    
                    
                    13,292,397Gross
      Profit
                    
                    $
                    9,615,502
                    
                    
                    $
                    8,046,840





Sales. Sales volume decreased
by 527 metric tons, or 11.9%, period on period, to 3,891 metric tons for the six
months ended June 30, 2009, from 4,418 metric tons for the six months ended June
30, 2008. Sales revenues decreased by $235,750, or 1.1%, from $21,339,237
in the six months ended June 30, 2008, to $21,103,487 for the six months ended
June 30, 2009. This decrease was primarily due to a decrease in subcontracting
revenue, as compared to the six months ended June 30, 2008, as we shifted to
produce more of our higher margin product line in fiscal 2009.




38


Sales by product
line.A break-down of our sales by product line for the six
months ended June 30, 2009 and 2008 is as follows:





Six Months Ended June 30,2009
                
                
                2008
                
                
                Period-on-periodProduct category
                
                Quantity
                  (tons)
                
                
                $ Amount
                
                
                % of sales
                
                
                Quantity
                  (tons)
                
                
                $ Amount
                
                
                % of
                  sales
                
                
                Qty.
                  VarianceMilk
      powder
                
                
                2,891
                
                
                
                18,395,943
                
                
                
                87.2
                
                
                
                2,922
                
                
                
                16,828,825
                
                
                
                78.9
                
                
                
                (31
                )Rice
      powder
                
                
                112
                
                
                
                634,465
                
                
                
                3.0
                
                
                
                97
                
                
                
                532,338
                
                
                
                2.4
                
                
                
                15Soybean
      powder
                
                
                309
                
                
                
                554,823
                
                
                
                2.6
                
                
                
                230
                
                
                
                418,715
                
                
                
                2.0
                
                
                
                79Subcontracting
                
                
                579
                
                
                
                1,518,256
                
                
                
                7.2
                
                
                
                1,169
                
                
                
                3,559,359
                
                
                
                16.7
                
                
                
                (590
                )Total
                
                
                3,891
                
                
                
                21,103,487
                
                
                
                100.0
                
                
                
                4,418
                
                
                
                21,339,237
                
                
                
                100.0
                
                
                
                (527
                )




There
were various changes to the break-down of sales among our product lines over the
six months ended June 30, 2009, as we increased production in most lines, but
attempted to adjust our sales mix to higher margin products, and away from
subcontracting. Rice powder accounted for 3.0% of our sales mix for the six
months ended June 30, 2009, at an average selling price of $5,665 per metric
ton, as compared to 2.4% of our sales mix in the six months ended June 30, 2008,
at an average selling price of $5,488 per metric ton. Milk powder accounted
for 87.2% of six months ended June 30, 2009 sales mix, at an average selling
price of $6,363 per metric ton, as compared to 78.9% of first quarter 2008, at
an average selling price of $5,759 per metric ton. We decreased our subcontract
production during the six months ended June 30, 2009 to 7.2% of the sales mix,
at an average selling price of $2,622 per metric ton, as compared to 16.7% of
the sales mix in the six months ended June 30, 2008, at an average sales price
of $3,045 per metric ton.




A
breakdown of our average selling price by product line for the six months ended
June 30, 2009 and 2008 is as follows:




Six
      Months Ended
                          June
      30,Average selling prices
                        
                        2009
                        
                        
                        2008
                        
                        
                        Variance$
                        
                        
                        $
                        
                        
                        $
                        
                        
                        
                        %Milk
      powder
                        
                        
                        6,363
                        
                        
                        
                        5,759
                        
                        
                        
                        604
                        
                        
                        
                        10.5Rice
      powder
                        
                        
                        5,665
                        
                        
                        
                        5,488
                        
                        
                        
                        177
                        
                        
                        
                        3.2Soybean
      powder
                        
                        
                        1,796
                        
                        
                        
                        1,820
                        
                        
                        
                        (24
                        )
                        
                        
                        (1.3
                        )Subcontracting
                        
                        
                        2,622
                        
                        
                        
                        3,045
                        
                        
                        
                        (423
                        )
                        
                        
                        (13.9
                        )Total
                        
                        
                        5,424
                        
                        
                        
                        4,830
                        
                        
                        
                        594
                        
                        
                        
                        12.3




Cost of Goods
Sold.  Cost of goods sold decreased by $1,804,412, or 13.6%,
from $13,292,397 in the six months ended June 30, 2008, to $11,487,985 for the
six months ended June 30, 2009. This decrease was directly related to our
reduction in subcontracting work during the six months ended June 30, 2009.
Overall our cost per metric ton decreased by $57, or 1.9%, to $2,952 per metric
ton in the six months ended June 30, 2009, as compared to $3,009 per metric ton
in six months ended June 30, 2008, due to increases in our sales prices and the
reductions in the price of raw materials we use to produce our
products.




39


A
breakdown of cost of sales by product line for the years ended June 30, 2009 and
2008 is as follows:




Six
      Months Ended June 30,2009
                        
                        
                        2008
                        
                        
                        Variance$
                        
                        
                        $
                        
                        
                        $
                        
                        
                        
                        %Cost of salesMilk
      powder
                        
                        
                        9,376,411
                        
                        
                        
                        9,702,132
                        
                        
                        
                        (325,721
                        )
                        
                        
                        (3.4
                        )Rice
      powder
                        
                        
                        248,810
                        
                        
                        
                        208,760
                        
                        
                        
                        40,050
                        
                        
                        
                        19.2Soybean
      powder
                        
                        
                        430,563
                        
                        
                        
                        261,697
                        
                        
                        
                        168,866
                        
                        
                        
                        64.5Subcontracting
                        
                        
                        1,432,201
                        
                        
                        
                        3,119,808
                        
                        
                        
                        (1,687,607
                        )
                        
                        
                        (54.1
                        )Total
                        
                        
                        11,487,985
                        
                        
                        
                        13,292,397
                        
                        
                        
                        (1,804,412
                        )
                        
                        
                        (13.6
                        )Cost per units sold(per
      ton)Milk
      powder
                        
                        
                        3,243
                        
                        
                        
                        3,320
                        
                        
                        
                        (77
                        )
                        
                        
                        2.3Rice
      powder
                        
                        
                        2,222
                        
                        
                        
                        2,152
                        
                        
                        
                        70
                        
                        
                        
                        3.3Soybean
      powder
                        
                        
                        1,393
                        
                        
                        
                        1,138
                        
                        
                        
                        255
                        
                        
                        
                        22.4Subcontracting
                        
                        
                        2,474
                        
                        
                        
                        2,669
                        
                        
                        
                        (195
                        )
                        
                        
                        (7.3
                        )Average
      cost per unit sold
                        
                        
                        2,952
                        
                        
                        
                        3,009
                        
                        
                        
                        (57
                        )
                        
                        
                        (1.9
                        )




Gross Profit. Gross profit was
$9,615,502, or 45.6% of our sales for the six months ended June 30, 2009, as
compared to gross profit of $8,046,840, or 37.7%, for the six months ended June
30, 2008. During the six months ended June 30, 2009, our gross margin on milk
powder increased to 49.0%, from 42.3% in the same period of the prior year, due
to an increase in the average sales price of 10.5%, while there was a 2.3%
decrease in the cost per metric ton from the six months ended June 30,
2008. The gross margin for soybean powder declined 15.1% to 22.4% in the
six months ended June 30, 2009, as compared to 37.5% in the six months ended
June 30, 2008, due to an increase in the average cost per ton of 22.4% in the
six months ended June 30, 2009 as compared to the same period in
2008.




A
breakdown of gross margin by product line for the years June 30, 2009 and 2008
is as follows:




Six
      Months Ended June 30,2009
                                
                                
                                2008
                                
                                
                                Period-on-periodProduct category
                                
                                $ Amount
                                
                                
                                Gross
                                  Margin %
                                
                                
                                $ Amount
                                
                                
                                Gross
                                  Margin %
                                
                                
                                Margin
                                  VarianceMilk
      powder
                                
                                
                                9,019,532
                                
                                
                                
                                49.0
                                
                                
                                
                                7,126,693
                                
                                
                                
                                42.3
                                
                                
                                
                                6.7Rice
      powder
                                
                                
                                385,655
                                
                                
                                
                                60.8
                                
                                
                                
                                323,578
                                
                                
                                
                                60.8
                                
                                
                                
                                —Soybean
      powder
                                
                                
                                124,260
                                
                                
                                
                                22.4
                                
                                
                                
                                157,018
                                
                                
                                
                                37.5
                                
                                
                                
                                (15.1
                                )Subcontracting
                                
                                
                                86,055
                                
                                
                                
                                5.7
                                
                                
                                
                                439,551
                                
                                
                                
                                12.3
                                
                                
                                
                                (6.6
                                )Total
                                
                                
                                9,615,502
                                
                                
                                
                                45.6
                                
                                
                                
                                8,046,840
                                
                                
                                
                                37.7
                                
                                
                                
                                7.9




40


Operating
Expenses





For the Six
      Months
                      Ended June
      30,2009
                    
                    
                    2008Operating ExpensesSelling
      and administrative expenses
                    
                    $
                    6,100,398
                    
                    
                    $
                    6,964,150Depreciation
      and amortization
                    
                    
                    86,512
                    
                    
                    
                    30,431Total
      operating expenses
                    
                    $
                    6,186,910
                    
                    
                    $
                    6,994,581





Selling Expenses. Selling
expenses overall decreased by $577,507, or 10.7%, from $5,381,871 in the six
months ended June 30, 2008, to $4,804,364 for the six months ended June 30,
2009. The major factors in the decrease in selling expenses are as
follows:





·
            Advertising
      decreased by $1,623,479, or 76.8%, to $491,724 in 2009, from $2,115,203 in
      2008, due to a less aggressive marketing campaign in
  2009.





·
            Entertainment
      expenses decreased by $44,694, or 14.9%, to $255,357 in 2009, from
      $300,051 in 2008, as we reduced our marketing as compared to
      2008.





·
            Transportation
      expenses decreased by $90,237, or 17.4%, to $429,643 in 2009, from
      $519,880 in 2008, as a result of our shipping costs decreasing in 2009 as
      compared to 2008.





These
decreases were partially offset by increases in:





·
            Outdoor
      promotion expenses by $282,754, or 262.5%, to $390,469 in 2009, from
      $107,715 in 2008 as we increased our outdoor promotions during
      2009,





·
            Promotion
      expenses by $403,115, or 119.8%, to $739,487 in 2009, from $336,372 in
      2008, as increased our direct promotions compared to
  2008.





·
            Selling
      salaries by $148,931, or 16.0%, to $1,079,558 in 2009, from $930,927 in
      2008, as we increased our sales during
2009.





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.





Administrative Expenses.
Administrative expenses decreased by $286,245, or 18.1%, from $1,582,279 in six
months ended June 30, 2008, to $1,296,034 for the six months ended June 30,
2009. The major factors in the decrease in administrative expenses are as
follows:





·
            Liquidated
      damages of $487,199 were incurred in 2008, as a result of our failure to
      satisfy certain registration requirements. No liquidated damages were
      incurred in 2009.





·
            Increase
      in stock option expenses of $75,688 in 2009 from stock options granted in
      2009 partially offset the decrease in liquidated
  damages.




41


Provision
for Income Taxes





For the Six
      Months
                      Ended June
      30,2009
                    
                    
                    2008Provision
      for Income TaxesCurrent
                    
                    $
                    615,894
                    
                    
                    $
                    317,291Deferred
                    
                    
                    —
                    
                    
                    
                    —$
                    615,894
                    
                    
                    $
                    317,291





Provision for Income Taxes.
Income taxes increased by $298,603, or 94.1%, from $317,291 for the six months
ended June 30, 2008, to $615,894 for the six months ended June 30, 2009. This
increase was due to the increase in our taxable income in our operating
subsidiaries.





Liquidity
and Capital Resources





Uses
of Capital





For the Six
                            Months Ended
                            June
      30,2009
                          
                          
                          2008Net
      cash provided by operating activities
                          
                          $
                          848,559
                          
                          
                          $
                          214,931Net
      cash used in investing activities
                          
                          
                          (4,189,873
                          )
                          
                          
                          (5,352,128
                          )Net
      cash provided by financing activities
                          
                          $
                          758,231
                          
                          
                          $
                          1,959,287





Net Cash Provided By Operating
Activities.For the six months ended June 30, 2009, $848,559
was provided by operating activities, compared with $214,931 provided by
operating activities for the six months ended June 30, 2008. Our net cash flows
provided from operating activities during 2009 was due to the following
factors:





·
            Net
      income was $2,815,842 for the six months ended June 30, 2008 partially
      offset by:





·
            Trade
      accounts receivable increased by $563,653, due to the increased level of
      sales during the year.





·
            Inventory
      increased by $747,598, due to seasonal summer build up in products as
      compared to December 2008.





·
            Accounts
      payable and accrued expenses increased by $483,663 at June 30, 2009, as
      compared to the same period in 2008, due to increases in production of
      products and expenses.




Net Cash Used In Investing
Activities.For the six months ended June 30, 2009, we used
$4,189,873 in investing activities, compared with $5,352,128 used in investing
activities for the six months ended June 30, 2008. The $4,189,873 was for the
construction of our new production facility.


42




Net Cash Provided By Financing
Activities.For the six months ended June 30, 2009, $758,231
was provided by financing activities, compared with $1,959,287 provided by
financing activities for the six months ended June 30, 2008. We raised $758,231
through the exercise of warrants during the six months ended June 30, 2009, in
connection with the consummation of the First Warrant Tender Offer as further
described in “- Recent Developments – First Warrant Tender Offer”
above.





General




In recent
years, the Chinese government has initiated programs to promote milk consumption
and is providing incentives to increase dairy production. Over the same period,
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 $44.3 million
in 2008, a 461% increase over three years. Net income increased from
approximately $0.7 million in 2005 to approximately $2.3 million in 2008, a 220%
increase over three years.





Cash and
cash equivalents at June 30, 2009 decreased by 35.3% to $4,752,255, from
$7,343,588 at December 31, 2008. Working capital increased from approximately
$1.4 million in 2005 to approximately $10 million in 2009, including cash
generated from operations, as well as funds raised from private offerings of
promissory notes and warrants we consummated in fiscal 2008. 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.





Production
capacity has been the bottle neck for our growth in recent years, because
production has not been able to keep up with demand. 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. The
first phase of this project is expected to 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
in the fourth quarter of fiscal 2009, assuming we obtain the remaining $6.0
million we require to complete construction and fully equip the first production
line. 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 the second production
line would be an additional $15.0 million.





Historically
we have 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
connection with the October Offerings, we received aggregate net proceeds of
$4,395,104. The net proceeds from the October Offerings were used in connection
with the Repurchase Transaction, to pay expenses related to our Reverse Merger
and October Offerings, and for general working capital purposes. The Repurchase
Transaction, Reverse Merger and October Offerings are further described in “-
Recent Developments - Reverse Merger, Private Placements and Related
Transactions” above.




43




In June 2008, we closed the June Note
Offering, pursuant to which we received aggregate gross proceeds of $2,250,000.
In addition, on November 10, 2008, we closed the November Note Offering,
pursuant to which we received aggregate gross proceeds of $500,000. We used the
gross proceeds from the June Note Offering and the November Note Offering
primarily for (a) the construction and equipping of our new production facility,
and (b) expenses related to these offerings. The June Note Offering and November
Note Offering are further described in “- Recent Developments - Sale of Notes
and Warrants” above.





As of
April 24, 2008, we commenced the First Warrant Tender Offer, pursuant to which
the holders of warrants received in connection with the October Offerings had
the opportunity to tender their warrants for shares of our common stock at a
reduced exercise prices. On March 2, 2009, we closed the First Warrant Tender
Offer. In connection with the First Warrant Tender Offer:





·
            a
      total of 183,457 warrants were tendered at the reduced exercise price of
      $1.63 per share (originally $2.04 per share), for an aggregate exercise
      price of $299,035; and




·
            a
      total of 175,937 warrants were tendered at the reduced exercise price of
      $2.61 per share (originally $3.26 per share) for an aggregate exercise
      price of $459,196.




As a result, we received gross proceeds
of $758,231 and issued an aggregate of 359,394 shares of our common stock. We
used the proceeds we received from the First Warrant Tender Offer for the
construction and equipping of our new production facility, and expenses related
to this offer.





We have no sources for the additional
financing we may need to complete the construction of 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. However, on
August 13, 2009, we closed our Second Warrant Tender Offer, pursuant to
which:





·
            a
      total of 49,000 Original Warrants with an exercise price of $2.04 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share; and




·
            a
      total of 2,205,828 Original Warrants with an exercise price of $3.26 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share.




In
addition to the reduced exercise prices, the Amended Warrants have exercise
periods shortened to fifteen (15) days following the expiration of the Second
Warrant Tender Offer. Therefore, any warrant holder that exchanged its Original
Warrants for Amended Warrants in the Second Warrant Tender Offer who
wishes to exercise the Amended Warrants received in connection therewith
must do so on or before August 28, 2009. If all of the 2,254,828 Amended
Warrants are exercised at the reduced exercise price of $1.63, we will receive
gross proceeds of $3,675,370.We intend to apply any
proceeds received in connection with the exercise of the Amended Warrants toward
the cost of completing the construction and equipping of our new production
facility. However, we will retain broad discretion over the use of the net
proceeds and may use the money for other corporate purposes.





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 will serve as
our corporate headquarters. The purchase price of this building was paid out of
our retained earnings.


44





Currently, we spend approximately 8% -
12% of total revenues on advertising and promotional plans through out the year.
We spent approximately $3.0 million, $1.9 million and $0.8 million on
advertising and promotion in fiscal 2008, 2007 and 2006, respectively. We plan
to keep spending an aggregate of between $4.0 million and $5.0 million on
advertising and promotion in fiscal 2009, which will still fall within our
standard budget for advertising and promotion of 8% - 12% of total revenues, but
in 2009 we plan to spread the expense over the entire year rather than in the
first half of the year as we did in 2008. 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
Offerings, as further described in “- Recent Developments - Reverse Merger,
Private Placements and Related Transactions” above, we entered into Registration
Rights Agreements (each, a “Registration Rights Agreement,” and collectively the
“Registration Rights Agreements”) with Mr. Winfield, the Initial Purchasers and
the Additional Purchasers (collectively, the “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 Securities and
Exchange Commission (the “Commission”) (the “Registration Statement”) covering
the resale of (i) the shares of common stock purchased in the October Offerings
(the “Purchased Shares”), and (ii) the common stock issuable upon exercise of
Warrant W-1, Warrant W-2, the Class A Warrants, and the Class B Warrants
(collectively (i), (ii), (iii) and (iv), 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 Commission, 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 are required to pay liquidated damages to the holders of the
Purchased Shares if (i) we fail to file the Registration Statement within thirty
(30) business days from the Closing Date, (ii) the Commission does 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 Commission)
(the “Effectiveness Date”), (iii) we fail to request acceleration of
effectiveness within five (5) business days of a notice of no further review
from the Commission, (iv) we fail to respond to the Commission 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 will
accumulate at the rate of one and one-half percent (1.5%) of the purchase price
paid by the Investors for units of our securities purchase in the October
Offerings for each thirty (30) day period during which a registration default is
continuing; provided, however, that (i) we shall not be liable for liquidated
damages with respect to any warrants or shares of common stock underlying the
warrants, and (ii) in no event will 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 purchaser in the October Offerings shall be
20% of the aggregate purchase price paid by such purchaser.





Notwithstanding anything to the
contrary stated in the Registration Rights Agreements, we are entitled to limit
the Registrable Securities to the extent necessary to avoid any issues arising
from the recent interpretations by the SEC of Rule 415 of the Securities Act of
1933, as amended.


45





We have not yet satisfied these
registration requirements and, as a result, accrued a total of $1,201,998 in
liquidated damages through October 19, 2008, the date the shares purchased in
the October Offerings became eligible for sale pursuant to Rule 144 under the
Securities Act of 1933, as amended. We have not yet paid any of the liquidated
damages, which are payable in cash or shares of our common stock, at our
discretion. If paid in shares of common stock, the shares will be valued at
$1.80 per share, the closing price on the Over-the-Counter Bulletin Board on
October 20, 2008, resulting in the issuance of approximately 667,777shares of our common
stock.





Share Repurchase and Put/Call
Agreements





On October 9, 2007, we consummated the
Repurchase Transaction with a shareholder, as further described in “- Recent
Developments - Reverse Merger, Private Placements and Related Transactions”
above. We repurchased the Repurchased Shares, to reduce the overall dilution
created by the October Offerings. The Repurchased Shares are currently being
held in treasury.





Immediately following the closing of
the Repurchase Transaction, we entered into Put/Call Agreements with 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 Financial
      Industry Regulatory Authority’s Over-the-Counter Bulletin Board (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”);




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




46




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.





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.





Warrants





In connection with the October
Offerings, as further described in “- Recent Developments - Reverse Merger,
Private Placements and Related Transactions” above, we issued warrants to
purchase an aggregate of 7,988,870 shares of common stock, of which (i) 373,334
are exercisable at a price of $0.94 per share; (ii) 1,333,333 are exercisable at
a price of $1.50 per share; (iii) 1,374,230 are exercisable at a price of $2.04
per share; and (iv) 4,907,973 are exercisable at a price of $3.26 per
share.





Warrant W-1 represents the right to
purchase 266,667 shares of our common stock, at an exercise price of $0.94 per
share. Warrant W-1 is scheduled to expire on the three-year anniversary of its
date of issuance; provided, however, that we need to extend the expiration date
in connection with our failure to satisfy our requirement to register the shares
underlying Warrant W-1. Warrant W-1 is exercisable for cash only, provided a
registration statement covering the shares of common stock underlying Warrant
W-1 is effective. Otherwise, Warrant W-1 is exercisable on a cashless basis. The
number of shares of our common stock to be deliverable upon exercise of Warrant
W-1 will be subject to adjustment for, among other things, subdivision or
consolidation of shares, rights or warrants issues, dividend distributions,
stock dividends, bonus issues, asset distributions, and other standard dilutive
events. Warrants to purchase an aggregate of 106,667 shares of our common stock
issued to a finder, have terms and conditions identical to the those of Warrant
W-1.





Warrant W-2 represents the right to
purchase 1,333,333 shares of our common stock, at an exercise price of $1.50 per
share. Warrant W-2 is scheduled to expire on the two-year anniversary of its
date of issuance; provided, however, that we need to extend the expiration date
in connection with our failure to satisfy our requirement to register the shares
underlying Warrant W-2. Warrant W-2 is exercisable for cash only, provided a
registration statement covering the shares of common stock underlying the
Warrant W-2 is effective. Otherwise, Warrant W-2 is exercisable on a cashless
basis. The number of shares of our common stock to be deliverable upon exercise
of Warrant W-2 will be subject to adjustment for, among other things,
subdivision or consolidation of shares, rights or warrants issues, dividend
distributions, stock dividends, bonus issues, asset distributions, and other
standard dilutive events. At anytime one year following the date a registration
statement covering the shares of common stock underlying the Warrant W-2 is
declared effective, we will have the ability to call the Warrant W-2 at a price
of $0.01 per warrant, upon thirty (30) days prior written notice to the holders
of the warrants, if the closing price of the common stock exceeded $1.88 for
each of the ten (10) consecutive trading days immediately preceding the date
that the call notice is given by us.


47





Prior to the exercise of 183,457 of the
Class A Warrants in our First Warrant Tender Offer, and tender of 49,000 of the
Class A Warrants in our Second Warrant Tender Offer, our Class A Warrants
represented the right to purchase an aggregate of 981,591 shares of our common
stock, at an exercise price of $2.04 per share. The Class A Warrants are
scheduled to expire on the three-year anniversary of their date of issuance;
provided, however, that we need to extend the expiration date in connection with
our failure to satisfy our requirement to register the shares underlying the
Class A Warrants. The Class A Warrants are exercisable for cash only, provided a
registration statement covering the shares of common stock underlying the Class
A Warrants is effective. Otherwise, the Class A Warrants are exercisable on a
cashless basis. The number of shares of common stock to be deliverable upon
exercise of the Class A Warrants will be subject to adjustment for, among other
things, subdivision or consolidation of shares, rights or warrants issues,
dividend distributions, stock dividends, bonus issues, asset distributions, and
other standard dilutive events. Warrants to purchase 392,639 shares of our
common stock issued to finders and placement agents, have terms and conditions
identical to the those of the Class A Warrants; except that, as of March 2,
2009, the exercise price of 235,583 of these warrants was reduced from $2.04 to
$1.63, as partial consideration for services rendered in connection with a
consulting agreement the Company entered into with one of these
parties.





Prior to the exercise of 175,937 of the
Class B Warrants in our First Warrant Tender Offer, and tender of 2,205,828 of
the Class B Warrants in our Second Warrant Tender Offer, our Class B Warrants
represented the right to purchase an aggregate of 4,907,973 shares of our common
stock, at an exercise price of $3.26 per share. The Class B Warrants are
scheduled to expire on the two-year anniversary of their date of issuance;
provided, however, that we need to extend the expiration date in connection with
our failure to satisfy our requirement to register the shares underlying the
Class B Warrants. The Class B Warrants are exercisable for cash only, provided a
registration statement covering the shares of common stock underlying the Class
B Warrants is effective. Otherwise, the Class B Warrants are exercisable on a
cashless basis. The number of shares of common stock to be deliverable upon
exercise of the Class B Warrants will be subject to adjustment for, among other
things, subdivision or consolidation of shares, rights or warrants issues,
dividend distributions, stock dividends, bonus issues, asset distributions, and
other standard dilutive events. At anytime one year following the date a
registration statement covering the shares of common stock underlying the Class
B Warrants is declared effective, we will have the ability to call the Class B
Warrants at a price of $0.01 per Class B Warrant, upon thirty (30) days prior
written notice to the holders of the Class B Warrants, if the closing price of
the common stock exceeded $4.08 for each of the ten (10) consecutive trading
days immediately preceding the date that the call notice is given by
us.





Warrant W-1, Warrant W-2, the Class A
Warrants and the Class B Warrants (collectively, the “2007 Warrants”) provide
that in no event shall the holder be entitled to exercise a number of 2007
Warrants (or portions thereof) in excess of the number of 2007 Warrants (or
portions thereof) upon exercise of which the sum of (i) the number of shares of
common stock beneficially owned by the holder and its affiliates (other than
shares of common stock which may be deemed beneficially owned through the
ownership of the unexercised 2007 Warrants and the unexercised or unconverted
portion of any of our other securities (subject to a limitation on conversion or
exercise analogous to the limitation contained herein) and (ii) the number of
shares of common stock issuable upon exercise of the 2007 Warrants (or portions
thereof) with respect to which the determination described herein is being made,
would result in beneficial ownership by the holder and its affiliates of more
than 9.9% of the outstanding shares of common stock. For purposes of the
immediately preceding sentence, beneficial ownership shall be determined in
accordance with Section 13(d) of the Securities Exchange Act of 1934, as
amended, and Regulation 13D-G thereunder, except as otherwise provided in clause
(i) of the preceding sentence. Notwithstanding anything to the contrary
contained herein, the limitation on exercise of the 2007 Warrants may be waived
by written agreement between us and the holder; provided, however, such waiver
may not be effective less than ninety-one (61) days from the date
thereof.





As of April 24, 2008, we commenced the
First Warrant Tender Offer, pursuant to which the holders of the 2007 Warrants
had the opportunity to tender their 2007 Warrants for exercise prices reduced by
20%. The First Warrant Tender Offer is further described in “Recent Developments
– First Warrant Tender Offer” above.


48





On March
2, 2009, we closed on the First Warrant Tender Offer. In connection with the
First Warrant Tender Offer:





·
            a
      total of 183,457 warrants were tendered at the reduced exercise price of
      $1.63 per share (originally $2.04 per share), for an aggregate exercise
      price of $299,035; and




·
            a
      total of 175,937 warrants were tendered at the reduced exercise price of
      $2.61 per share (originally $3.26 per share) for an aggregate exercise
      price of $459,196.




As a
result, we received gross proceeds of $758,231 and issued an aggregate of
359,394 shares of our common stock. We used the proceeds we received from the
Warrant Tender Offer for the construction and equipping of our new production
facility, and expenses related to the Warrant Tender Offer.





As of
June 19, 2009, we commenced the Second Warrant Tender Offer to all holders of
the 2007 Warrants, pursuant to which the holders of the 2007 Warrants had the
opportunity to voluntarily exchange any or all of the 2007 Warrants for Amended
Warrants. The Second Warrant Tender Offer is further described in “Recent
Developments – Second Warrant Tender Offer” above.





On August
13, 2009, we closed on the Second Warrant Tender Offer. In connection with the
Second Warrant Tender Offer:





·
            a
      total of 4,900 2007 Warrants with an exercise price of $2.04 per share
      were exchanged for Amended Warrants with a reduced exercise price of $1.63
      per share; and




·
            a
      total of 2,205,828 Original Warrants with an exercise price of $3.26 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share.




The only
differences between the 2007 Warrants and the Amended Warrants issued in
connection with the Second Warrant Tender Offer, are that the Amended
Warrants:





·
            have
      the lower exercise prices described
above;





·
            will
      expire on August 28, 2009, and the expiration date will not be extended
      for our failure to register the underlying
  shares;





·
            will
      not be subject to the limitation contained in the 2007 Warrants, which
      provides that the 2007 Warrants may not be exercised if the exercise would
      cause the holder and its affiliates to hold an aggregate of more than 9.9%
      of the outstanding shares of our common stock;
  and





·
            must
      be exercised for cash, as a cashless exercise of the Amended Warrants will
      not be permitted.




Any
warrant holder that exchanged its 2007 Warrants for Amended Warrants in the
Second Warrant Tender Offer who wishes to exercise the Amended
Warrants received in connection therewith must do so on or before August 28,
2009. If all of the 2,254,828 Amended Warrants are exercised at the reduced
exercise price of $1.63, we will receive gross proceeds of
$3,675,370.


49





If all of
the remaining 5,374,648 2007 Warrants (including warrants issued to finders and
placement agents) were exercised for cash pursuant to their terms, we would
receive $12,818,999 in proceeds, although
there can be no assurance that any of these 2007 Warrants will be
exercised.




In June 2008 we closed the June Note
Offering, pursuant to which we granted the June Warrants. The June Note Offering
is further described in “Recent Developments - Sale of Notes and Warrants”
above. As amended on December 31, 2008, the June Warrants represent the right to
purchase an aggregate of 225,000 shares of our common stock, at an exercise
price of $1.63 per share. The June Warrants will expire five years after the
date of issuance. The June Warrants may be exercised for cash only. The number
of shares of our common stock deliverable upon exercise of the June Warrants
will be subject to adjustment for, among other things, subdivision or
consolidation of shares, and certain other standard dilutive events. A holder of
the June Warrants will not be entitled to exercise a number of June Warrants in
excess of the number of June Warrants upon exercise of which would result in
beneficial ownership by such holder and his, her or its affiliates of more than
9.9% of the outstanding shares of our common stock, unless this provision is
waived by written agreement between us and the holder not less than sixty-one
(61) days from the date of such waiver.





In connection with the June Note
Offering, we engaged a placement agent to whom we paid a non-refundable retainer
of $25,000, and a placement fee in the amount of $97,500, and granted warrants
to purchase an aggregate of 45,000 shares of our common stock, the terms and
conditions of which are identical to the those of the June Warrants, as
amended.





If all of the June Warrants (including
warrants issued to a placement agent) were exercised for cash pursuant to their
terms, we would receive $440,000 in proceeds, although
there can be no assurance that any of these June Warrants will be
exercised.





In
addition, as of July 4, 2009, we granted the placement agent warrants to
purchase an additional 97,500 shares of our common stock in consideration for
its services in connection with the amendment of the June Notes and June
Warrants as of December 31, 2008. The terms and conditions of these additional
warrants are identical to the those of the June Warrants, as amended, except
that they will expire on December 31, 2011, and are exercisable either for cash,
at an exercise price of $1.63 per share, or on a cashless basis. If all of these
additional warrants were exercised for cash pursuant to their terms, we would
receive $158,925 in proceeds, although
there can be no assurance that any of these additional Warrants will be
exercised.





In November 2008 we closed the November
Note Offering, pursuant to which we granted the November Warrants. The November
Note Offering are further described in “Recent Developments - Sale of Notes and
Warrants” above. The November Warrants represent the right to purchase an
aggregate of 50,000 shares of our common stock, at an exercise price of $2.61
per share. The November Warrants will expire three years after the date of
issuance. The November Warrants may be exercised for cash only. The number of
shares of our common stock deliverable upon exercise of the November Warrants
will be subject to adjustment for, among other things, subdivision or
consolidation of shares, and certain other standard dilutive events. A holder of
the November Warrants will not be entitled to exercise a number of November
Warrants in excess of the number of November Warrants upon exercise of which
would result in beneficial ownership by such holder and his, her or its
affiliates of more than 9.9% of the outstanding shares of our common stock,
unless this provision is waived by written agreement between us and the holder
not less than sixty-one (61) days from the date of such waiver.





In connection with the November Note
Offering, we engaged a placement agent to whom we paid a placement fee in the
amount of $40,000, and granted warrants to purchase an aggregate of 25,000
shares of our common stock, the terms and conditions of which are identical to
the those of the November Warrants.


50





If all of the November Warrants
(including warrants issued to a placement agent) were exercised for cash
pursuant to their terms, we would receive $195,750 in proceeds, although
there can be no assurance that any of these November Warrants will be
exercised.





We have granted the holders of June
Warrants and November Warrants “piggyback” registration rights with respect to
the shares underlying their warrants.





Promissory Notes





In the June Note Offering, further
described in “- Recent Developments - Sale of Notes and Warrants” above, we also
issued the June Notes. As amended on December 31, 2008, the June Notes bear
interest at a rate of 10% until they become due and payable on December 31,
2009. 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 June
Notes at any time without penalty, upon 15 days prior written notice. Each
holder of the June Notes has the right to be prepaid any amounts due under his,
her or its June 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 June 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 (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 each June Note if: (a)
we fail to pay principal or interest when due on the June Note; (b) we breach
any material covenant or other material term or condition contained in the June
Note or securities purchase agreement entered into in connection with the June
Note Offering (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 June 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 American Stock Exchange. Upon the occurrence of any Event
of Default under a June Note, unless such Event of Default shall have been
waived in writing by the holder, the holder may consider the June 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 June Note or any other right or remedy afforded by
law.


51





In the November Note Offering, further
described in “- Recent Developments - Sale of Notes and Warrants” above, we also
issued the November Note. The November Note bears interest at a rate of 10%
until it becomes due and payable on November 10, 2009. 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 November Note at any time without
penalty, upon 15 days prior written notice. The holder of the November Note has
the right to be prepaid any amounts due under his November Note from the
proceeds of any future offering we consummate resulting in gross proceeds of
$6,500,000 or more. So long as we have any obligation under the November 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) sell, lease or otherwise dispose of any significant
portion of its assets; (d) lend money, give credit or make advances; or (e)
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 November Note if: (a) we fail to pay principal or
interest when due on the November Note; (b) we breach any material covenant or
other material term or condition contained in the November Note or securities
purchase agreement entered into in connection with the November Note Offering
(the “November 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 November Note or the November 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 American Stock Exchange.
Upon the occurrence of any Event of Default under the November Note, unless such
Event of Default shall have been waived in writing by the holder, the holder may
consider the November 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 Note or any other right
or remedy afforded by law.





Stock
Options





On March 2, 2009, our board of
directors adopted our 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 our business. On March 11,
2009 (the “Record Date”), we obtained the written consent of the holders of
15,414,577 shares of our common stock, which as of the Record Date represented
approximately 52.7% of our outstanding voting securities, to adopt the Plan.
1,500,000 shares of the Company’s common stock have been reserved for issuance
under the Plan.





Following
the adoption of the Plan, our board of directors approved the grant of an
aggregate of 703,200 stock option awards to our executive officers and
directors.Each
option has an exercise price of $0.42 per share, which was the closing price of
our common stock on the OTCBB on March 2, 2009, the date on which the
options were granted. Each option has a term of ten (10) years from the date of
grant and will vest with respect to 25% of the shares underlying the option on
each of September 2, 2009, March 2, 2010, September 2, 2010 and March 2,
2011.





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, the State
Administration of Foreign Exchange (“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 in our Annual
Report for more information.


52





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.





Contractual
Obligations and Commercial Commitments





Our
contractual obligations, as of June 30, 2009, 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
                            
                            $
                            1,589,442
                            
                            
                            $
                            1,589,442
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Construction
      contract
                            
                            
                            1,866,942
                            
                            
                            
                            1,866,942
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Debt
      Obligations
                            
                            
                            3,130,288
                            
                            
                            
                            3,130,288
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Advertising
      contract
                            
                            
                            409,914
                            
                            
                            
                            409,914
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Operating
      leases
                            
                            
                            69,032
                            
                            
                            
                            69,032
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —Total:
                            
                            $
                            7,065,618
                            
                            
                            $
                            7,065,618
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —





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


53





·
            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





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 six months of fiscal 2009, 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 Annual Report on Form 10-K for our fiscal
year ended December 31, 2008 for a more complete discussion of our critical
accounting policies and estimates.





Recent accounting
pronouncements





In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement
No. 133 (SFAS 161). FAS 161 changes the disclosure requirements for
derivative instruments and hedging activities. Entities are required to provide
enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.. On January 1, 2009,
we adopted SFAS 161. The adoption of this standard did not have a material
impact on our financial position, results of operations, or cash
flows.





In June
2008, the EITF reached final consensuses on EITF Issue 08-4, Transition Guidance for Conforming
Changes to Issue No. 98-5. Certain conclusions reached in EITF Issue No.
98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, were nullified in EITF Issue No. 00-27,
Application of EITF Issue No.
98-5 to Certain Convertible Instruments. Moreover, some of the
conclusions in EITF Issue No. 98-5 and EITF Issue No. 00-27 were superseded by
SFAS No. 150 , Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. While the conclusions reached in EITF Issue No. 98-5 were
subsequently updated to reflect the issuance of EITF Issue No. 00-27 and SFAS
No. 150, the transition guidance in EITF Issue No. 98-5 was not revised. On
January 1, 2009, we adopted EITF 08-4. The adoption of this standard did not
have a material impact on our financial condition, results of operations or cash
flows.


54





In June
2008, the EITF reached final consensuses on EITF Issue 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity's Own Stock.  In
EITF Issue 07-5, the EITF reached the consensus that evaluation of whether an
equity-linked financial instrument (or embedded feature) is indexed to the
company's own stock should be based on a two-step approach. Under the two-step
approach, an equity-linked financial instrument (or embedded feature) is not
deemed indexed to the entity's own stock if the strike price is denominated in a
currency other than the issuer's functional currency (but the determination of
whether the instrument is indexed to the company's own stock is not affected by
the currency in which the underlying shares are traded). Also, market-based
employee stock valuation instruments are not considered to be indexed to the
entity's own stock (presumably because they are influenced by, among other
factors, employee behavior, which is not an input used to estimate the fair
value of the forward contract or option). An exercise contingency is a provision
entitling the entity (or the counterparty) to exercise an equity-linked
financial instrument or embedded feature based on changes in an underlying,
which includes the occurrence (or nonoccurrence) of a specified event.
Provisions that accelerate the timing of the entity's (or counterparty's)
ability to exercise an instrument or that extend the length of time that an
instrument is exercisable are exercise contingencies. On January 1, 2009, we
adopted EITF 07-5. The adoption of this standard did not have a material impact
on our financial condition, results of operations or cash flows.





In July
2008, the FASB issued FSP No. EITF 03-6-1, Unvested Share-Based Awards as
Participating Securities for EPS Purposes. FSP No. EITF 03-6-1
clarifies the circumstances under which unvested share-based payment awards
should be considered participating securities for purposes of determining basic
earnings per share (EPS). On January 1, 2009, we adopted FSP No. EITF 03-6-1.
The adoption of this standard did not have a material impact on our financial
condition, results of operations or cash flows.





In
December 2008, the FASB issued FSP no. FAS 132(R)-1, Employers’ Disclosures about
Postretirement Benefit Plan Assets. The FSP amends SFAS No. 132 (revised
2003), Employers’ Disclosures
about Pensions and Other Postretirement Benefits, to provide guidance on
an employer's disclosures about plan assets of a defined benefit pension or
other postretirement plan. The disclosures about plan assets required by FSP No.
FAS 123(R)-1 are to be provided for fiscal years beginning after December 15,
2009. We are currently assessing the impact of FSP No. FAS123(R)-1.





In
April 2009, the FASB issued FSP SFAS No. 107-1, Interim Disclosures about Fair Value
of Financial Instruments, which amends SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, and Accounting Principles Board (APB) Opinion
No. 28, Interim Financial
Reporting. FSP SFAS No. 107-1 will require disclosures about fair
value of financial instruments in financial statements for interim reporting
periods and in annual financial statements of publicly-traded companies. This
FSP also will require entities to disclose the method(s) and significant
assumptions used to estimate the fair value of financial instruments in
financial statements on an interim and annual basis and to highlight any changes
from prior periods. On June 30, 2009, we adopted FSP SFAS No. 107-1. The
adoption of this standard did not have a material impact on our financial
condition, results of operations or cash flows.





In April
2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. The FSP amends the other-than-temporary
impairment guidance for debt securities to make the guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments on debt and equity securities. On June 30, 2009, we adopted FSP No.
FAS 115-2 and FSP No. FAS 124-2. The adoption of this standard did not have a
material impact on our financial condition, results of operations or cash
flows.


55





In April
2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.” The FSP
provides additional guidance for estimating fair value when the market activity
for an asset or liability has declined significantly. On June 30, 2009, we
adopted FSP No. FAS 157-4, the adoption of this standard did not have a material
impact on our financial condition, results of operations or cash
flows.





In May
2009, the FASB issued SFAS No. 165, Subsequent Events, which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. We have adopted the provisions of
SFAS No. 165, which became effective for interim and annual reporting
periods ending after June 15, 2009. Subsequent events have been
evaluated through the date and time the financial statements were issued on
August 14, 2009. No material subsequent events have occurred since
June 30, 2009 that required recognition or disclosure in our current period
financial statements.





In
June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation
No. 46(R), which amends FASB Interpretation No. 46 (revised
December 2003) to address the elimination of the concept of a qualifying
special purpose entity. SFAS 167 also 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. Additionally, SFAS No. 167 provides more timely and
useful information about an enterprise’s involvement with a variable interest
entity. SFAS No. 167 will become effective in the first quarter of 2010. We are
currently evaluating whether this standard will have an impact on our
consolidated financial statements.





In
June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles. SFAS No. 168 will become the single source of authoritative
nongovernmental GAAP, superseding existing FASB, American Institute of Certified
Public Accountants (AICPA), EITF, and related accounting literature. SFAS No.
168 reorganizes the thousands of GAAP pronouncements into roughly 90 accounting
topics and displays them using a consistent structure. Also included is relevant
SEC guidance organized using the same topical structure in separate sections.
SFAS No. 168 will be effective for financial statements issued for reporting
periods that end after September 15, 2009. This will have an impact on our
financial statement disclosures since all future references to authoritative
accounting literature will be referenced in accordance with SFAS No.
168.





Off-Balance
Sheet Arrangements





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


56


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 and are not
required to provide the information under this item.





Item
4.  Controls and Procedures.





Disclosure
Controls and Procedures





We are required to maintain disclosure
controls and procedures that are designed to ensure that information required to
be disclosed in our reports filed under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information is accumulated and communicated to our management, including
our president (also our principal executive officer) and our chief financial
officer (also our principal financial and accounting officer) to allow for
timely decisions regarding required disclosure.





On October 9, 2007, American
International Dairy Holding Co. Inc. (“AIDH”) entered into an Agreement and Plan
of Reorganization and Merger (the “Merger Agreement”) with our predecessor
filer, Micro-Tech Identification Systems, Inc. (“Micro-Tech”), AIDH Acquisition,
Inc., Micro-Tech’s newly formed, wholly owned Nevada subsidiary (“Acquisition
Sub”), and Tryant, LLC, Micro-Tech’s majority shareholder, pursuant to
which:





·
            Acquisition
      Sub merged with and into AIDH, and AIDH, as the surviving corporation,
      became a wholly owned subsidiary of Micro-Tech (the
    “Merger”);




·
            Each
      share of AIDH’s capital stock issued and outstanding immediately prior to
      the closing of the Merger was converted into the right to receive 1.020833
      shares of Micro-Tech’s Common Stock (an aggregate of 24,305,546 shares of
      Micro-Tech’s Common Stock, par value $0.001 per share, were issued to the
      holders of AIDH’s capital stock);




·
            AIDH’s
      officers and directors replaced Micro-Tech’s officers and directors as
      officers and directors of the filing company;
  and




·
            The
      filing company succeeded to the business of AIDH as its sole line of
      business.




As a result of the transactions, there
was a change in control of the filing company, as the stockholders of AIDH
became the majority stockholders the filing company. For accounting purposes,
the transaction was accounted for as a reverse acquisition under the purchase
method. Accordingly, AIDH and its subsidiary are treated as the continuing
entity for accounting purposes. As a result of this transaction, we became
subject to the laws related to reporting companies, including the Sarbanes-Oxley
Act of 2002, as amended.





In connection with the audit for the
fiscal years ended December 31, 2008 and 2007, Windes & McClaughry
Accountancy Corporation (“Windes”), our independent registered public accounting
firm, noted matters involving our internal controls that it considered to be
significant deficiencies, and taken together constitute a material weakness,
under the standards of the Public Company Accounting Oversight Board, or PCAOB.
Under the PCAOB standards, a significant deficiency is a control deficiency, or
combination of control deficiencies, that, in Windes’s judgment, would adversely
affect the ability to initiate, authorize, record, process, or report external
financial data reliably in accordance with generally accepted accounting
principles such that there is more than a remote likelihood that a misstatement
of the annual or interim financial statements that is more than inconsequential
will not be prevented or detected. A material weakness is a significant
deficiency, or combination of significant deficiencies, that, in Windes’s
judgment, results in more than a remote likelihood that a material misstatement
of the annual or interim financial statements will not be prevented or
detected.


57





The material weaknesses identified by
Windes were as follows:





·
            Improper
      treatment of the effects of exchange rate changes on cash balances held in
      foreign currencies in the 2006 statements of cash flows;
    and




·
            Inadequate
      or incomplete review and analysis of certain contractual and other
      liabilities.




Our management has discussed these
material weaknesses with our board of directors and has engaged in the following
remediation efforts to ensure that the significant deficiencies do not
reoccur:





·
            We
      hired an outside consultant to assist with the preparation of our
      financial statements.




·
            We
      implemented new review and analysis processes for all significant
      contractual and other liabilities, including, without
      limitation:




(a)
            the
      requirement that white papers be prepared to document all material
      transactions;




(b)
            the
      establishment of checklists and timelines to insure timely reporting of
      financial information;




(c)
            the
      utilization of comparison review of Chinese accounting standards versus
      U.S. GAAP standards.




·
            We
      purchased, and are in the process of employing, new revenue accounting
      software.




In
addition, we retained an outside consultant to assist us with the
self-assessment required by Section 404 of the Sarbanes-Oxley Act of
2002.




These
remediation efforts are designed to address the material weakness identified by
Windes and to improve and strengthen our overall control environment. We believe
these actions will prevent the significant deficiencies from reoccurring. Our
management, including our principal executive officer and principal financial
officer, does not expect that disclosure controls or internal controls over
financial reporting will prevent all errors, even as the aforementioned
remediation measures are implemented and further improved to address all
deficiencies. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions.





The implementation of our remediation
plan will require substantial expenditures, could take a significant period of
time to complete, and could distract our officers and employees from the
operation of our business. However, our management believes that these
remediation efforts will be complete by the end of the 2009 fiscal
year.





Our management has evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures as of the date of this report, under the supervision and with the
participation of our president (also our principal executive officer) and chief
financial officer (also our principal financial and accounting officer), in
order to conclude if our disclosure controls and procedures are effective. Based
on the information set forth above, our management has determined that, as of
the date of this report, we do not have effective disclosure controls and
procedures.


58





Changes
in Internal Control Over Financial Report




In its
Annual Report on Form 10-K for the fiscal year ended December 31, 2008 (the
“Annual Report”), our management reported that, as of the date of such report,
our internal control over financial reporting was not effective. In the first
quarter of fiscal 2009, an outside consultant we retained to assist us with the
self-assessment required by Section 404 of the Sarbanes-Oxley Act of 2002,
completed the documentation of our internal controls and procedures. However,
upon review of the work product, our management determined that the prepared
documentation did not contain sufficient detail. Therefore, in the first quarter
of 2009, we retained an additional consultant to help management refine such
documentation. That consultant has not yet completed the documentation of our
internal controls and procedures.





Based
upon the foregoing, our management has determined that there were no changes in
our internalcontrol over financial
reporting, identified in connection with the evaluation that occurredduring our last fiscal
quarter, under the supervision and with the participation of our president (also
our principal executive officer) and chief financial officer (also our principal
financial and accounting officer), that materially affected, or are reasonable
likely tomaterially affect, our
internal control over financial reporting.


59


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 Securities Exchange Act of 1934 and are not
required to provide the information under this item.





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





In the three-month period ended June
30, 2009, and subsequent period through the date hereof, we did not consummate
any unregistered sales of equity securities, except as follows:





Second
Warrant Tender Offer





As of June 19, 2009, we commenced an
offer (the “Second Warrant Tender Offer”) to all holders of warrants to purchase
shares of our common stock, having exercise prices of either $0.94, $1.50,
$1.63, $2.04 or $3.26 per share, originally issued in connection with the
October Offerings (the “Original Warrants”), the opportunity to voluntarily
exchange any or all of the Original Warrants for amended warrants exercisable at
reduced exercise prices (“Amended Warrants”), for a limited period of
time.





The terms
of the Amended Warrants, include the following:





·
            With
      respect to the 373,344 warrants having an exercise price of $0.94 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $0.75 per
      share;





·
            With
      respect to the 1,333,333 warrants having an exercise price of $1.50 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.20 per
      share;





·
            With
      respect to the 235,583 warrants having an exercise price of $1.63 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.30 per
      share;





·
            With
      respect to the 955,190 warrants having an exercise price of $2.04 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.63 per
      share; and





·
            With
      respect to the 4,732,036 warrants having an exercise price of $3.26 per
      share, a holder accepting the Second Warrants Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.63 per
      share.





On August
13, 2009, we closed the Second Warrant Tender Offer. In connection with the
Second Warrant Tender Offer:


60





·
            a
      total of 49,000 Original Warrants with an exercise price of $2.04 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share; and




·
            a
      total of 2,205,828 Original Warrants with an exercise price of $3.26 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share.




The only
differences between the Original Warrants and the Amended Warrants issued in
connection with the Second Warrant Tender Offer, are that the Amended
Warrants:





·
            have
      the lower exercise prices described
above;





·
            will
      expire on August 28, 2009, and the expiration date will not be extended
      for our failure to register the underlying
  shares;





·
            will
      not be subject to the limitation contained in the 2007 Warrants, which
      provides that the 2007 Warrants may not be exercised if the exercise would
      cause the holder and its affiliates to hold an aggregate of more than 9.9%
      of the outstanding shares of our common stock;
  and





·
            must
      be exercised for cash, as a cashless exercise of the Amended Warrants will
      not be permitted.





We
believe that the issuance of the Amended Warrants in this transaction is
exempt from registration under the Securities Act of 1933, as amended, pursuant
to Section 3(a)(9), thereunder (and/or Section 4(2), as a transaction by an
issuer not involving a public offering).





Issuance
of Shares of Common Stock to Consultant





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 June
30, 2009, we issued 37,804 shares of common stock to the consultant, with a fair
value of $33,475, pursuant to the IR Agreement. The fair value of the stock was
determined by the closing price of the stock on the 10th day of each month,
which is the day the number of shares is determined.





We
believe that this transaction is exempt from registration under the Securities
Act of 1933, as amended, pursuant to Section 4(2), or Regulation D promulgated
thereunder, as transactions by an issuer not involving a public offering.




Issuance
of Additional Warrants to Placement Agent




In June
2008, we sold to two investors (the “Investors”) an aggregate of (i) $2,250,000
of promissory notes (the “Original Notes”) and (ii) warrants to purchase 225,000
shares of our common stock (the “Original Warrants”). As of December 31, 2008,
we entered into an Amendment with the Investors (the “Amendment”), pursuant to
which the Investors received Amended and Restated Notes in exchange for the
Original Notes, and Amended and Restated Warrants in exchange for the Original
Warrants. As of July 4, 2009, in consideration for its services in connection
with the Amendment, we issued a placement agent warrants to purchase 97,500
shares of common stock, exercisable either for cash, at an exercise price of
$1.63 per share, or on a cashless basis. These warrants will expire on December
31, 2011.




61





We believe that this transaction is
exempt from registration under the Securities Act of 1933, as amended, pursuant
to Section 4(2), or Regulation D promulgated thereunder, as transactions by an
issuer not involving a public offering.





Item
3.          Defaults Upon Senior
Securities.





In the three-month period ended June
30, 2009, and subsequent period through the date hereof, we did not default upon
any senior securities.





Item
4.          Submission of Matters
to a Vote of Security Holders.





In the
three-month period ended June 30, 2009, and subsequent period through the date
hereof, we did not submit any matters to a vote of our security
holders.





Item
5.          Other
Information.




As of
June 19, 2009, we commenced an offer (the “Second Warrant Tender Offer”) to allholders of warrants to
purchase shares of our common stock, having exercise prices of either $0.94,
$1.50, $1.63, $2.04 or $3.26 per share, originally issued in connection with the
October Offerings (the “Original Warrants”), the opportunity to voluntarily
exchange any or all of the Original Warrants for amended warrants exercisable at
reduced exercise prices (“Amended Warrants”), for a limited period of time.
 
 The terms
of the Amended Warrants, include the following:
 
 ·
              With
      respect to the 373,344 warrants having an exercise price of $0.94 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $0.75 per
      share;
 
 ·
              With
      respect to the 1,333,333 warrants having an exercise price of $1.50 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.20 per
      share;
 
 ·
              With
      respect to the 235,583 warrants having an exercise price of $1.63 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.30 per
      share;
 
 ·
              With
      respect to the 955,190 warrants having an exercise price of $2.04 per
      share, a holder accepting the Second Warrant Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.63 per
      share; and
 
 ·
              With
      respect to the 4,732,036 warrants having an exercise price of $3.26 per
      share, a holder accepting the Second Warrants Tender Offer may exchange
      some or all of the warrants for amended warrants exercisable at $1.63 per
      share.
 
 On August
13, 2009, we closed the Second Warrant Tender Offer. In connection with the
Second Warrant Tender Offer:
 
 ·
              a
      total of 49,000 Original Warrants with an exercise price of $2.04 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share; and
  ·
              a
      total of 2,205,828 Original Warrants with an exercise price of $3.26 per
      share were exchanged for Amended Warrants with a reduced exercise price of
      $1.63 per share.
  The only
differences between the Original Warrants and the Amended Warrants issued in
connection with the Second Warrant Tender Offer, are that the Amended
Warrants:
 
 ·
              have
      the lower exercise prices described
above;
 
 ·
              will
      expire on August 28, 2009, and the expiration date will not be extended
      for our failure to register the underlying
  shares;
 
 ·
              will
      not be subject to the limitation contained in the Original Warrants, which
      provides that the Original Warrants may not be exercised if the exercise
      would cause the holder and its affiliates to hold an aggregate of more
      than 9.9% of the outstanding shares of our common stock;
    and
 
 ·
              must
      be exercised for cash, as a cashless exercise of the Amended Warrants will
      not be permitted.
 
 Since the
Amended Warrants have exercise periods shortened to fifteen (15) days following
the expiration of the Second Warrant Tender Offer, any warrant holder that
exchanged its Original Warrants for Amended Warrants in the Second Warrant
Tender Offer who wishes to exercise the Amended Warrants received in
connection therewith must do so on or before August 28, 2009. If all of the
Amended Warrants are exercised at the reduced exercise price of $1.63, we will
receive gross proceeds of $3,675,370.We intend to apply any
proceeds receivedin connection with the exercise of the
AmendedWarrants toward the cost of completing
the construction and equipping of our new productionfacility. However, we will retain broad
discretionover the use of
the net proceeds and may use the money for other
corporate purposes.


62




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




63




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: August 14, 2009
                By:
                
                /s/
      Yang Yong ShanYang
      Yong ShanChairman,
      Chief Executive Officer andPresidentDated: August 14, 2009
                By:
                
                /s/
      Shu
      KanekoShu
      KanekoChief
      Financial Officer and
Secretary




64