UNITED STATES


SECURITIES AND EXCHANGE
COMMISSION


WASHINGTON, D.C.
20549


__________





FORM
10-Q/A


(Amendment No. 1)





(Mark
      One)x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended:June 30,
      2008ORo
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      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.


Yes x No o


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


Yes o No x




As of
August 14, 2008, the issuer had 29,299,332 shares of Common Stock issued and
outstanding (not including an additional 1,944,444 shares of Common Stock of the
issuer currently being held in treasury).





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 filero
            Accelerated
      fileroNon-accelerated
      filerx
            Smaller
      reporting companyx









AMENDMENT
NO. 1 TO QUARTERLY REPORT ON FORM
10-Q


OF EMERALD DAIRY INC. AND
SUBSIDIARIES


FOR THE PERIOD ENDED JUNE 30,
2008





TABLE OF CONTENTS





PAGEPART I
              -
              FINANCIAL
      INFORMATIONItem
      1.
              
              Financial
      Statements
              2Condensed
      Consolidated Balance Sheets as of June 30, 2008 (Unaudited) and
      December 31, 2007
              2Condensed
      Consolidated Statements of Income for the Three and Six Months Ended
      June 30, 2008 and 2007 (Unaudited)
              3Condensed
      Consolidated Statements of Cash Flows for the Six Months Ended June
      30, 2008 and 2007 (Unaudited)
              4Footnotes
      to Condensed Consolidated Financial Statements (Unaudited)
              5Item
      2.
              
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              21Item
      3
              
              Quantitative
      and Qualitative Disclosures About Market Risk
              48Item
      4T.
              
              Controls
      and Procedures
              48PART II
              -
              OTHER
      INFORMATIONItem
      1.
              
              Legal
      Proceedings
              51Item
      1A.
              
              Risk
      Factors
              51Item
      2.
              
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              51Item
      3.
              
              Defaults
      Upon Senior Securities
              52Item
      4.
              
              Submission
      of Matters to a Vote of Security Holders
              52Item
      5.
              
              Other
      Information
              53Item
      6.
              
              Exhibits
              53Signatures
              54




EXPLANATORY NOTE
 
 This Amendment No. 1 to the Quarterly Report on Form
10-Q (“10-Q/A”), for the fiscal quarter ended June 30, 2008, of Emerald Dairy
Inc. (as originally filed on August 14, 2008, the "Form 10-Q"), is being filed
in response to comments from the Staff of the Securities and Exchange Commission
(“Commission”).  The Form 10-Q is restated herein in its entirety. The
disclosures in this amendment continue to speak as of the date of the Form 10-Q,
and do not reflect events occurring after the filing of the Form 10-Q.
Accordingly, this Form 10-Q/A should be read in conjunction with our other
filings made with the Commission subsequent to the filing of the Form 10-Q,
including any amendments to those filings. The filing of this Form 10-Q/A shall
not be deemed an admission that the Form 10-Q filed included any untrue
statement of material fact or omitted to state a material fact necessary to make
a statement not misleading.
  The Company has attached to this 10-Q/A updated
certifications executed as of the date of this Form 10-Q/A by the principal
executive officer and principal financial and accounting officer, as required by
Sections 302 and 906 of the Sarbanes Oxley Act of 2002. These updated
certifications are attached as Exhibits 31.1, 31.2, 32.1 and 32.2 to this
10-Q/A.




1


PART I. FINANCIAL
INFORMATION





Item 1. Financial
Statements


Emerald Dairy Inc. and
Subsidiaries


Condensed Consolidated Balance
Sheet


June 30, 2008 and December 31,
2007





2008
            
            2007(Unaudited)
            
            (Audited)ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            3,821,111
            
            $
            6,560,931Trade
      accounts receivable
            
            
            6,973,861
            
            
            5,096,828Inventory
            
            
            2,274,328
            
            
            1,000,427Advances
      to equipment suppliers
            
            
            3,695,928
            
            
            -Other
      current assets
            
            
            3,618,880
            
            
            3,936,751Total current
      assets
            
            
            20,384,108
            
            
            16,594,937Property, plant and equipment,
      net
            
            
            3,715,262
            
            
            3,320,081Intangible assets,
      net
            
            
            1,392,585
            
            
            115,228$
            25,491,955
            
            $
            20,030,246LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      LiabilitiesAccounts
      and accrued expenses
            
            $
            3,981,539
            
            $
            2,395,190Notes
      payable, net of debt discount of $191,834 at June 30, 2008
            
            
            2,058,166
            
            
            273,973Other
      current liabilities
            
            
            687,466
            
            
            614,977Loan
      from shareholder
            
            
            209,305
            
            
            196,526Total current
      liabilities
            
            
            6,936,476
            
            
            3,480,666Put/Call
      Liability
            
            
            3,169,444
            
            
            3,169,444Stockholders'
      EquityPreferred
      stock ($0.001 par value, 10,000,000 shares authorized, none issued and
      outstanding at June 30, 2008 and December 31, 2007)
            
            
            -
            
            
            -Common
      stock ($0.001 par value, 100,000,000 shares authorized, 31,243,776 issued
      and outstanding at June 30, 2008 and December 31, 2007)
            
            
            31,244
            
            
            31,241Treasury
      Stock (1,944,444 shares at June 30, 2008 and December 31,
      2007)
            
            
            (1,944
            )
            
            (1,944
            )Additional
      paid-in capital
            
            
            4,923,348
            
            
            4,666,244Retained
      earnings
            
            
            8,493,063
            
            
            7,791,895Accumulated
      other comprehensive income
            
            
            1,940,324
            
            
            892,700Total stockholders'
      equity
            
            
            15,386,035
            
            
            13,380,136$
            25,491,955
            
            $
            20,030,246





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





2





Emerald Dairy Inc. and
Subsidiaries


Condensed Consolidated Statements of
Income


For the Three and Six Months Ended
June 30, 2008 and 2007


(Unaudited)





Three months
      ended
            
            Six months
      endedJune 30,
            
            June 30,
            
            June 30,
            
            June 30,2008
            
            2007
            
            2008
            
            2007Sales
            
            $
            10,904,778
            
            $
            6,645,580
            
            $
            21,339,237
            
            $
            12,528,194Cost of Goods
      Sold
            
            
            7,281,163
            
            
            4,926,820
            
            
            13,292,397
            
            
            8,430,391Gross
    Profit
            
            
            3,623,615
            
            
            1,718,760
            
            
            8,046,840
            
            
            4,097,803Operating
      ExpensesSelling
      and administrative expenses
            
            
            2,634,812
            
            
            722,224
            
            
            6,964,150
            
            
            2,423,732Depreciation
      and amortization
            
            
            15,570
            
            
            11,986
            
            
            30,431
            
            
            23,845Total operating
      expenses
            
            
            2,650,382
            
            
            734,210
            
            
            6,994,581
            
            
            2,447,577Other Income
      (Expense)Interest
      income
            
            
            3,978
            
            
            1,802
            
            
            9,606
            
            
            2,632Interest
      expense
            
            
            (42,150
            )
            
            (5,172
            )
            
            (43,406
            )
            
            (8,590
            )Total
      other income (expense)
            
            
            (38,172
            )
            
            (3,370
            )
            
            (33,800
            )
            
            (5,958
            )Net Income Before Provision for
      Income Tax
            
            
            935,061
            
            
            981,180
            
            
            1,018,459
            
            
            1,644,268Provision for Income
      TaxesCurrent
            
            
            236,711
            
            
            58,350
            
            
            317,291
            
            
            82,652Deferred
            
            
            -
            
            
            -
            
            
            -
            
            
            -236,711
            
            
            58,350
            
            
            317,291
            
            
            82,652Net
    Income
            
            $
            698,350
            
            $
            922,830
            
            $
            701,168
            
            $
            1,561,616Basic Earnings Per
      Share
            
            $
            0.02
            
            $
            0.04
            
            $
            0.02
            
            $
            0.07Basic Weighted Average Shares
      Outstanding
            
            
            29,299,332
            
            
            23,536,315
            
            
            29,299,332
            
            
            21,674,862Diluted Earnings Per
      Share
            
            $
            0.02
            
            $
            0.04
            
            $
            0.02
            
            $
            0.07Diluted Weighted Average Shares
      Outstanding
            
            
            29,563,708
            
            
            23,536,315
            
            
            29,563,708
            
            
            21,674,862The Components of Other
      Comprehensive IncomeNet
      Income
            
            $
            698,350
            
            $
            922,830
            
            $
            701,168
            
            $
            1,561,616Foreign
      currency translation adjustment
            
            
            440,717
            
            
            (274,045
            )
            
            1,375,312
            
            $
            156,667Income
      tax related to other comprehensive income
            
            
            (149,844
            )
            
            93,175
            
            
            (467,606
            )
            
            (53,267
            )Comprehensive
      Income
            
            $
            989,223
            
            $
            741,960
            
            $
            1,608,874
            
            $
            1,665,016





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





3





Emerald Dairy Inc. and
Subsidiaries


Condensed Consolidated Statements of
Cash Flows


For the Six Months Ended June 30,
2008 and 2007





2008
            
            2007(Restated)


Cash flows from operating
      activitiesNet
    Income
              
              $
              701,168
              
              $
              1,561,616Adjustments to reconcile net
      cash provided byoperating
      activitiesDepreciation
      and amortization
              
              
              193,559
              
              
              68,263Amortization
      of loan discount
              
              
              18,766
              
              
              -Net change in assets and
      liabilitiesTrade
      accounts receivable
              
              
              (1,565,617
              )
              
              (26,013
              )Inventory
              
              
              (1,212,775
              )
              
              292,043Advance
      to suppliers and other receivables
              
              
              -
              
              
              (184,695
              )Deposits
              
              
              604,913
              
              
              -Accounts
      payable and accrued expenses
              
              
              1,440,003
              
              
              (161,573
              )Advances
      from employees
              
              
              34,914
              
              
              (212,681
              )Taxes
      payable
              
              
              -
              
              
              (16,215
              )Net
      cash provided by (used in) operating
      activities
              
              
              214,931
              
              
              (114,644
              )




Cash flows from investing
      activitiesDeposit on equipment
      purchase
                
                
                (3,695,928
                )
                
                -Purchases
      of fixed assets and intangibles
                
                
                (1,656,200
                )
                
                (521,169
                )Net cash used in investing
      activities
                
                
                (5,352,128
                )
                
                (521,169
                )Cash flows from financing
      activitiesSale
      of stock for cash
                
                
                -
                
                
                2,000,000Repayments
      of notes payable
                
                
                (290,713
                )
                
                -Advances
      on notes payable
                
                
                2,250,000
                
                
                262,709Loans
      from shareholders
                
                
                -
                
                
                (52,188
                )Net cash provided by financing
      activities
                
                
                1,959,287
                
                
                2,210,521Effect of exchange
      rate
                
                
                438,090
                
                
                (34,019
                )Net increase (decrease) in
      cash
                
                
                (2,739,820
                )
                
                1,540,689Cash and cash equivalents at
      beginning of period
                
                
                6,560,931
                
                
                641,164Cash and cash equivalents at
      end of period
                
                $
                3,821,111
                
                $
                2,181,853





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





4




Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





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 through
its wholly owned subsidiaries.




American
International Dairy Holdings, Inc., a Nevada corporation, was formed in 2005 for
the purpose of acquiring the stock in HeilongjiangXing An Ling Dairy, Co. On
May 30, 2005, AIDH, pursuant to the Share Transfer Agreement acquired HeilongjiangXing An Ling Dairy Co.
Limited, (XAL) a corporation formed on September 8, 2003 in Heilongjiang Providence, The People’s
Republic of China, (PRC). 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, soybean and rice powder. Through
the Company’s network of over 600 salespeople, the Company’s products are
distributed throughout 20 provinces in the People’s Republic of China, and sold
in over 5,600 retail outlets.





Prior to
September 23, 2006, XAL owned 57.69% of Heilongjiang Beian 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”), under the laws of the PRC. In July
2008, HXD commenced construction of a production facility in Hailun City,
Heilongjiang Province, PRC. The Company estimates that the cost of the new
facility, including land use rights, construction and equipment, will be
approximately $20.0 million. It is anticipated that HXD will engage in the
manufacture of the Company's milk, soybean and rice powder products at this new
facility, beginning in the first quarter of 2009.





2.
            Basis of Preparation of
      Financial Statements





XAL and
LvBao 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, 2007.





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, 2008 and the results of their
operations for the three and six months ended June 30, 2008 and 2007, and cash
flows for the six months ended June 30, 2008 and 2007. The results of operations
for the three and six months ended June 30, 2008 and 2007 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).





5





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





2.
            Basis of Preparation of
      Financial Statements
(Continued)





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 were eliminated.





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 including, 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 and stock warrant valuation. Actual results may differ from
these estimates.





Foreign Currency - The
Company’s principal country of operations is The People’s Republic of China. The
financial position and results of operations of the Company are determined using
the local currency (“Renminbi” or “Yuan”) as the functional currency. The
results of operations denominated in foreign currency are translated at the
average rate of exchange during the reporting period.




Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the exchange rates prevailing at the balance sheet date. The
registered equity capital denominated in the functional currency is translated
at the historical rate of exchange at the time of capital contribution. All
translation adjustments resulting from the translation of the financial
statements into the reporting currency (“US Dollars”) are dealt with as a
separate component within stockholders’ equity. Translation adjustments totaled
$440,717 and $1,375,312, for the three and six months ended June 30, 2008,
respectively. Translation adjustments totaled $(274,045) and $103,400 for the three and six months ended
June 30, 2007, respectively.





As of
June 30, 2008 and 2007, the exchange rate was 6.8543 Yuan and 7.613 Yuan 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, 2008, the Company has no sales or contracts that included multiple
deliverables that would fall under the scope of 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.





6





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007


3.
                Summary of Significant
      Accounting Policies
(Continued)
 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 SFAS 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 financials
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 9) expires. The Company does not
have any significant deferred tax asset or liabilities that relate to tax
jurisdictions not covered by the tax holiday.
 
 The
Company does not accrue United States income tax on unremitted earnings from
foreign operations, as it is the Company’s intention to invest these earnings in
the foreign operations indefinitely.




Enterprise income
tax





Under the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the State Council which came into effect on
January 1, 1994, income tax is payable by a Wholly Foreign Owned Enterprises at
a rate of 15% of their taxable income. Preferential tax treatment may, however,
be granted pursuant to any law or regulations from time to time promulgated by
the State Council. XAL enjoyed a 100% exemption from enterprise income taxes
starting on January 10, 2006 due to its classification as a “Wholly Foreign
Owned Enterprise.” On March 16, 2007, The People’s Republic of China 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 will qualify 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 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.





Recent accounting
pronouncements





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements (SFAS
157). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting
principles, and expands disclosures about fair value measurements. This
statement does not require any new fair value measurements; rather, it applies
under other accounting pronouncements that require or permit fair value
measurements. The provisions of this statement are to be applied prospectively
as of the beginning of the fiscal year in which this statement is initially
applied, with any transition adjustment recognized as a cumulative-effect
adjustment to the opening balance of retained earnings. The provisions of SFAS
157 are effective for the fiscal years beginning after November 15, 2007.
The adoption of this standard did not have a material impact on our financial
condition, results of operations or cash flows.





7





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





3.
            Summary of Significant
      Accounting Policies
(Continued)


In
September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans (SFAS No. 158), an amendment of FASB Statements No. 87, 88, 106
and 132(R). SFAS No. 158 requires (a) recognition of the funded
status (measured as the difference between the fair value of the plan assets and
the benefit obligation) of a benefit plan as an asset or liability in the
employer’s statement of financial position, (b) measurement of the funded
status as of the employer’s fiscal year-end with limited exceptions, and
(c) recognition of changes in the funded status in the year in which the
changes occur through comprehensive income. The requirement to recognize the
funded status of a benefit plan and the disclosure requirements are effective as
of the end of the fiscal year ending after December 15, 2006. The
requirement to measure the plan assets and benefit obligations as of the date of
the employer’s fiscal year-end statement of financial position is effective for
fiscal years ending after December 15, 2008. This Statement has no current
applicability to the Company’s financial statements. Management adopted this
Statement on December 31, 2006 and the adoption of SFAS No. 158
did not have a material impact to the Company’s financial position, results of
operations, or cash flows.
 
 In
February 2007, the FASB issued Statement No. 159 The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS
159). This statement permits companies to choose to measure many financial
assets and liabilities at fair value. Unrealized gains and losses on items for
which the fair value option has been elected are reported in earnings. SFAS 159
is effective for fiscal years beginning after November 15, 2007. The adoption of
this standard did not have a material impact on our financial condition, results
of operations or cash flows.
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (SFAS
141(R)). SFAS 141(R) will change the accounting for business combinations. Under
SFAS No. 141(R), an acquiring entity will be required to recognize all the
assets acquired and liabilities assumed in a transaction at the acquisition-date
fair value with limited exceptions. SFAS No. 141(R) will change the
accounting treatment and disclosure for certain specific items in a business
combination. SFAS No. 141(R) applies prospectively to business combinations
for which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. SFAS 141(R) will
impact the Company in the event of any future acquisition.
  In
December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51 (SFAS
160). SFAS 160 establishes new accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS No. 160 is effective for fiscal years beginning on or
after December 15, 2008. The Company does not believe that SFAS 160 will
have a material impact on its consolidated financial statements.
  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. The guidance in SFAS 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application encouraged. This Statement
encourages, but does not require, comparative disclosures for earlier periods at
initial adoption. The Company is currently assessing the impact of SFAS
161.




8


Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 
 3.
              Summary of Significant
      Accounting Policies
(Continued)


In June
2008, the Emerging Issues Task Force (EITF) reached a 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 Issue No. 98-5 to Certain Convertible
Instruments.”Moreover, some of the conclusions in Issue No. 98-5 and 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 Issue No. 98-5 were
subsequently updated to reflect the issuance of Issue No. 00-27 and SFAS No.
150, the transition guidance in Issue No. 98-5 was not revised. The EITF reached
a consensus on Issue No. 08- 4, which
provides such guidance and requires that (1) conforming changes made to Issue
No. 98-5 resulting from Issue No. 00-27 and SFAS No. 150 be effective for
financial statements of fiscal years ending after December 15, 2008, with early
application allowed, and (2) the effect of applying the conforming changes be
presented retrospectively (with the cumulative effect of the change reported in
retained earnings as of the beginning of the first period presented). The
Company is currently assessing the impact of EITF Issue 08-4.





4.
            Concentrations of Business and
      Credit Risk





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 Federal Deposit Insurance Corporation up to $100,000. As of June 30, 2008
$236,681 of U.S. cash balances are in excess of insured amounts.





The
Company operates in China, which may give rise to significant foreign currency
risks from fluctuations and the degree of volatility of foreign exchange rates
between U.S. dollars and the Chinese currency RMB.





Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash and trade 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
six months ended June 30, 2008 and 2007, no single customer accounted for 10% or
more of sales revenues.





As of
June 30, 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 from foreign subsidiaries may be subject to some restrictions.





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.





9





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





5.
            Inventory





As of
June 30, 2008 and December 31, 2007 inventory consists of the
following:





2008
            
            2007Raw
      materials
            
            $
            1,808,549
            
            $
            634,018Work-in-process
            
            
            389,661
            
            
            349,334Finished
      goods
            
            
            66,694
            
            
            8,490Repair
      parts
            
            
            9,424
            
            
            8,585$
            2,274,328
            
            $
            1,000,427




6.
            Other current
      assets





As of
June 30, 2008 and December 31, 2007, other current assets consist of the
following:





2008
            
            2007Advances
      to milk suppliers
            
            $
            371,273
            
            $
            652,398Deposit
      on building purchase
            
            
            1,172,985
            
            
            1,101,370Deposit
      on new facility site
            
            
            574,821
            
            
            539,725Deposit
      on contract
            
            
            1,163,613
            
            
            1,534,247Other
      Receivables
            
            
            50,000
            
            
            50,000Advances
      to staff
            
            
            13,703
            
            
            18,924Prepaid
      expenses
            
            
            272,485
            
            
            40,087$
            3,618,880
            
            $
            3,936,751




7.
            Property, Plant, and
      Equipment





As of
June 30, 2008 and December 31, 2007, Property, Plant, and Equipment consist of
the following:





2008
            
            2007Building
            
            $
            1,147,407
            
            $
            1,007,475Plant
      and Machinery
            
            
            2,938,882
            
            
            2,512,451Motor
      vehicles
            
            
            524,500
            
            
            459,547Dairy
      cows
            
            
            233,183
            
            
            211,220Office
      equipment
            
            
            43,432
            
            
            52,6964,887,403
            
            
            4,243,389Less:
      Accumulated depreciation
            
            
            (1,172,142
            )
            
            (923,308
            )$
            3,715,262
            
            $
            3,320,081




Depreciation
expenses totaled $94,396 and $183,302 for the three and six months ended June
30, 2008, respectively, and $37,149 and $105,412 for the three and six months
ended June 30, 2007, respectively. $78,826 and $152,871 were included as a
component of cost of goods sold for the three and six months ended June 30,
2008, respectively, and $25,163 and $81,567 for the three and six months ended
June 30, 2007, respectively.





10





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





8.
            Intangible
      Assets





June 30,
              2008
            
            December 31,
              2007Land
      use rights
            
            $
            1,350,190
            
            $
            66,839Patents
            
            
            52,959
            
            
            49,7261,403,149
            
            
            116,565Less:
      Accumulated amortization
            
            
            (10,564
            )
            
            (1,337
            )$
            1,392,585
            
            $
            115,228




For the
three and six months ended June 30, 2008, amortization expenses totaled $5,813
and $8,187, respectively. There was no amortization for the six months ended
June 30, 2007.





9.
            Income
    Taxes





On May
30, 2005, American International Dairy Holdings, Inc. executed a Share Transfer
Agreement with Heilongjiang Xing An Ling Dairy Co., Ltd.,
a corporation organized and existing under the laws of People’s Republic of
China. 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 33%.





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 30,2008
                
                2007
                
                2008
                
                2007U.S.
      Operations
                
                $
                (815,000
                )
                $
                (39,000
                )
                $
                (1,189,000
                )
                $
                (53,000
                )Chinese
      Operations
                
                
                1,751,000
                
                
                1,020,000
                
                
                2,208,000
                
                
                1,698,000$
                936,000
                
                $
                981,000
                
                $
                1,019,000
                
                $
                1,645,000
 11
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 
 9.
              Income Taxes
      (Continued)




The
components of the provision for income taxes are approximately as
follows:


Three Months
                Ended June 30,
              
              Six Months
                Ended June 30,2008
              
              2007
              
              2008
              
              2007Federal,
      State and Local
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Peoples
      Republic of China -Federal and Local
              
              
              236,700
              
              
              58,300
              
              
              317,000
              
              
              82,600$
              236,700
              
              $
              58,300
              
              $
              317,000
              
              $
              82,600




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 30,2008
            
            2007
            
            2008
            
            2007Income
      tax provision at Federal statutory rate
            
            $
            319,000
            
            $
            334,000
            
            $
            347,000
            
            $
            559,000State
      income taxes, net of Federal benefit
            
            
            57,000
            
            
            59,000
            
            
            62,000
            
            
            99,000U.S.
      tax rate in excess of foreign tax rate
            
            
            (123,000
            )
            
            (72,000
            )
            
            (155,000
            )
            
            (119,000
            )Abatement
      of foreign income taxes
            
            
            (339,300
            )
            
            (277,700
            )
            
            (408,000
            )
            
            (477,400
            )Increase
      in valuation allowance
            
            
            323,000
            
            
            15,000
            
            
            471,000
            
            
            21,000$
            236,700
            
            $
            58,300
            
            $
            317,000
            
            $
            82,600




The
Company has a U.S. net operating loss carryforwardsof approximately $792,000 as
of December 31, 2007 which expires in 2027. The deferred tax asset associated
with these net operating loss carryforwards was fully reserved as of June 30,
2008.





The
change in the valuation allowance as of June 30, 2008 and 2007 was $471,000 and
$21,000, respectively.





The
effects of the tax exemption per share were as follows:





Three
      Months
              Ended June 30,
            
            Six
      Months
              Ended June 30,2008
            
            2007
            
            2008
            
            2007Tax
      Saving
            
            $
            339,300
            
            $
            277,700
            
            $
            408,000
            
            $
            477,400Benefit
      per share:Basic
            
            $
            0.01
            
            $
            0.01
            
            $
            0.01
            
            $
            0.02Diluted
            
            $
            0.01
            
            $
            0.01
            
            $
            0.01
            
            $
            0.02


12
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 
 9.
                Income Taxes
      (Continued)
 Had the
tax exemption not been in place for the three and six months ended June 30, 2008
and 2007, the Company estimates the following pro forma financial statement
impact.
 
 Three Months
                Ended June 30,
              
              Six Months
                Ended June 30,2008
              
              2007
              
              2008
              
              2007Net
      income before tax provision, as reported
              
              $
              936,000
              
              $
              981,000
              
              $
              1,019,000
              
              $
              1,644,000Less
      Tax provision not exempted
              
              
              236,700
              
              
              58,300
              
              
              317,000
              
              
              82,700Less
      Tax provision exempted
              
              
              339,300
              
              
              277,700
              
              
              408,000
              
              
              477,400$
              360,000
              
              $
              645,000
              
              $
              294,000
              
              $
              1,083,900
  10.
              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, 2008 and 2007, respectively, the Company contributed
$27,910, $54,813, $22,893 and $45,043 in pension
contributions.





11.
            Notes
      payable





In June
2008, the Company sold 8% promissory notes maturing December 31, 2008 and
three-year warrants to purchase 225,000 shares of common stock at an exercise
price of $2.61 for $2,250,000. Any amount of principal or interest outstanding
after December 31, 2008 will bear interest at a rate of 12%. In accordance with
Accounting Principles Board Opinion No. 14, "Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants", the proceeds from issuance of the
notes were allocated to the notes and warrants based upon their relative fair
values. This allocation resulted in allocating $210,600 to the warrants to be
treated as loan discount to be amortized over the life of the notes. During the
three and six months ended June 30, 2008, $18,766 of the loan discount was
amortized to interest expense. The following assumptions were used to calculate
the fair value of the warrants using the Black - Scholes Model:





Dividend
      yield
            
            
            0
            %Expected
      volatility
            
            
            118.01
            %Risk-free
      interest rate
            
            
            3.17
      - 3.35
            %Expected
      life
            
            
            3
      yearsStock
      price
            
            $
            1.63Exercise
      price
            
            $
            2.61





13


Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 11.
                Notes payable
      (Continued)
 The notes
may be prepaid in their entirety without penalty upon 15 day notice. So long as
the Company has any obligation under the notes, there are limitations on its
ability to: (a) pay dividends or make other distributions on its capital stock;
(b) redeem, repurchase or otherwise acquire any of its securities; (c) create,
incur or assume any liability for borrowed money; (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.





In
connection with the sale of the notes in June 2008, the Company paid a placement
agent $122,500 in fees and delivered 45,000 three- year warrants to purchase
45,000 shares of common stock at an exercise price of $2.61. The warrants were
valued at $46,507 using a Black-Scholes Model and together with the fee were
treated as deferred issuance costs to be amortized over the life of the notes.
Deferred
issuance costs are included in prepaid expenses in the consolidated balance
sheet. The following assumptions were used to calculate the fair
value of the warrants:





Dividend
      yield
            
            
            0
            %Expected
      volatility
            
            
            118.01
            %Risk-free
      interest rate
            
            
            3.35
            %Expected
      life
            
            
            3
      yearsStock
      price
            
            $
            1.63Exercise
      price
            
            $
            2.61





In
connection with the sale of notes in June 2008, the Company paid legal fees of
$15,000 that were treated as deferred issuance costs and are being amortized
over the life of the notes.





12.
            Related-Party
      Transactions




On May
28, 2006, the Company purchased machinery, facilities, housing and 100 cows from
a stockholder of the Company for a note of $209,305, which approximated
historical cost of these assets. The note does not bear interest and is due on demand. Since
the note does not have a set repayment date, interest is not being imputed on the principal amount under the
note.





13.
            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.
  14


Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 
 13.
              Put/Call Liability
      (Continued)
 T he
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.





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”).





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 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. As of June 30, 2008 there has been no change in the Put/Call liability as
the fair market value of the underlying common stock has not
changed.





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).





15





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





14.
            Equity





Registration Rights
Agreement





On
October 9, 2007 and October 19, 2007, the Company entered into Registration
Rights Agreements (each, a “Registration Rights Agreement,” and collectively the
“Registration Rights Agreements”) with the accredited investors,( the
“Investors”), pursuant to which it agreed that within thirty (30) business days
of the Closing Date (the Filing Date), the Company will file a registration
statement (the Registration Statement) with the Securities and Exchange
Commission (the “Commission”) covering the resale of (i) the shares of Common
Stock purchased in the above placements (collectively, the “Offerings”) (the
“Purchased Shares”), (ii) the Common Stock issuable upon exercise of the
warrants issued in the Offerings (the “Registrable Securities”). Further, the
Company agreed to use its 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, the Company will be required to pay
liquidated damages (payable in cash in arrears at the end of each month during
which a registration default occurs and is continuing) to the holders of the
Purchased Shares, the First Investor Warrants, the Class A Warrants, the Class B
Warrants, or the Common Stock issued upon exercise of the First Investor
Warrants, Class A Warrants and Class B Warrant (collectively, the “Securities”)
if (i) the Company fails 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) the Company fails to request acceleration of
effectiveness within five (5) business days of a notice of no further review
from the Commission, (iv) the Company fails to respond to the Commission within
ten (10) business days of receipt by the Company 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 the Company
suspends 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 the
Company suspends 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 the Company unable to comply with
SEC requirements, or (B) for more than sixty (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 the Securities offered for each thirty (30) day period during
which a registration default is continuing; provided, however, that (i) the Company 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 the Company be liable
for liquidated damages in excess of 1.5% of the aggregate purchase price of the
securities purchased in the Offerings in any 30 day period, and (iii) the
maximum aggregate liquidated damages payable to any Investor in the Offerings
shall be 20% of the aggregate purchase price paid by such
Investor.





Notwithstanding
anything to the contrary stated in the Registration Rights Agreements, the
Company shall be 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.





As of
June 30, 2008, there were accrued liquidated damages of $702,498. Additional
liquidated damages of $359,299 and $552,799 were accrued in the three and six
months ended June 30, 2008. The Company has not yet paid out any of the accrued
liquidated damages, which are payable in cash or shares of its common stock, or
a combination thereof, at the Company’s sole
discretion.  Additionally, the Company is will accrue
$4,500 per day in liquidated damages until such time as the requirements described above have
been satisfied.





16





Emerald
Dairy Inc. and Subsidiaries


Footnotes
to Condensed Consolidated Financial Statements


June 30,
2008 and 2007





14.
            Equity
      (Continued)





Warrants





Information
with respect to stock warrants outstanding as of June 30, 2008 are as
follows:




Exercise Price
            
            Outstanding
              December 31,
              2007
            
            Granted
            
            Expired or
              Exercised
            
            Outstanding
              June 30,
              2008
            
            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-
            
            
            -0-
            
            
            804,884
            
            
            10/09/2010$2.04
            
            
            569,346
            
            
            -0-
            
            
            -0-
            
            
            569,346
            
            
            10/19/2010$2.61
            
            
            -0-
            
            
            195,000
            
            
            -0-
            
            
            195,000
            
            
            6/12/2011$2.61
            
            
            -0-
            
            
            75,000
            
            
            -0-
            
            
            75,000
            
            
            6/20/2011$3.26
            
            
            2,061,227
            
            
            -0-
            
            
            -0-
            
            
            2,061,227
            
            
            10/09/2009$3.26
            
            
            2,846,746
            
            
            -0-
            
            
            -0-
            
            
            2,846,746
            
            
            10/19/2009





Warrant Tender
Offer





As of
April 24, 2008, we commenced an offer (“Offer”) to the holders
(“Warrantholders”) of our then outstanding warrants, pursuant to which the
Warrantholders may tender their Warrants for shares of our 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 Offer may 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 Offer may 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 Offer may 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 Offer may exercise some or all of such warrants at $2.61 per
      share of Common Stock.




A
Warrantholder may tender less than the full number of its warrants. If a
Warrantholder tenders less than all of its warrants, the remaining warrants not
tendered will remain outstanding until they expire by their current terms or are
exercised. In addition, a Warrantholder may change its election and withdraw
from the Offer. If a Warrantholder accepts our Offer, the exercise price for the
tendered warrants must be paid in cash. The Offer will expire on
October 31, 2008, as extended, unless we sooner extend or terminate the
period of time during which the offer is open, by giving oral or written notice
of such extension or termination.





15.
            Common Welfare
      Reserves





The
Company is required to transfer 10% of its net income, as determined in
accordance with PRC accounting rules and regulations, to the general reserve.
The Company voluntarily contributed an additional 5% in the three months ended
June 30, 2008. The balance of these reserves at June 30, 2008 and 2007, was
$1,340,713 and $639,331, respectively. These amounts are restricted and are
included in retained earnings.


17
 Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 15.
                Common Welfare Reserves
      (Continued)
 
 This fund can only be
utilized on capital items for the collective benefit of the Company’s employees,
such as construction of dormitories, cafeteria facilities, and other staff
welfare facilities. The fund is non-distributable other than upon
liquidation.
  16.
              Other Comprehensive
      Income
 
 SFAS No.
130, Reporting Comprehensive
Income ,
requires the reporting of comprehensive income in addition to net income from
operations. Comprehensive income is a more inclusive financial reporting
methodology that includes disclosure of certain financial information that
historically has not been recognized in the calculation of net
income.


The
Company reports comprehensive income (loss) in its consolidated statements of
stockholders’ equity. Comprehensive income (loss) represents changes in
stockholders’ equity from non-owner sources. The components of other
comprehensive income included adjustments from foreign currency
translation.





17.
            Earnings Per
      Share





SFAS 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, 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.





There
were no dilutive shares for the three and six months ended June 30,
2007.





The
following reconciles the components of the EPS computation:





Income
            
            Shares
            
            Per Share(Numerator)
            
            (Denominator)
            
            AmountFor
      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
            
            $
            0.02For
      the three months ended June 30, 2007:Net
      income
            
            $
            922,830Basic
      EPS income available to common shareholders
            
            $
            922,830
            
            
            23,536,315
            
            $
            0.04Effect
      of dilutive securities:Warrants
            
            
            —
            
            
            —Diluted
      EPS income available to common shareholders
            
            $
            922,830
            
            
            23,536,315
            
            $
            0.04


18
 
 Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
 17.
              Earnings Per Share
      (Continued)


Income
            
            Shares
            
            Per Share(Numerator)
            
            (Denominator)
            
            AmountFor
      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
            
            $
            0.02For
      the three months ended June 30, 2007:Net
      income
            
            $
            1,561,616Basic
      EPS income available to common shareholders
            
            $
            1,561,616
            
            
            21,674,862
            
            $
            0.07Effect
      of dilutive securities:Warrants
            
            
            —
            
            
            —Diluted
      EPS income available to common shareholders
            
            $
            1,561,616
            
            
            21,674,862
            
            $
            0.07




18.
            Commitments and
      Contingencies





The
Company has various purchase commitments for materials, supplies and services
incident to the ordinary conduct of business, generally for quantities required
for the Company’s business and at prevailing market prices. No material annual
loss is expected from these commitments.





The
Company has placed a deposit of $574,821 with a governmental agency allowing the
Company to negotiate a possible purchase of an additional processing facility.
No agreement as to the purchase of the facility has been reached.





The
Company has contracted to purchase an office building for $1,911,010 of which a
deposit of $1,172,985 has been made. The balance of $738,025 will be due on
expected completion of the building expected by the end of the third quarter of
2008.




The
Company has contracted to purchase equipment from a supplier for a second
processing facility for $5,279,897 of which $3,695,928 has been
advanced.





The
Company has advances to milk suppliers of $371,273 which will be offset against
future milk purchases from those suppliers.





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 will expire 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.


19
 Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 June 30,
2008 and 2007
  18.
              Commitments and Contingencies
      (Continued)
 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 are required to pay an employee
deposit upon commencement of employment, which is standard in the PRC. The
deposits are protection against potential loss in the event of a dishonest act
by an employee, such as theft, forgery, larceny, or embezzlement. The Company
considers this obligation as short term liability for the following two
reasons:
 
 ·
                The purpose of the advance by employee is for
      potential loss as a result of dishonest act by such employee. Since the
      Company does not know when it may happen, the Company believes it makes
      sense to consider it a short term liability;
  and
 
 ·
                The Company needs to return the fund to the
      employee who leaves the Company without any wrongdoing. Since the Company
      does not know the precise timing of refund, the Company believes it makes
      sense to consider it a short term
  liability.
 
 The basic terms of advances from employees
are:
 
 ·
                All Company employees must to pay an employee
      deposit.
 
 ·
                The deposit amount depends on employee position,
      as follows:





Position
                                                
                                                Deposit AmountGeneral
      Manager
                                                
                                                $
                                                4,000Assistant
      General Manager
                                                
                                                $
                                                2,667Senior
      Manager
                                                
                                                $
                                                2,533Assistant
      Senior Manager
                                                
                                                $
                                                2,400Manager
                                                
                                                $
                                                2,000Administrative
      Staff
                                                
                                                $
                                                1,600Other
      Employee
                                                
                                                $
                                                1,333
 
 ·
                All new employees must pay the deposit before they
      start work.
 
 ·
                The deposit must be paid in cash to the Company’s
      accounting department and receipt will be issued for the deposit
      amount.
 
 ·
                If an employee leaves the Company for any reason
      (except in the event of a dishonest act by an employee, such as theft,
      forgery, larceny, or embezzlement), the accounting department will refund
      the deposit.
 
 ·
                No interest accrues on these
      advances.
 
 As of June 30, 2008, the Company held employee deposits
in the aggregate amount of $337,671.


19.
            Operating
      Leases





The
Company leases various distribution facilities. All leases are on an annual
basis and commence on January 1, of each year. For the three and six months
ended June 30, 2008 and 2007, the Company incurred rental expense of $32,440,
$63,960, $37,161 and $56,745, respectively. As of June 30, 2008, the Company had
outstanding lease commitments totaling $65,880, all of which are due within the
next year.





20.
            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.





For the
three and six months ended June 30, 2008, the Company’s sales revenue from
various products are as follows:





Three Months
              Ended June 30,
            
            Six Months
              Ended June 30,2008
            
            2007
            
            2008
            
            2007Milk
      powder
            
            $
            8,529,387
            
            $
            5,245,419
            
            $
            16,828,825
            
            $
            9,682,094Soybean
      milk powder
            
            
            204,917
            
            
            144,380
            
            
            418,715
            
            
            287,142Rice
      powder
            
            
            261,835
            
            
            220,140
            
            
            532,338
            
            
            436,185Sub-contract
      processing
            
            
            1,908,639
            
            
            1,035,641
            
            
            3,559,359
            
            
            2,122,773$
            10,904,778
            
            $
            6,645,580
            
            $
            21,339,237
            
            $
            12,528,194,






21.
                Restatement
 
 The Company has restated the June 30, 2008 Consolidated
Statement of Cash Flows to properly reflect the payment of a deposit on an
equipment purchase contract.
 
 The effects of the restatement for the six months ended
June 30, 2008 are as follows:
 
 As PreviouslyReported
                      
                      
                      As RestatedConsolidated
      Statement of Cash Flows:Deposits
                      
                      $
                      (3,091,015
                      )
                      
                      $
                      604,913Net
      cash provided by operating activities
                      
                      $
                      (3,480,997
                      )
                      
                      $
                      214,931Deposit
      on equipment purchase
                      
                      $
                      —
                      
                      
                      $
                      (3,695,928
                      )Net
      cash used in investing activities
                      
                      $
                      (1,656,200
                      )
                      
                      $
                      (5,352,128
                      )




20




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





Forward Looking
Statements





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





Overview





We are a
producer of milk powder, rice powder and soybean milk powder, which currently
comprise approximately 96%, 2% and 2% of our sales, respectively. Through our
network of over 600 salespeople, our products are distributed throughout 20
provinces in the PRC, and sold in over 5,600 retail
outlets.





Our
products are marketed under two brand names:





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




· “Yi Bai,”
which is designed for middle and high-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
China 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 a rate of approximately 17%
through 2010. Currently, it is estimated that demand for infant formula in China
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 China. In addition, we have received a Product Exemption
from Quality Surveillance Inspection waiver from the State General
Administration.  Only companies that have passed their product quality
inspections for five consecutive years are awarded this certificate of
waiver.





Because
of our close proximity to its 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 plan on producing
approximately 9,000 tons of milk powder. 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 will enable us to produce an additional 9,000 tons of milk powder
annually, beginning in fiscal 2009. As a result, we believe we will have the
capacity to produce almost 20,000 tons of milk powder per year by fiscal 2010.
It is expected that our production of rice powder and soymilk powder will also
increase in volume, while continuing to comprise approximately 2% and 2% of our
overall sales, respectively.




21





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





·
            HeilongjiangXing 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 Securities Act
Rule 405 and Exchange Act Rule 12b-2, without material assets or activities. On
October 9, 2007, we completed a reverse merger (the “ReverseMerger”), 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, $.001 par
value per share (“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 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.





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.





22
 
 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). Pursuant
to the Put/Call Agreements we have the right to repurchase an aggregate of
1,944,444 shares of our Common Stock from the Put/Call Shareholders under
certain circumstances. In addition, the Put/Call Shareholders have 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”).


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.





Warrant Tender
Offer





As of
April 24, 2008, we commenced an offer (“Offer”) to the holders
(“Warrantholders”) of our then outstanding warrants, pursuant to which the
Warrantholders may tender their Warrants for shares of our 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 Offer may 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 Offer may 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 Offer may 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 Offer may exercise some or all of such warrants at $2.61 per
      share of Common Stock.




We
determined to reduce the exercise prices of the warrants by 20%, because we
believed this would provide sufficient incentive to the warrant holders to
exercise their warrants early, even though they have no obligation to do
so.


A
Warrantholder may tender less than the full number of its warrants. If a
Warrantholder tenders less than all of its warrants, the remaining warrants not
tendered will remain outstanding until they expire by their current terms or are
exercised. In addition, a Warrantholder may change its election and withdraw
from the Offer. If a Warrantholder accepts our Offer, the exercise price for the
tendered warrants must be paid in cash. The Offer will expire on
October 31, 2008, as extended, unless we sooner extend or terminate the
period of time during which the Offer is open, by giving oral or written notice
of such extension or termination.




23




As of the
date hereof, a limited number of Warrantholders have elected to tender their
warrants. However, since any Warrantholder may change its election and withdraw
from the Offer, the funds related to such transactions are being held in escrow,
and will not be released to us until the Offer expires.





Sale of Notes and
Warrants





In June
2008, we conducted a private offering of up to a maximum of (i) $3,000,000 of
our 8% promissory notes (the “Notes”) and (ii) warrants to purchase 300,000
shares of our Common Stock, at an exercise price of $2.61 per share (the “New
Warrants”) (the “Note Offering”). On June 12, 2008, one “accredited investor”
purchased, for a purchase price of $1,500,000, a Note in the principal amount of
$1,500,000, and New 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 Note in the principal amount of $750,000, and New Warrants
to purchase 75,000 shares of our Common Stock. The rights and obligations under
the warrants are further described in “— Liquidity and Capital Resources —
Warrants” below.





In
connection with the 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 New Warrants.




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 on a production facility to be
located in Hailun City, Heilongjiang Province, PRC. When completed, the new
facility will have the capacity to produce approximately 9,000 tons of infant
formula milk powder annually. We anticipate that production will begin at this
facility in the second quarter of 2009.





Trends and
Uncertainties





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 the populous, the government views increased dairy production as
a solution to improve employment in rural areas thus improving social stability.
It is expected that there will be a steady narrowing of the significant gap
between China’s per capita milk consumption of 15kg per person and the global
average of 100 kg per person.





Industry
Growth




The dairy
market today in China is over $13.0 billion. According to the
website of China National Bureau of Statistics, between 2000
to 2005 the dairy industry in China 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 China is projected to grow at rate of
15% per year from 2006 to 2012, to reach $32 billion by 2012.




24


On its
website, theDairy 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 China;





· 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 China outstrips supply by at
least 2-to-1. Production capacity has been the bottle neck for our growth in
recent years, because production has not been able to keep up with demand. In
July 2008, we commenced construction of a new production facility, with annual
production capacity of 9,000 tons of milk powder, which is expected to start
production in the first 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.  Management will need to raise $10.0 million to
$15.0 million to fund the construction of new production facility.We plan to apply the net proceeds we
received from the Note Offering, further described in “— Recent Developments —
Sale of Notes and Warrants” above, and any proceeds we receive from the Offer,
further described in “— Recent Developments — Warrant Tender Offer” above,
toward the construction of this new production facility.  Other than
that, we have no additional commitments for 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.
  Product Pricing and Raw Material
Supply





Historically
we have been able to obtain raw milk and other raw materials to meet our
production needs. The price of raw milk is affected by regional market in
Heilongjiang China 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 we grow. 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 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 China. Most of the
International and larger players 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 have been focusing on less developed second and
third 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.





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 2008. 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 China. Over time, this will help increase our revenues.




25


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.




Results of
Operations





Three Months Ended June 30, 2008
Compared to Three Months Ended June 30, 2007





The
following summarizes changes in our operations for the three months ended June
30, 2008 and 2007. Net income decreased by $224,480, or 24.3%, from $922,830 in
the three months ended June 30, 2007 to $698,350 for the three months ended June
30, 2008.





Sales and Cost of Goods
Sold





For the Three
      Months
              Ended June
      30,2008
            
            2007Sales
            
            $
            10,904,778
            
            $
            6,645,580Cost of Goods
      Sold
            
            
            7,281,163
            
            
            4,926,820Gross Profit
            
            $
            3,623,615
            
            $
            1,718,760





Sales. Sales
volume increased by 302 metric tons, or 16.2%, period on period, to 2,168
metric tons for the three months ended June 30, 2008, from 1,866 metric tons for
the three months ended June 30, 2007. As a result, sales revenues increased by
$4,259,198, or 64.1%, from $6,645,580 in the three months ended June 30, 2007,
to $10,904,778 for the three months ended June 30, 2008. This increase was due
to the following factors:





·
            We
      expanded the market areas in the twenty provinces in which we sell our
      products and our products are now sold in over 5,600 retail
      outlets;




·
            Our
      products have became increasing popular in mainland China due to our
      continued sales and marketing efforts;
and




26


·
            The
      average selling price for all products has increased by $1,493 per metric
      ton, or 42.2%, as compared to the three months ended June 30,
      2007.




Sales by product line. A
break-down of our sales by product line for the three months ended June 30, 2008
and 2007 is as follows:




Three
      Months Ended June 30,2008
                
                2007
                
                Period-on-periodProduct category
                
                Quantity
                  (tons)
                
                $  Amount
                
                % of sales
                
                Quantity
                  (tons)
                
                $Amount
                
                % ofsales
                
                Quantity
                  VarianceMilk
      powder
                
                
                1,426
                
                
                8,529,387
                
                
                78.2
                
                
                1,239
                
                
                5,245,419
                
                
                78.9
                
                
                187Rice
      powder
                
                
                48
                
                
                261,835
                
                
                2.4
                
                
                47
                
                
                220,140
                
                
                3.3
                
                
                1Soybean
      powder
                
                
                113
                
                
                204,917
                
                
                1.9
                
                
                96
                
                
                144,380
                
                
                2.2
                
                
                17Subcontracting
                
                
                581
                
                
                1,908,639
                
                
                17.5
                
                
                484
                
                
                1,035,6411
                
                
                15.6
                
                
                97Total
                
                
                2,168
                
                
                10,904,778
                
                
                100.0
                
                
                1,866
                
                
                6,645,580
                
                
                100.0
                
                
                302





There
were very few changes to the break-down of sales among our products over the
three months ended June 30, 2008, as compared to the three months ended June 30,
2007. Soybean powder only accounted for 1.9% of our sales mix for the three
months ended June 30, 2008, at an average selling price of $1,813 per metric
ton, as compared to 2.2% of our sales mix in the three months ended June 30,
2007, at an average selling price of $1,504 per metric ton. Milk powder
accounted for 78.2% of the sales mix for the quarter ended June 30, 2008, at an
average selling price of $5,981 per metric ton, as compared to 78.9% of the
quarter ended June 2007, at an average selling price of $3,962 per metric ton.
We increased our subcontract production during the quarter ended June 30, 2008
to 17.5% of the sales mix, at an average selling price of $3,285 per metric ton,
as compared to 15.6% of the sales mix in the same quarter in 2007, at an average
sales price of $2,140 per metric ton.





A
breakdown of our average selling price by product line for the three months
ended June 30, 2008 and 2007 is as follows:





Three Months
       Ended
              June 30,Average selling prices
      (per ton)
            
            2008
            
            2007
            
            Variance$
            
            $
            
            $
            
            %Milk
      powder
            
            
            5,981
            
            
            3,962
            
            
            2,019
            
            
            51.0Rice
      powder
            
            
            5,455
            
            
            4,684
            
            
            771
            
            
            16.5Soybean
      powder
            
            
            1,813
            
            
            1,504
            
            
            309
            
            
            20.5Subcontracting
            
            
            3,285
            
            
            2,140
            
            
            1,145
            
            
            53.5Average
      total selling price
            
            
            5,030
            
            
            3,537
            
            
            1,493
            
            
            42.2





Cost of Goods
Sold. Cost of
goods sold increased by $2,354,343, or 47.8%, from $4,926,820 in the three
months ended June 30, 2007, to $7,281,163 for the three months ended June 30,
2008. This increase was directly related to an increase in sales during quarter
of 64.1%. Overall, our cost per metric ton increased by $736, or 28.1%, to
$3,358 per metric ton in the quarter ended June 30, 2008, as compared to $2,622
per metric ton in quarter ended June 30, 2007. This increase in cost per metric
ton was the result of an increase in the price of raw materials we use to
produce our products.




27


A
breakdown of cost of sales by product line for the three months ended June 30,
2008 and 2007 is as follows:
 
 Three
      Months Ended June 30,2008
              
              2007
              
              Variance$
              
              $
              
              $
              
              %Cost of
      salesMilk
      powder
              
              
              5,397,268
              
              
              3,831,293
              
              
              1,565,975
              
              
              40.9Rice
      powder
              
              
              110,345
              
              
              100,232
              
              
              10,113
              
              
              10.1Soybean
      powder
              
              
              128,073
              
              
              100,264
              
              
              27,809
              
              
              27.7Subcontracting
              
              
              1,645,477
              
              
              895,031
              
              
              750,446
              
              
              83.8Total
              
              
              7,281,163
              
              
              4,926,820
              
              
              2,354,343
              
              
              47.8Cost per units sold (per
      ton)Milk
      powder
              
              
              3,785
              
              
              2,894
              
              
              891
              
              
              30.8Rice
      powder
              
              
              2,298
              
              
              2,133
              
              
              165
              
              
              7.7Soybean
      powder
              
              
              1,133
              
              
              1,044
              
              
              89
              
              
              8.5Subcontracting
              
              
              2,832
              
              
              1,849
              
              
              983
              
              
              53.2Average
      cost per unit sold
              
              
              3,358
              
              
              2,622
              
              
              736
              
              
              28.1
 
 Gross Profit. Gross
profit was $3,623,615, or 33.2% of our sales for the three months ended June 30,
2008, compared to gross profit of $1,718,760, or 25.7% for the three months
ended June 30, 2007. During the quarter ended June 30, 2008 our gross margin on
milk powder increased 9.7% due to an increase in the average sales price of
51.0% from quarter ended June 30, 2007, partially offset by a 30.8% increase in
the cost per metric ton from the quarter ended June 30, 2007. The gross margin
for soybean powder increased 6.9% to 37.5% in quarter ended June 30, 2008, as
compared to 30.6% in quarter ended June 30, 2007 due to increase in the average
sales price of 20.5% in quarter ended June 30, 2008, as compared to 2007,
partially offset by an increase of 8.5% in the cost per metric ton from the
quarter ended June 30, 2007 to the quarter ended June 30, 2008.
 
 A
breakdown of gross margin by product line for the three months ended June 30,
2008 and 2007 is as follows:
 Three
      Months Ended June 30,2008
                
                2007
                
                Period-on-periodProduct category
                
                $  Amount
                
                Gross
                  Margin %
                
                $Amount
                
                Gross
                  Margin %
                
                Margin
                  VarianceMilk
      powder
                
                
                3,132,119
                
                
                36.7
                
                
                1,414,126
                
                
                27.0
                
                
                9.8Rice
      powder
                
                
                151,490
                
                
                57.9
                
                
                119,908
                
                
                54.5
                
                
                3.4Soybean
      powder
                
                
                76,844
                
                
                37.5
                
                
                44,116
                
                
                30.6
                
                
                6.9Subcontracting
                
                
                263,162
                
                
                13.8
                
                
                140,610
                
                
                13.6
                
                
                0.2Total
                
                
                3,623,615
                
                
                33.2
                
                
                1,718,760
                
                
                25.7
                
                
                7.4
  28
  Operating
Expenses
 
 For the Three Months
                Ended June
      30,2008
              
              2007Operating
      ExpensesSelling
      expenses
              
              $
              1,650,537
              
              $
              531,767Administrative
      expenses
              
              
              984,275
              
              
              190,457Depreciation
      and amortization
              
              
              15,570
              
              
              11,986Total
      operating expenses
              
              $
              2,650,382
              
              $
              734,210
 
 Selling Expenses . Selling
expenses overall increased by $1,118,770, or 210.4%, from $531,767 in the
quarter ended June 30, 2007, to $1,650,537 for the quarter ended June 30, 2008.
The major factors in the increase in selling expenses are as
follows:
 
 ·
              Advertising
      increased by $518,848, or 1,583.6%, to $551,612 in 2008, from $32,765 in
      2007, due to our marketing campaign to increase brand awareness and
      sales.
 
 ·
              Selling
      salaries increased by $174,983, or 56.9%, to $482,611 in 2008, from
      $307,628 in 2007, as the amounts we paid to our sales staff rose due to
      increased sales.
 
 ·
              Travelling
      expenses incurred by the sales staff increased by $136,444, or 105.6%, to
      $265,655 in 2008, from $129,211 in 2007, due to the expansion of our sales
      network.
 
 ·
              Transportation
      expenses increased by $69,700, or 34.7%, to $270,838 in 2008, from
      $201,138 in 2007, as a result of shipping more product in 2008 as compared
      to 2007.
 
 ·
              Entertainment
      expenses increased by $70,855, or 86.9%, to $152,413 in 2008, from $81,558
      in 2007, as a result of the increase in the sales staff and
      network.
  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 increased by $793,818, or 416.8%, from $190,457 in the
quarter ended June 30, 2007, to $984,275 for the quarter ended June 30, 2008.
The major factors in the increase in administrative expenses are as
follows:
 
 ·
              Liquidated
      damages incurred in 2008 of $359,299 related to registration rights
      agreements we entered into, which were not similarly incurred in
      2007.
 
 ·
              Increase
      in legal and accounting fees in 2008 of $214,323, or 451.2%, to $261,823,
      as compared to $47,500 in 2007, due to costs associated with audits and
      SEC filings not required prior to the reverse merger we consummated in
      October 2007.
 
 ·
              Increase
      in consultant expenses of $49,197, or 696.2%, to $56,263 in 2008, as
      compared to $7,066 in 2007, for services related to possible financing and
      funding.
 
 ·
              Increase
      of administrative salaries of $43,407, or 126%, to 77,853 in 2008, from
      $34,446 in 2007, related to 6 additional administrative personnel hired
      during 2008.
  29
 ·
                  Increase
      in entertainment expenses of $30,710, or 118%, to $56,744 in 2008, from
      $26,035 in 2007, due to increased travel and entertainment by
      administrative personnel to develop financing and funding for our
      growth.
 ·
              Increase
      of travel expenses of $26,775, or 120.7%, to $48,952 in 2008, from $22,177
      in 2007, due to the increase in travel by administrative personnel to
      develop financing and funding for our
growth.
  Provision for Income
Taxes
 
 For the Three
      Months
                Ended June
      30,2008
              
              2007Provision for Income
      TaxesCurrent
              
              $
              236,711
              
              $
              58,350Deferred
              
              
              —
              
              
              —$
              236,711
              
              $
              58,350
 
 Provision for Income
Taxes . Income
taxes increased by $178,361, or 305.7%, from $58,350 in the three months ended
June 30, 2007, to $236,711 for the three months ended June 30, 2008. This
increase was due to the increase in our pre-tax income and the reduction in the
tax exemption for XAL to 50% of the statutory enterprise income tax rate from
100% as of January 1, 2008.
 
 Six Months Ended June 30, 2008
Compared to Six Months Ended June 30, 2007
 
 The
following summarizes changes in our operations for the six months ended June 30,
2008 and 2007. Net income decreased by $860,448, or 55.1%, from $1,561,616 in
the six months ended June 30, 2007, to $701,168 for the six months ended June
30, 2008. The decrease in net income during the six months ended
June 30, 2008, as compared to the same period in the prior year, was due to an
increase in our operating expenses, which offset an increase in our gross
profit, as further described below.
 
 Sales and Cost of Goods
Sold
 
 For the Six
      Months
                Ended June
      30,2008
              
              2007Sales
              
              $
              21,339,237
              
              $
              12,528,194Cost of Goods
      Sold
              
              
              13,292,397
              
              
              8,430,391Gross Profit
              
              $
              8,046,840
              
              $
              4,097,803
 
 Sales. Sales
volume increased by 706 metric tons, or 19%, period on period to 4,418 metric
tons for the six months ended June 30, 2008, from 3,712 metric tons for the six
months ended June 30, 2007. As a result, sales revenues increased by $8,811,043,
or 70.3%, from $12,528,194 in the six months ended June 30, 2007, to $21,339,237
for the six months ended June 30, 2008. This increase was due to the following
factors:
 
 ·
              We
      expanded the market areas in the twenty provinces in which we sell our
      products and our products are now sold in over 5,600 retail
      outlets;
  30
 ·
                  Our
      products have became increasing popular in mainland China due to our
      continued sales and marketing efforts;
and
  ·
                  The
      average selling price for all products has increased by $1,455 per metric
      ton, or 43.1%, as compared to the six months ended June 30,
      2007.
 Sales by product line. A
break-down of our sales by product line for the six months ended June 30, 2008
and 2007 is as follows:
 Six
      Months Ended June 30,2008
                
                2007
                
                Period-on-periodProduct category
                
                Quantity
                  (tons)
                
                $  Amount
                
                % of sales
                
                Quantity
                  (tons)
                
                $Amount
                
                % of
                  sales
                
                Qty.
                  VarianceMilk
      powder
                
                
                2,922
                
                
                16,828,825
                
                
                78.9
                
                
                2,493
                
                
                9,682,094
                
                
                77.3
                
                
                429Rice
      powder
                
                
                97
                
                
                532,338
                
                
                2.4
                
                
                922
                
                
                436,185
                
                
                3.5
                
                
                5Soybean
      powder
                
                
                230
                
                
                418,715
                
                
                2.0
                
                
                192
                
                
                287,142
                
                
                2.3
                
                
                38Subcontracting
                
                
                1,169
                
                
                3,559,359
                
                
                16.7
                
                
                935
                
                
                2,122,7731
                
                
                16.9
                
                
                234Total
                
                
                4,418
                
                
                21,339,237
                
                
                100.0
                
                
                3,712
                
                
                12,528,194
                
                
                100.0
                
                
                706
 
 There
were very few changes to the break-down of sales among our products over the six
months ended June 30, 2008, as compared to the six months ended June 30, 2007.
Soybean powder only accounted for 2.0% of our sales mix for the six months ended
June 30, 2008, at an average selling price of $1,820 per metric ton, as compared
to 2.3% of our sales mix in the six months ended June 30, 2007, at an average
selling price of $1,499 per metric ton. Milk powder accounted for 78.9% of sales
mix in the six months ended June 30, 2008, at an average selling price of $5,759
per metric ton, as compared to 77.3% of the sales mix in six months ended June
30, 2007, at an average selling price of $3,884 per metric ton. Our subcontract
production during the six months ended June 30, 2008 decreased to 16.7% of the
sales mix, at an average selling price of $3,045 per metric ton, as compared to
16.9% of the sales mix in the six months ended June 30, 2007, at an average
sales price of $2,270 per metric ton.
 
 A
breakdown of our average selling price by product line for the six months ended
June 30, 2008 and 2007 is as follows:
 
 Six Months
       Ended
                June 30,Average selling prices
      (per ton)
              
              2008
              
              2007
              
              Variance$
              
              $
              
              $
              
              %Milk
      powder
              
              
              5,759
              
              
              3,884
              
              
              1,875
              
              
              48.3Rice
      powder
              
              
              5,488
              
              
              4,725
              
              
              763
              
              
              16.1Soybean
      powder
              
              
              1,820
              
              
              1,499
              
              
              321
              
              
              21.4Subcontracting
              
              
              3,045
              
              
              2,270
              
              
              775
              
              
              34.1Average
      total selling price
              
              
              4,830
              
              
              3,375
              
              
              1,455
              
              
              43.1
 
 Cost of Goods
Sold. Cost of
goods sold increased by $4,862,006, or 57.7%, from $8,430,391 in the six months
ended June 30, 2007, to $13,292,397 for the six months ended June 30, 2008. This
increase was directly related to an increase in sales during quarter of 70.3%.
Overall our cost per metric ton increased by $738, or 32.5%, to $3,009 per
metric ton in the quarter ended June 30, 2008, as compared to $2,271 per metric
ton in quarter ended June 30, 2007.
  31
  A
breakdown of cost of sales by product line for the six months ended June 30,
2008 and 2007 is as follows:
 
 Six
      Months Ended June 30,2008
              
              2007
              
              Variance$
              
              $
              
              $
              
              %Cost of
      salesMilk
      powder
              
              
              9,702,132
              
              
              6,260,815
              
              
              3,441,317
              
              
              55.0Rice
      powder
              
              
              208,760
              
              
              190,251
              
              
              18,509
              
              
              9.7Soybean
      powder
              
              
              261,697
              
              
              199,404
              
              
              62,293
              
              
              31.2Subcontracting
              
              
              3,119,808
              
              
              1,779,921
              
              
              1,339,887
              
              
              75.3Total
              
              
              13,292,397
              
              
              8,430,391
              
              
              4,862,006
              
              
              57.7Cost per units sold(per
      ton)Milk
      powder
              
              
              3,320
              
              
              2,511
              
              
              809
              
              
              32.2Rice
      powder
              
              
              2,152
              
              
              2,061
              
              
              91
              
              
              4.4Soybean
      powder
              
              
              1,138
              
              
              1,041
              
              
              97
              
              
              9.3Subcontracting
              
              
              2,669
              
              
              1,904
              
              
              765
              
              
              40.2Average
      cost per unit sold
              
              
              3,009
              
              
              2,271
              
              
              738
              
              
              32.5
 
 Gross Profit. Gross
profit was $8,046,840, or 37.7%, of our sales for the six months ended June 30,
2008, compared to gross profit of $4,097,803, or 32.7%, for the six months ended
June 30, 2007. During the six months ended June 30, 2008 our gross margin on
milk powder increased 7.0%, due to an increase in the average sales price of
48.3% from six months ended June 30, 2007, partially offset by a 32.2% increase
in the cost per metric ton from the six months ended June 30, 2007. The gross
margin for soybean powder increased 6.9%, to 37.5% in six months ended June 30,
2008, as compared to 30.6% in six months ended June 30, 2007, due to increase in
the average sales price of 21.4% in six months ended June 30, 2008, as compared
to 2007, partially offset by an increase of 9.3% in the cost per metric ton from
the six months ended June 30, 2007 to the six months ended June 30,
2008.
 
 A
breakdown of gross margin by product line for the six months ended June 30, 2008
and 2007 is as follows:
 Six Months Ended June 30,2008
                
                2007
                
                Period-on-periodProduct category
                
                $  Amount
                
                Gross
                  Margin %
                
                $Amount
                
                Gross
                  Margin %
                
                Margin
                  VarianceMilk
      powder
                
                
                7,126,693
                
                
                42.3
                
                
                3,421,279
                
                
                35.3
                
                
                7.0Rice
      powder
                
                
                323,578
                
                
                60.8
                
                
                245,934
                
                
                56.4
                
                
                4.4Soybean
      powder
                
                
                157,018
                
                
                37.5
                
                
                87,738
                
                
                30.6
                
                
                6.9
                )Subcontracting
                
                
                439,551
                
                
                12.3
                
                
                342,852
                
                
                116.2
                
                
                (3.8
                )Total
                
                
                8,046,840
                
                
                37.7
                
                
                4,097,803
                
                
                32.7
                
                
                5.0
  32





Operating
Expenses





For the Six Months Ended
              June 30,2008
            
            2007Operating
      ExpensesSelling
      expenses
            
            $
            5,381,870
            
            $
            2,071,845Administrative
      expenses
            
            
            1,582,279
            
            
            351,887Depreciation
      and amortization
            
            
            30,431
            
            
            23,845Total
      operating expenses
            
            $
            6,994,581
            
            $
            2,447,577





Selling Expenses . Selling
expenses overall increased by $3,310,025, or 159.8%, from $2,071,845 in the six
months ended June 30, 2007, to $5,381,870 for the six months ended June 30,
2008. The major factors in the increase in selling expenses are as
follows:





·
            Advertising
      increased by $2,060,7888, or 3,787.2%, to $2,115,203 in 2008, from $54,415
      in 2007, due to our marketing campaign to increase brand awareness and
      sales.





·
            Selling
      salaries increased by $321,985, or 52.9%, to $930,627 in 2008, from
      $608,642 in 2007, as the amounts of commissions we paid our sales
      staff rose due to increased
sales.





·
            Travelling
      expenses incurred by the sales staff increased by $260,095, or 101.3%, to
      $516,743 in 2008, from $256,648 in 2007, due to the expansion of our sales
      network.





·
            Transportation
      expenses increased by $127,474 or 32.5%, to $519,880, in 2008 from
      $392,406 in 2007, as a result of shipping more product in 2008 as compared
      to 2007.





·
            Entertainment
      expenses increased by $137,990, or 85.1%, to $300,051 in 2008, from
      $162,061 in 2007, as a result of the increase in the sales staff and
      network.




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 increased by $1,230,392, or 349.7%, from $351,887 in the
six months ended June 30, 2007, to $1,582,279 for the six months ended June 30,
2008. The major factors in the increase in administrative expenses are as
follows:





·
            Liquidated
      damages incurred in 2008 of $487,199 related to registration rights
      agreements we entered into, which were not similarly incurred in
      2007.





·
            Increase
      in legal and accounting fees in 2008 of $296,707, or 624.6%, to $344,207,
      as compared to $47,500 in 2007, due to costs associated with audits and
      SEC filings not required prior to the reverse merger we consummated in
      October 2007.





·
            Increase
      in consultant expenses of $49,772, or 672.7%, to $57,171 in 2008, as
      compared to $7,399 in 2007, for services related to possible financing and
      funding.





·
            Increase
      of administrative salaries of $141,238, or 207.7%, to $209,252 in 2008,
      from $68,014 in 2007, related to 10 additional administrative personnel
      hired during 2008.




33


·
              Increase
      in entertainment expenses of $53,584, or 105.3%, to $104,462 in 2008, from
      $50,878 in 2007, due to increased travel and entertainment by
      administrative personnel to develop financing and funding for our
      growth.


·
            Increase
      of travel expenses of $50,580, or 105.7%, to $98,418 in 2008, from $47,838
      in 2007, due to the increase in travel by administrative personnel to
      develop financing and funding for our
growth.





Provision for Income
Taxes





For the Six Months Ended
              June 30,2008
            
            2007Provision for Income
      TaxesCurrent
            
            $
            317,291
            
            $
            82,652Deferred
            
            
            —
            
            
            —$
            317,291
            
            $
            82,652





Provision for Income
Taxes . Income
taxes increased by $234,639, or 283.9%, from $82,652 in the six months ended
June 30, 2007, to $317,291 for the six months ended June 30, 2008. This increase
was due to the increase in our pre-tax income and the reduction in the
tax





Liquidity and Capital
Resources





Uses of
Capital





For the Six Months Ended
              June 30,2008
              (Restated)
            
            2007Net cash provided by (used in) operating
      activities
            
            $
            214,931
            
            $
            (114,644
            )Net cash used in investing
      activities
            
            
            (5,352,128
            )
            
            (521,169
            )Net cash provided
      by financing activities
            
            $
            1,959,287
            
            $
            2,210,521





Net Cash Provided By (Used In)
Operating Activities. For the
six months ended June 30, 2008, $214,931 was provided by operating
activities, compared with $114,644 used in operating activities for the six
months ended June 30, 2007. Our net cash flows provided by operating activities
increased during 2008 due to the following factors:








·
            Trade
      accounts receivable increased by $1,565,617, due to the increase level of
      sales during the year.




34


·
            We
      increased inventory at June 30, 2008 by $1,212,775, due to better
      management of the production
process.





·
            Accounts
      payable and accrued expenses increased by $1,440,002 at June 30, 2008, as
      compared to 2007, due to increases in production of products and
      expenses.





Net Cash Used In Investing
Activities. For the
six months ended June 30, 2008, we used $5,352,128in investing activities,
compared with $521,169 used in investing activities for the six months ended
June 30, 2007. Our increase in net cash flows used in investing activities
during 2008 was due to our purchase of land use rights for a new production
facility in the amount of $1,280,574, and our purchase of fixed assets of
$375,626. We alsopaid
out advances on the purchase of equipment for a new processing facility in the
amount of $3,695,928 during2008, a trend
we expect will continue as we acquire additional equipment for our new facility,
as standard business practices in China require large deposits upon order of
such equipment.




Net Cash Provided By (Used In)
Financing Activities. For the
six months ended June 30, 2008, $1,959,287 was provided by financing activities,
compared with approximately $2,210,521 provided by financing activities for the
six months ended June 30, 2007. We raised $2,250,000 with the sale of 8%
promissory notes payable due on December 31, 2008 and warrants in June 2008. We
also paid off notes payable of $290,713 in the six months ended June 30, 2008.





General




We have
experienced tremendous growth well above the industry average during recent
years. Sales increased from approximately $7.9 million in 2005 to approximately
$29.6 million in 2007, a 275% increase over two years, or a compound annual
growth rate of 66%. Net income increased from approximately $0.8 million in 2005
to approximately $4.2 million in 2007, a 425% increase over two years, or a
compound annual growth rate of 100%. Following the same trend, working capital
increased from approximately $1.4 million in 2005 to approximately $13.1 million
in 2007, including cash generated from operations as well as funds raised from
private offering we consummated in October 2007.





Cash and
cash equivalents at June 30, 2008 decreased by 41.8%, to $3,821,111, from
$6,560,931 at December 31, 2007. Based upon our short term liabilities, we
believe our cash and cash equivalents are adequate to satisfy our working
capital needs and sustain our ongoing operations for the next twelve months. We
are expecting the cash flows to fluctuate in the future as we try to raise funds
from the capital markets to implement our growth strategy.





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, sales staff and advertising
expenditures.




Historically
we relied on investments by our Chief Executive Officer and shareholders, and
bank loans, to meet our cash and capital expenditures. However, as the amount of
capital expenditures increases, we will depend more on the capital markets to
raise funds through private and public offerings of equity and/or debt.




35


In
connection with the October Offerings, we received aggregate net proceeds of
$4,395,104.  The net proceeds from the October Offerings have been used to repurchase 1,944,444 shares of our
common stock from two existing stockholders and for expenses related to our
Reverse Merger and October Offerings, and for general working capital
to fund continuing
operations.  The Reverse Merger
andOctober Offerings are further described in “— Recent Developments
— Reverse Merger, Private Placements and
Related Transactions” above.
 In July 2008, we commenced construction of a newproduction facilityHailun City, Heilongjiang Province, PRC,that will have
annual production capacity of 9,000 tons of milk powder, which is expected to
commence production in thesecond quarter
of 2009.  This project is expected to cost an aggregate of
approximately $20.0 million, including land use rights, construction expenses
and equipment costs.  Management will need to raise $10.0 million to
$15.0 million to fund the construction of the new production
facility.
 
 In June
2008, we closed the Note Offering, pursuant to which we received aggregate net
proceeds of $2,003,742.  We plan to use the net proceeds from the Note Offering primarily for
the construction and equipping of our new production facility. The Note Offering
is further described in “— Recent Developments — Sale of Notes and Warrants” above.
 
 One
additional way we expect to raise funds in the short term, is through the Offer
we have made to our Warrantholders, as further described in “—Recent Developments — Warrant Tender Offer” above.  As of
the date hereof, a limited number of Warrantholders have elected to tender their
warrants.  However, since any Warrantholder may change its election
and withdraw from the Offer, the funds related to such transactions are being
held in escrow, and will not be released to us until October 31, 2008, the
expiration date of the Offer, unless we sooner extend or terminate the period of
time during which the Offer is open.  If all of the Warrantholders
exercise their warrants in connection with the Offer, we will raise an aggregate
of $16,929,805.
  We have
no additional commitments for 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.
  In
addition to constructing our new production facility, we have contracted to
purchase an office building for approximately $1.8 million, of which a deposit
of approximately $1.1 million has been made. This office building, which is
located in Heilongjiang Province, PRC, will serve as our corporate headquarters.
The balance of approximately $0.7 million will be due on expected completion of
the building expected by the end of the fourth quarter of 2008. These funds
will be paid out of our retained earnings.





Currently,
we spend about 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 2007, 2006 and 2005,
respectively. We plan to increase spending on advertising and promotion to an
aggregate of between $4.0 million and $5.0 million in fiscal 2008. This will
still fall within our standard budget for advertising and promotion of 8% - 12%
of total revenues. The funds for advertising and promotion will generally come
out of our earnings.





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


Another way we plan to grow our business in the future
is through the introduction of a new organic product line.  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 and introduce an organic
label product line beginning in the fourth quarter of fiscal 2008. Initially, we
will need to test the market to determine demand for organic milk
products.  Therefore, we do not expect to make any significant
expenditures on our organic product line for the foreseeable
future.


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.




36


Pursuant
to the Registration Rights Agreements, weare 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 sixty (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.




As of June 30, 2008, there were accrued
liquidated damages of $702,498.We have
not yet paid out any of the accrued liquidated damages, which are payable in
cash or shares of our common stock, or a combination thereof, at our sole
discretion.  Additionally, we will accrue$4,500 per day in liquidated damagesuntil such time as the requirements described above have
been satisfied.
 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
the Put/Call Shareholders granted us an option to repurchase an aggregate of
1,944,444 shares (the “Put/Call Shares”) from the Put/Call Shareholders (the
“Call Option”), for a 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 us, or (ii) all of
      the Put/Call Shares are freely tradable without registration pursuant to
      Rule 144; and




37


·
            The
      closing price of a share of our Common Stock 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 us.




We may
only exercise our Call Option by delivering a written notice (a “Call Option
Exercise Notice”) to the Put/Call Shareholders 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.




In
addition, the Put/Call Shareholders shall have the right to cause us to
repurchase the Put/Call Shares from the Put/Call Shareholders (the “Put Right”),
for a price shall be $1.63 per share (the “Put Purchase Price”),
if:





·
            We
      fail to exercise its Call Option within ten (10) days of a date on which
      all of the Call Option Conditions have been met;
  or




·
            We
      consummate a private offering of not less than $5,000,000 of its
      securities (a “Qualified Offering”);
or




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




Initially,
our failure to (i) file the Registration Statement within thirty (30) business
days of the Closing Date (the “Filing Date”), (ii) 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 (iii) keep the Registration Statement
continuously effective until all of the Registrable Securities are available for
sale without registration pursuant to Rule 144, would have served as a Put Right
Trigger as well. However, as of April 9, 2008, the Put/Call Shareholders agreed
to amend the Put/Call Agreements to delete this clause.  We did not pay any consideration to the Put/Call
Shareholders in connection with their waiver of this
provision.





The
Put/Call Shareholders shall exercise their Put Right by giving written notice
(“Put Exercise Notice”) of their exercise of the Put Right to us within thirty
(30) days of a Put Right Trigger. The Put/Call Shareholders 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 Put/Call Shareholders, our repurchase of the
Put/Call Shares shall be consummated within ninety (90) days following the date
of the Put Exercise Notice.





If the
Put/Call Shareholders exercised their Put Rights we would be forced to
repurchase the Put/Call Shares for an aggregate of $3,169,444.





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.




38


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 No. W-1 will expire on October 9,
2010. Warrant W-1 is exercisable for cash only, provided a registration
statement covering the shares of Common Stock underlying Warrant W-1 is
effective. 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 will expire on October 9, 2009.
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. 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.





Our Class
A Warrants represent 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 will
expire on the three-year anniversary of their date of issuance. The Class A
Warrants will be exercisable for cash only, provided a registration statement
covering the shares of Common Stock underlying the Class A Warrants is
effective. 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.





The Class
B Warrants represent 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
will expire on the two-year anniversary of their date of issuance. The Class B
Warrants will be exercisable for cash only, provided a registration statement
covering the shares of Common Stock underlying the Class B Warrants is
effective. 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.


39


Warrant
W-1, Warrant W-2, the Class A Warrants and the Class B Warrants (collectively,
the “October Warrants”) provide that in no event shall the holder be entitled to
exercise a number of October Warrants (or portions thereof) in excess of the
number of October 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 October 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 October 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 October Warrants may be waived by written agreement between us
and the holder; provided, however, such waiver may not be effective less than
sixty-one (61) days from the date thereof.





If all of
the October Warrants were exercised for cash pursuant to their terms, we would
receive $21,154,354 in proceeds. However, as of April 24, 2008, we commenced the
Offer to the holders of the October Warrants, pursuant to which they may tender
their October Warrants for shares of our Common Stock at a reduced exercise
prices. The Offer is further described in “Recent Developments - Warrant Tender
Offer” above. The purpose of this Offer is to encourage the exercise of the
October Warrants in order to raise additional capital. We intend to apply the
proceeds toward costs related to constructing and equipping our new production
facility, which we believe will enable us to produce an additional 9,000 tons of
milk powder in fiscal 2009. In addition, by reducing the number of outstanding
warrants, we can provide greater certainty to investors and potential investors
regarding the number of shares of Common Stock which are, and may become,
outstanding. If all of October Warrants are exercised pursuant to the Offer, we
will raise $16,929,805 in proceeds.





In June
2008 we closed the Note Offering, pursuant to which we granted the New Warrants.
The Note Offering is further described in “— Recent Developments — Sale of
Notes and Warrants” above. The New Warrants represent the right to purchase an
aggregate of 225,000 shares of our Common Stock, at an exercise price of $2.61
per share. The New Warrants will expire three years after the date of issuance.
The New Warrants may be exercised for cash only. The number of shares of our
Common Stock deliverable upon exercise of the New Warrants will be subject to
adjustment for, among other things, subdivision or consolidation of shares, and
certain other standard dilutive events. The holder of the New Warrants will not
be entitled to exercise a number of New Warrants in excess of the number of New
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. Warrants to purchase 45,000 shares of our Common Stock issued to a
placement agent, have terms and conditions identical to the those of the New
Warrants.




40


Promissory
Notes





In the
Note Offering, further described in “— Recent Developments — Sale of Notes and
Warrants” above, we also issued the Notes. The Notes will bear interest at a
rate of 8% until they become due and payable on December 31, 2008. 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 Notes at any time without
penalty, upon 15 days prior written notice. Each holder of the Notes has the
right to be prepaid any amounts due under his, her or its 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 Notes, there are
limitations on our ability to: (a) pay dividends or make other distributions on
its capital stock; (b) redeem, repurchase or otherwise acquire any of its
securities; (c) create, incur or assume any liability for borrowed money; (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
Note if: (a) we fail to pay principal or interest when due on the Note; (b) we
breach any material covenant or other material term or condition contained in
the Note or securities purchase agreement entered into in connection with the
Note Offering (the “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 Note or the 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 Note, unless such Event of Default shall have been waived in
writing by the holder, the holder may consider the 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.




Changes in foreign exchange regulations in the PRC and
ability to pay dividends in foreign currency or conduct other foreign exchange
business
 
 The Renminbi is currently not a freely convertible
currency, and the restrictions on currency exchange may limit our ability to use
revenues generated in RMB to fund our business activities outside the PRC, or to
make dividends or other payments in United States dollars. The PRC government
strictly regulates conversion of RMB into foreign currencies. Over the years,
foreign exchange regulations in the PRC have significantly reduced the
government’s control over routine foreign exchange transactions under current
accounts. In the PRC, SAFE, regulates the conversion of the RMB into foreign
currencies. Pursuant to applicable PRC laws and regulations, foreign invested
enterprises incorporated in the PRC are required to apply for “Foreign Exchange
Registration Certificates.” Currently, conversion within the scope of the
“current account” (e.g. remittance of foreign currencies for payment of
dividends, etc.) can be effected without requiring the approval of SAFE.
However, conversion of currency in the “capital account” (e.g. for capital items
such as direct investments, loans, securities, etc.) still requires the approval
of SAFE.  See the discussion in Risk Factors appearing in our Annual
Reporton Form 10-KSB, for the fiscal year
ended December 31,2007.




Transactions with Related
Parties





Purchase of Assets from Chief
Executive Officer




On May 28, 2006, American International
Dairy Holding Co., Inc., our wholly-owned subsidiary, purchasedand received title to machinery, facilities,
housing and 100 cows from Yang Yong Shan, our President, Chief Executive Officer
and director, in exchange for a promissory note in the amount of $209,305, which was still outstanding as of the date
hereof. The note does not bear interest and is due on demand. Since the note does not have a set repayment date,
interest is not being imputed on the principal amount under the
note.We believe this was an arms-length transaction, since
the price paid for this property and equipment was approximately the same amount
we would have had to pay to purchase similar assets from a third
party.





Dividends





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


41




Contractual Obligations and
Commercial Commitments





Our
contractual obligations, as of June 30, 2008, were as follows:





Payments Due By
      PeriodContractual
      obligations
                  
                  Total
                  
                  Less than
                    1 year
                  
                  1-3 years
                  
                  After
                    3-5 years
                  
                  More than
                    5 yearsBuilding
      purchase
                  
                  $
                  738,025
                  
                  $
                  738,025
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Equipment
      purchase
                  
                  $
                  1,583,969
                  
                  $
                  1,583,969Operating
      leases
                  
                  $
                  65,880
                  
                  $
                  65,880
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Total:
                  
                  $
                  2,387,874
                  
                  $
                  2,387,874
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —





Critical Accounting Policies and
Estimates





Our
consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require use
to make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of our financial statements and the reported amounts of
revenues and expenses during the reporting periods. The consolidated financial
statements include the our accounts and those of our wholly owned subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation. In our opinion, the condensed consolidated financial statements
contain all the adjustments necessary (consisting only of normal recurring
accruals) to make our financial position and the results of operations and cash
flows not misleading. Critical accounting policies are those that require the
application of management’s most difficult, subjective, or complex judgments,
often because of the need to make estimates about the effect of matters that are
inherently uncertain and that may change in subsequent periods. In preparing the
financial statements, we utilized available information, including our past
history, industry standards and the current economic environment, among other
factors, in forming our estimates and judgments, giving due consideration to
materiality. Actual results may differ from these estimates. In addition, other
companies may utilize different estimates, which may impact the comparability of
our results of operations to those of companies in similar businesses. We
believe that of our significant accounting policies, the following may involve a
higher degree of judgment and estimation.





Inventory





Inventory
is stated at the lower of cost or market. Cost is determined using the weighted
average method. Market value represents the estimated selling price in the
ordinary course of business less the estimated costs necessary to complete the
sale.





Raw
materials consist of raw milk, soybeans, and rice and rice powder. Work in
process consists of materials and products in process of conversion to powder
but not yet packaged.





The cost
of inventories comprises all costs of purchases, costs of conversion and other
costs incurred in bringing the inventories to their present location and
condition. The costs of conversion of inventories include fixed and variable
production overheads, taking into account the stage of completion.




42


Property and
equipment





Property
and equipment is stated at the historical cost, less accumulated depreciation.
Depreciation on property, plant, and equipment is provided using the
straight-line method over the estimated useful lives of the assets after taking
into account any salvage value as follows:




Buildings
            
            
            30
      yearsCommunication
      equipment, plant and machinery
            
            
            10
      - 30 yearsMotor
      vehicles
            
            
            10
      yearsDiary
      cows
            
            
            5
      yearsFurniture,
      Fixtures, and Equipment
            
            
            5
      - 10 years




Expenditures
for renewals and betterments were capitalized, while repairs and maintenance
costs are normally charged to the statement of operations in the year in which
they are incurred. In situations where it can be clearly demonstrated that the
expenditure has resulted in an increase in the future economic benefits expected
to be obtained from the use of the asset, the expenditure is capitalized as an
additional cost of the asset.





Upon sale
or disposal of an asset, the historical cost and related accumulated
depreciation or amortization of such asset were removed from their respective
accounts and any gain or loss is recorded in the statements of
operations.





We review
the carrying value of property, plant, and equipment for impairment whenever
events and circumstances indicate that the carrying value of an asset may not be
recoverable from the estimated future cash flows expected to result from its use
and eventual disposition. In cases where undiscounted expected future cash flows
are less than the carrying value, an impairment loss is recognized equal to an
amount by which the carrying value exceeds the fair value of assets. The factors
considered by management in performing this assessment include current operating
results, trends and prospects, the manner in which the property is used, and the
effects of obsolescence, demand, competition, and other economic factors. Based
on this assessment, there was no impairment at December 31, 2007. There can be
no assurance, however, that market conditions will not change or demand for the
Company’s products or services will continue, which could result in impairment
of long-lived assets in the future.





Intangible
Assets





Intangible
assets consist of land use rights we acquired and are amortized on a straight
line basis over the lives of the rights agreements, which is fifty years and
patents which are amortized on a straight line basis over the remaining life of
the patents which is five years. We evaluate the carrying value of intangible
assets during the fourth quarter of each year and between annual evaluations if
events occur or circumstances change that would more likely than not reduce the
fair value of the intangible asset below its carrying amount. There were no
impairments recorded during the year ended December 31, 2007.





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.




43


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, 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 the
industry in which we operate, after taking into effect the benefits from any
special tax credits or “tax holidays” allowed in the country of
operations.





We do not
accrue United States income tax on unremitted earnings from foreign operations
as it is our intention to invest these earnings in the foreign operations
indefinitely.





Enterprise income
tax





Under the
“Provisional Regulations of The People’s
Republic of China Concerning Income Tax on Enterprises” promulgated by
the State Council which came into effect on January 1, 1994, income tax is
payable by a Wholly Foreign Owned Enterprises at a rate of 15% of their taxable
income. Preferential tax treatment may, however, be granted pursuant to any law
or regulations from time to time promulgated by the State Council. XAL enjoyed a
100% exemption from enterprise income taxes starting on January 10, 2006 do it
is 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 say 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 will end on January 10, 2008, at which time XAL will
qualify under the current tax structure for a 50% reductions in the statutory
enterprise income tax rates for an additional three years.





Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax
assets, including tax loss and credit carry forwards, and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect of deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in the
deferred tax assets and deferred tax liabilities. The components of the deferred
tax assets and liabilities are individually classified as current and
non-current based on their characteristics. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.




A
provision has not been made at June 30, 2008 for U.S. or additional foreign
withholding taxes on approximately $8,525,000 of undistributed earnings of
foreign subsidiaries because it is the present intention of management to
reinvest the undistributed earnings indefinitely in foreign operations.
Generally, such earnings become subject to U.S. tax upon the remittance of
dividends and under certain other circumstances. It is not practicable to
estimate the amount of deferred tax liability on such undistributed
earnings.




44


In 2006,
the Financial Accounting Standards Board (FASB) issued FIN 48, which clarifies
the application of SFAS 109 by defining a criterion that an individual income
tax position must meet for any part of the benefit of that position to be
recognized in an enterprise’s financial statements and provides guidance on
measurement, derecognition, classification, accounting for interest and
penalties, accounting in interim periods, disclosure and transition. In
accordance with the transition provisions, we adopted FIN 48 effective January
1, 2007.





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





Based on
all known facts and circumstances and current tax law, we believe that the total
amount of unrecognized tax benefits as of June 30, 2008, is not material to its
results of operations, financial condition or cash flows. We also believe that
the total amount of unrecognized tax benefits as of June 30, 2008, if
recognized, would not have a material effect on its effective tax rate. We
further believe that there are no tax positions for which it is reasonably
possible, based on current Chinese tax law and policy, that the unrecognized tax
benefits will significantly increase or decrease over the next 12 months
producing, individually or in the aggregate, a material effect on our results of
operations, financial condition or cash flows.





Value added tax





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





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





Freestanding Financial Instruments
with Characteristics of Both Liabilities and Equity





In
accordance with SFAS 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, we account for financial
instruments as a liability if it embodies an obligation to repurchase the our
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.




45


Fair value of financial
instruments





The
carrying amounts of certain financial instruments, including cash, accounts
receivable, other receivables, accounts payable, commercial notes payable, and
accrued expenses approximate their fair values as of June 30, 2008 because of
the relatively short-term maturity of these instruments.




Recently Issued Accounting
Pronouncements





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements (SFAS
157). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting
principles, and expands disclosures about fair value measurements. This
statement does not require any new fair value measurements; rather, it applies
under other accounting pronouncements that require or permit fair value
measurements. The provisions of this statement are to be applied prospectively
as of the beginning of the fiscal year in which this statement is initially
applied, with any transition adjustment recognized as a cumulative-effect
adjustment to the opening balance of retained earnings. The provisions of SFAS
157 are effective for the fiscal years beginning after November 15, 2007.
The adoption of this standard did not have a material impact on our financial
condition, results of operations of cash flows.





In
September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans (SFAS No. 158), an amendment of FASB Statements No. 87, 88, 106
and 132(R). SFAS No. 158 requires (a) recognition of the funded
status (measured as the difference between the fair value of the plan assets and
the benefit obligation) of a benefit plan as an asset or liability in the
employer’s statement of financial position, (b) measurement of the funded
status as of the employer’s fiscal year-end with limited exceptions, and
(c) recognition of changes in the funded status in the year in which the
changes occur through comprehensive income. The requirement to recognize the
funded status of a benefit plan and the disclosure requirements are effective as
of the end of the fiscal year ending after December 15, 2006. The
requirement to measure the plan assets and benefit obligations as of the date of
the employer’s fiscal year-end statement of financial position is effective for
fiscal years ending after December 15, 2008. This Statement has no current
applicability to our financial statements. Management adopted this Statement on
December 31,2006 and the adoption of SFAS No. 158 did not have a material impact
to our financial position, results of operations or cash flows.





In
February 2007, the FASB issued Statement No. 159 The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS
159). This statement permits companies to choose to measure many financial
assets and liabilities at fair value. Unrealized gains and losses on items for
which the fair value option has been elected are reported in earnings. SFAS 159
is effective for fiscal years beginning after November 15, 2007. The adoption of
this standard did not have a material impact on our financial condition, results
of operations of cash flows.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (SFAS
141(R)). SFAS 141(R) will change the accounting for business combinations. Under
SFAS No. 141(R), an acquiring entity will be required to recognize all the
assets acquired and liabilities assumed in a transaction at the acquisition-date
fair value with limited exceptions. SFAS No. 141(R) will change the
accounting treatment and disclosure for certain specific items in a business
combination. SFAS No. 141(R) applies prospectively to business combinations
for which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. SFAS 141(R) will
impact us in the event of any future acquisition.




In
December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51 (SFAS
160). SFAS 160 establishes new accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS No. 160 is effective for fiscal years beginning on or
after December 15, 2008. We do not believe that SFAS 160 will have a
material impact on its consolidated financial statements.


46




In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement
No. 133 (FAS
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. The guidance in FAS 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application encouraged. This Statement
encourages, but does not require, comparative disclosures for earlier periods at
initial adoption. We are currently assessing the impact of FAS 161.





In June
2008, the Emerging Issues Task Force (EITF) reached a 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 Issue No. 98-5 to
Certain Convertible Instruments .”
Moreover, some of the conclusions in Issue No. 98-5 and 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 Issue No. 98-5 were subsequently updated to reflect
the issuance of Issue No. 00-27 and SFAS No. 150, the transition guidance in
Issue No. 98-5 was not revised. The EITF reached a consensus on Issue No. 08-4,
which provides such guidance and requires that (1) conforming changes made to
Issue No. 98-5 resulting from Issue No. 00-27 and SFAS No. 150 be effective for
financial statements of fiscal years ending after December 15, 2008, with early
application allowed, and (2) the effect of applying the conforming changes be
presented retrospectively (with the cumulative effect of the change reported in
retained earnings as of the beginning of the first period presented). We are
currently assessing the impact of EITF Issue 08-4.





Off-Balance Sheet
Arrangements





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


47


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 4T. 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. Therefore,
we have only recently become subject to the laws related to reporting companies,
including the Sarbanes-Oxley Act of 2002, as amended.




48


In
connection with the audit for the fiscal year ended December 31, 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.





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 GAAP standards;and
  ·
              We purchased new revenue accounting software,
      which we will begin to employ in the near
  future.




49


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 fiscal 2008.
 
 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.
 
 Changes in Internal Control Over Financial
Report
 
 In its Annual Report on Form 10-KSB for the fiscal year
ended December 31, 2007 (the “Annual Report”), our management reported that, as
of the date of such report, our internal control over financial reporting was
not effective.  Since filing the Annual Report, we
have:
 
 ·
              Hired an outside consultant to assist with the
      preparation of our financial
statements;
  ·
              Implemented new review and analysis processes for
      all significant contractual and other liabilities;
    and
  ·
              Purchased new revenue accounting system software,
      which we will begin to employ in the near future.
  In addition, we are interviewing consultants to assist
us with the self-assessment required by Section 404 of the Sabanes- Oxley Act of
2002.
  Based in the foregoing, our management has determined
that there were 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.
  50


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, 2008, and subsequent period through the date
hereof, we did not consummate any unregistered sales of equity securities,
except as follows:





Sales of Notes and
Warrants





In June
2008, we conducted a private offering of up to a maximum of (i) $3,000,000 of
our 8% promissory notes (the “Notes”) and (ii) warrants to purchase 300,000
shares of our Common Stock, at an exercise price of $2.61 per share (the “New
Warrants”) (the “Note Offering”). On June 12, 2008, one “accredited investor”
(the “First Purchaser”) purchased, for a purchase price of $1,500,000, a Note in
the principal amount of $1,500,000, and New Warrants to purchase 150,000 shares
of our Common Stock. On June 20, 2008, an additional “accredited investor” (the
“Second Purchaser”) purchased, for a purchase price of $750,000, a Note in the
principal amount of $750,000, and New Warrants to purchase 75,000 shares of our
Common Stock.





In
connection with the Note Offering, we engaged a placement agent (the “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 New Warrants.





The
maturity date of the Notes is December 31, 2008. The Notes will bear interest at
a rate of 8% until they become due and payable. 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 Notes at any time without penalty, upon
15 days prior written notice. Each holder has the right to be prepaid any
amounts due under his, her or its Note from the proceeds of any future offering
we conduct resulting in gross proceeds of $4,500,000 or more. So long as we have
any obligation under the Notes, there are limitations on its ability to: (a) pay
dividends or make other distributions on its capital stock; (b) redeem,
repurchase or otherwise acquire any of its securities; (c) create, incur or
assume any liability for borrowed money; (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 Note if: (a) we fail to pay
principal or interest when due on the Note; (b) we breach any material covenant
or other material term or condition contained in the Note or securities purchase
agreement entered into in connection with the Note Offering (“Purchase
Agreement”), and such breach continues for a period of thirty (30) days after
written notice thereof; (c) any representation or warranty made by us under the
Note or the 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
Note, unless such Event of Default shall have been waived in writing by the
holder, the holder may consider the 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.


51


The New
Warrants represent the right to purchase an aggregate of 225,000 shares of our
Common Stock, at an exercise price of $2.61 per share. The New Warrants will
expire three years after the date of issuance. The New Warrants may be exercised
for cash only. The number of shares of our Common Stock deliverable upon
exercise of the New Warrants will be subject to adjustment for, among other
things, subdivision or consolidation of shares, and certain other standard
dilutive events. The holder of a New Warrant will not be entitled to exercise a
number of New Warrants in excess of the number of New 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.





We have
granted the First Purchaser, Second Purchaser and Placement Agent “piggyback”
registration rights with respect to the shares underlying the New Warrants they
received in connection with the Note Offering.





We
believe that these transactions are 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.





Adjustment to Outstanding
Shares





Due to an
administrative error by our predecessor filer, occurring on or around October 2,
1986, our total number of shares of Common Stock outstanding was short by 2,500
shares. Therefore, as of July 17, 2008, we authorized the transfer agent to
issue an aggregate of 2,500 shares to two shareholders.





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





Item 3. Defaults Upon Senior
Securities.





In the
three-month period ended June 30, 2008, 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, 2008, and subsequent period through the date
hereof, the we did not submit any matters to a vote of our
stockholders.


52


Item 5. Other Information.
 
 There was
no information we were required to disclose in a report on Form 8-K during the
three-month period ended June 30, 2008, or subsequent period through the date
hereof, which was not so reported.


Item 6.  Exhibits





Exhibit No.
            
            Description of
      Exhibit4.1
            
            Form
      of 8% Promissory Note — incorporated by reference from our Current
      Report on Form 8-K, filed on June 12, 20084.2
            
            Form
      of Warrant — incorporated by reference from our Current Report on Form
      8-K, filed on June 12, 200810.1
            
            Form
      of Securities Purchase Agreement — incorporated by reference from our
      Current Report on Form 8-K, filed on June 12, 200831.1
            
            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


53


SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this amended report to be signed on
its behalf by the undersigned, thereunto duly authorized.




EMERALD DAIRY
      INC.Dated: January
      30, 2009
            
            By:
            /s/ Yang Yong ShanYang
      Yong Shan
              Chairman,
      Chief Executive Officer andPresidentDated:
      January 30, 2009
            
            By:
            /s/ Shu KanekoShu
      Kaneko
              Chief
      Financial Officer and Secretary


54