UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549







FORM 10-Q





(Mark
      One)x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended
            March
      31, 2009oro
            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.


xYes     oNo





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


oYes     oNo




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





Large
      accelerated filer o
            Accelerated
      filer oNon-accelerated
      filer o
            Smaller
      reporting company x





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


oYes     xNo





The
registrant had 29,658,726 shares of common stock issued and outstanding as of
May 15, 2009 (not including an additional 1,944,444 shares of common stock of
the registrant currently being held in treasury).









QUARTERLY
REPORT ON FORM 10-Q


OF
EMERALD DAIRY INC. AND SUBSIDIARIES


FOR
THE PERIOD ENDED MARCH 31, 2009








TABLE
OF CONTENTS





PAGEPART I
                -
                FINANCIAL
      INFORMATIONItem
      1.
                
                Financial
      StatementsCondensed
      Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December
      31, 2008
                
                1Condensed
      Consolidated Statements of Income for the Three Months Ended March 31,
      2009 and 2008 (unaudited)
                
                2Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended March 31,
      2009 and 2008 (unaudited)
                
                3Notes
      to Condensed Consolidated Financial Statements (unaudited)
                
                4Item
      2.
                
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                
                23Item
      3.
                
                Quantitative
      and Qualitative Disclosures About Market Risk
                
                50Item
      4.
                
                Controls
      and Procedures
                
                50PART II
                -
                OTHER
      INFORMATIONItem
      1.
                
                Legal
      Proceedings
                
                53Item
      1A.
                
                Risk
      Factors
                
                53Item
      2.
                
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                
                53Item
      3.
                
                Defaults
      Upon Senior Securities
                
                54Item
      4.
                
                Submission
      of Matters to a Vote of Security Holders
                
                54Item
      5.
                
                Other
      Information
                
                54Item
      6.
                
                Exhibits
                
                55Signatures
                
                56








i


PART
I. FINANCIAL INFORMATION





Item
1.  Financial Statements





Emerald
Dairy Inc. and Subsidiaries


Condensed
Consolidated Balance Sheets





ASSETSMarch
      31,
                                            
                                            
                                            December
      31,2009
                                            
                                            
                                            2008(Unaudited)
                                            
                                            
                                            (Audited)Current
      AssetsCash
      and cash equivalents
                                            
                                            $
                                            8,154,392
                                            
                                            
                                            $
                                            7,343,588Trade
      accounts receivable,net
                                            
                                            
                                            6,771,412
                                            
                                            
                                            
                                            6,146,228Inventory,
      net
                                            
                                            
                                            1,362,413
                                            
                                            
                                            
                                            883,233Other
      current assets
                                            
                                            
                                            4,294,576
                                            
                                            
                                            
                                            4,337,332Total
      current assets
                                            
                                            
                                            20,582,793
                                            
                                            
                                            
                                            18,710,381Property,
      plant and equipmentProperty,
      plant and equipment, net
                                            
                                            
                                            5,973,361
                                            
                                            
                                            
                                            6,101,566Contruction
      in progress
                                            
                                            
                                            2,540,640
                                            
                                            
                                            
                                            2,482,3398,514,001
                                            
                                            
                                            
                                            8,583,905Intangible
      assets, net
                                            
                                            
                                            1,368,521
                                            
                                            
                                            
                                            1,380,089$
                                            30,465,315
                                            
                                            
                                            $
                                            28,674,375LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
                                            
                                            $
                                            4,421,587
                                            
                                            
                                            $
                                            4,651,947Notes
      payable, net of debt discount of $65,917 and $87,888 atMarch
      31, 2009 and December 31, 2008, respectively
                                            
                                            
                                            2,684,083
                                            
                                            
                                            
                                            2,662,112Other
      current liabilites
                                            
                                            
                                            435,915
                                            
                                            
                                            
                                            728,859Loan
      from shareholder
                                            
                                            
                                            209,939
                                            
                                            
                                            
                                            210,265Total
      current liabilities
                                            
                                            
                                            7,751,524
                                            
                                            
                                            
                                            8,253,183Commitments
      and Contingencies (Note 21)Stockholders'
      EquityPreferred
      stock ($0.001 par value, 10,000,000 shares authorized,
noneissued
      and outstanding at March 31, 2009 and December 31, 2008)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Common
      stock ($0.001 par value, 100,000,000 shares authorized,31,603,170
      and 31,241,276 issued and outstanding at March 31, 2009and
      December 31, 2008, respectively)
                                            
                                            
                                            31,603
                                            
                                            
                                            
                                            31,244Treasury
      Stock (1,944,444 shares at March 31, 2009 andDecember
      31, 2008, respectively)
                                            
                                            
                                            (1,944
                                            )
                                            
                                            
                                            (1,944
                                            )Additional
      paid-in capital
                                            
                                            
                                            9,002,301
                                            
                                            
                                            
                                            8,225,922Retained
      earnings (of which $2,062,907 and $1,314,861 are restricted
    atMarch
      31, 2009 and December 31, 2008, respectively, for commonwelfare
      reserves)
                                            
                                            
                                            11,659,108
                                            
                                            
                                            
                                            10,106,402Accumulated
      other comprehensive income
                                            
                                            
                                            2,022,723
                                            
                                            
                                            
                                            2,059,568Total
      stockholders' equity
                                            
                                            
                                            22,713,791
                                            
                                            
                                            
                                            20,421,192$
                                            30,465,315
                                            
                                            
                                            $
                                            28,674,375





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




1




Emerald
Dairy Inc. and Subsidiaries


Condensed
Consolidated Statements of Income


(Unaudited)





Three
      Months Ended March 31,2009
                              
                              
                              2008Sales
                              
                              $
                              10,856,552
                              
                              
                              $
                              10,434,459Cost
      of Goods Sold
                              
                              
                              5,848,675
                              
                              
                              
                              6,011,234Gross
      Profit
                              
                              
                              5,007,877
                              
                              
                              
                              4,423,225Operating
      ExpensesSelling
      expenses and adminstrative expenses
                              
                              
                              3,026,704
                              
                              
                              
                              4,329,338Depreciation
      and amortization
                              
                              
                              43,238
                              
                              
                              
                              14,861Total
      operating expenses
                              
                              
                              3,069,942
                              
                              
                              
                              4,344,199Other
      Income (Expense)Interest
      income
                              
                              
                              953
                              
                              
                              
                              5,628Interest
      expense
                              
                              
                              (48,352
                              )
                              
                              
                              (1,256
                              )Total
      other income (expense)
                              
                              
                              (47,399
                              )
                              
                              
                              4,372Net
      Income Before Provision for Income Tax
                              
                              
                              1,890,536
                              
                              
                              
                              83,398Provision
      for Income TaxesCurrent
                              
                              
                              337,830
                              
                              
                              
                              80,580337,830
                              
                              
                              
                              80,580Net
      Income
                              
                              $
                              1,552,706
                              
                              
                              $
                              2,818Basic
      Earnings Per Share
                              
                              $
                              0.05
                              
                              
                              $
                              0.00Basic
      Weighted  Average Shares Outstanding
                              
                              
                              29,415,137
                              
                              
                              
                              29,296,832Diluted
      Earnings Per Share
                              
                              $
                              0.05
                              
                              
                              $
                              0.00Diluted
      Weighted  Average Shares Outstanding
                              
                              
                              29,510,851
                              
                              
                              
                              29,513,646The
      Components of Other Comprehensive IncomeNet
      Income
                              
                              $
                              1,552,706
                              
                              
                              $
                              2,818Foreign
      currency translation adjustment
                              
                              
                              (55,826
                              )
                              
                              
                              934,595Income
      tax related to other comprehensive income
                              
                              
                              18,981
                              
                              
                              
                              (317,762
                              )Comprehensive
      Income
                              
                              $
                              1,515,861
                              
                              
                              $
                              619,651


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




2




Emerald
Dairy Inc. and Subsidiaries


Condensed
Consolidated Statements of Cash Flows


(Unaudited)





Three
      Months Ended March 31,2009
                                  
                                  
                                  2008Cash
      flows from operating activitiesNet
      Income
                                  
                                  $
                                  1,552,706
                                  
                                  
                                  $
                                  2,818Adjustments
      to reconcile net cash provided byoperating
      activitiesDepreciation
      and amortization
                                  
                                  
                                  133,083
                                  
                                  
                                  
                                  91,280Amortization
      of loan discount
                                  
                                  
                                  21,971
                                  
                                  
                                  
                                  -Capitalized
      interest
                                  
                                  
                                  (62,012
                                  )
                                  
                                  
                                  -Incentive
      stock options
                                  
                                  
                                  18,508
                                  
                                  
                                  
                                  -Net
      change in assets and liabilitiesTrade
      accounts receivable
                                  
                                  
                                  (634,733
                                  )
                                  
                                  
                                  (577,482
                                  )Inventory
                                  
                                  
                                  (480,552
                                  )
                                  
                                  
                                  (555,241
                                  )Other
      current assets
                                  
                                  
                                  36,018
                                  
                                  
                                  
                                  962,076Accounts
      payable and accrued expenses
                                  
                                  
                                  (223,133
                                  )
                                  
                                  
                                  1,342,845Other
      current liabilities
                                  
                                  
                                  (291,812
                                  )
                                  
                                  
                                  (71,897
                                  )Net
      cash provided by operating activities
                                  
                                  
                                  70,044
                                  
                                  
                                  
                                  1,194,399Cash
      flows from investing activitiesPurchases
      of fixed assets and intangibles
                                  
                                  
                                  (4,933
                                  )
                                  
                                  
                                  (27,469
                                  )Net
      cash used in investing activities
                                  
                                  
                                  (4,933
                                  )
                                  
                                  
                                  (27,469
                                  )Cash
      flows from financing activitiesExercise
      of warrants
                                  
                                  
                                  758,230
                                  
                                  
                                  
                                  -Repayments
      of notes payable
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (284,768
                                  )Loans
      from shareholders
                                  
                                  
                                  -
                                  
                                  
                                  
                                  329Net
      cash provided by (used in) financing activities
                                  
                                  
                                  758,230
                                  
                                  
                                  
                                  (284,439
                                  )Effect
      of exchange rate
                                  
                                  
                                  (12,537
                                  )
                                  
                                  
                                  224,629Net
      increase in cash
                                  
                                  
                                  810,804
                                  
                                  
                                  
                                  1,107,120Cash
      and cash equivalents at beginning of period
                                  
                                  
                                  7,343,588
                                  
                                  
                                  
                                  6,560,931Cash
      and cash equivalents at end of period
                                  
                                  $
                                  8,154,392
                                  
                                  
                                  $
                                  7,668,051





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





3


Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
   1.
              Description
      of Business
 
 Emerald
Dairy, Inc. (the “Company”), a Nevada corporation, is a producer of milk powder,
rice powder and soybean milk powder in the People’s Republic of China (“PRC”)
through its wholly-owned subsidiaries.
 
 The
Company’s subsidiary, American International Dairy Holdings, Inc. (“AIDH”), a
Nevada corporation, was formed in 2005 for the purpose of acquiring the stock in
Heilongjiang Xing An Ling Dairy, Co. (“XAL”), a corporation formed on September
8, 2003 in Heilongjiang Providence, pursuant to the laws of the PRC. On May 30,
2005, AIDH acquired  XAL, pursuant to a Share Transfer Agreement. This
transaction was treated as a recapitalization of XAL for financial reporting
purposes. The effect of this recapitalization was rolled back to the inception
of XAL for financial reporting purposes.
  XAL is a
dairy company engaged in manufacturing of milk powder, soybean powder and rice
powder. Through the Company’s network of over 800 salespeople, the Company’s
products are distributed throughout 20 provinces in the PRC, and sold in over
5,800 retail outlets.
 
 Prior to
September 23, 2006, XAL owned 57.69% of Heilongjiang Be’ian Nongken Changxing
LvBao Dairy Limited Liability Company (“LvBao”), with the remaining balance
being held by the Company’s sole shareholder. On September 23, 2006, the
remaining 42.31% ownership in LvBao was transferred to XAL and was treated as an
additional capital contribution. The effect of this contribution by the sole
shareholder was rolled back to September 8, 2003 for financial reporting
purposes. LvBao was formed on January 20, 2000 and is engaged in manufacturing
and sales of dairy products.
 
 On May
22, 2008, the Company formed a new wholly-owned subsidiary,
Hailun Xinganling Dairy Co., Ltd. (“HXD”), pursuant to the laws of the
PRC. In July 2008, HXD commenced construction of a production facility in
Hailun City, Heilongjiang Province, PRC. It is expected that the
construction and equipping of this new facility will be completed in the third
fiscal quarter of 2009. Upon completion, it is anticipated that HXD will engage
in the manufacture of the Company's milk powder, soybean powder and rice powder
products at this new facility.
 
 2.
              Basis
      of Preparation of Financial
Statements
 
 XAL,
LvBao and HXD maintain their books and accounting records in Renminbi (“RMB”),
the local currency of the PRC..
 
 The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements and related
notes. The accompanying unaudited condensed consolidated financial statements
and related notes should be read in conjunction with the audited consolidated
financial statements of the Company and notes thereto for the year ended
December 31, 2008, which are included in the Company’s Form 10-K for the year
ended December 31, 2008, filed with the SEC on April 9, 2009.
 
 In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (which include only normal
recurring adjustments) necessary to present fairly the balance sheets of Emerald
Dairy Inc. and its subsidiaries as of March 31, 2009, the results of their
operations for the three months ended March 31, 2009 and 2008, and their cash
flows for the three months ended March 31, 2009 and 2008. The results of
operations for the three months ended March 31, 2009 and 2008 are not
necessarily indicative of the results to be expected for the entire
year.
 4
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 2.
              Basis
      of Preparation of Financial Statements
  (Continued)
 
 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 (“U.S.
GAAP”) and are expressed in terms of U.S. dollars (see paragraph “Foreign
Currency” below).
 
 The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries, XAL, LvBao and HXD. All inter-company transactions
and balances have been eliminated in consolidation.
 
 3.
              Summary
      of Significant Accounting Policies
 
 Use of estimates - The
preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affected the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of net sales and expenses during the reported
periods.
 
 Significant
estimates and assumptions by management include, among others, values and lives
assigned to acquired intangible assets, reserves for customer returns and
allowances, uncollectible accounts receivable, slow moving, obsolete and/or
damaged inventory, deferred tax assets, property, plant and equipment, reserve
for employee benefit obligations, stock warrant valuation, income tax
uncertainties and other uncertainties. Actual results may differ from these
estimates.  The current economic environment has increased the degree
of uncertainty inherent in these estimates and assumptions.
 
 Cash and cash equivalents -Cash and cash equivalents represent cash on hand, demand deposits and all
highly liquid investments placed with banks or other financial institutions with
original maturities of three months or less. Substantially all of the Company’s
cash is held in bank accounts in the PRC and is not protected by the Federal
Deposit Insurance Corporation (“FDIC”) insurance, or any other similar
insurance. Accounts held at United States financial institutions are insured by
the FDIC up to $250,000. As of March 31, 2009, $189,395 in U.S. balances are in
excess of insured amounts. Given the current economic environment and risks in
the banking industry, there is a risk that the deposits may not be readily
available or covered by such insurance.
 
 Accounts receivable -Trade
accounts receivable are recorded at the invoiced amount and do not bear
interest. Amounts collected on trade accounts receivable are included in net
cash provided by operating activities in the consolidated statements of cash
flows. The Company maintains an allowance for doubtful accounts for estimated
losses inherent in its accounts receivable portfolio. In establishing the
required allowance, management considers historical losses, current receivables
aging, and existing industry and PRC economic data. The Company reviews its
allowance for doubtful accounts monthly. Past due balances over 90 days and over
a specified amount are reviewed individually for collectibility. Account
balances are charged off against the allowance after all means of collection
have been exhausted and the potential for recovery is considered remote. At
December 31, 2008 and 2007, there were no allowances for doubtful accounts based
on the review of the above factors. There were no write-off’s for 2008 and 2007,
respectively. The Company does not have any off-balance sheet credit exposure
related to its customers.
 
 Construction-in-Progress -
Plant and production lines currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditure, professional fees and
the interest expenses capitalized during the course of construction for the
purpose of financing the project. Upon completion and readiness for use of the
project, the cost of construction-in-progress is to be transferred to fixed
assets, at which time depreciation will commence. As of March 31, 2009, the
Company has incurred and capitalized into construction-in-progress $2,374,494 of
construction costs from the construction contract, $14,266 of costs paid by the
Company to vendors, and $151,880 of capitalized interest, for a balance of
$2,388,760.  The estimated cost to be incurred in 2009 to complete the
project is approximately $6,053,586.
 5
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 3.
              Summary
      of Significant Accounting Policies
(Continued)
 
 Capitalized Interest– The
Company’s policy is to capitalize interest costs on debt during the construction
of major projects exceeding one year.  A reconciliation of total
interest cost to interest expense as reported in the consolidated statements of
income for three months ended March 31, 2009 and 2008 is as
follows:
 
 Three
      Months Ended
                        March
      31, 2009
                      
                      
                      Three
      Months Ended
                        March
      31, 2008Interest
      cost capitalized
                      
                      $
                      62,012
                      
                      
                      $
                      —Interest
      cost charged to income
                      
                      
                      48,352
                      
                      
                      
                      1,256$
                      110,364
                      
                      
                      $
                      1,256
 
 Foreign Currency- The
Company’s principal country of operations is the PRC. The financial position and
results of operations of the Company are determined using the local currency,
RMB, as the functional currency. The results of operations denominated in
foreign currency are translated at the average rate of exchange during the
reporting period.
  Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the exchange rates prevailing at the balance sheet date. The
registered equity capital denominated in the functional currency is translated
at the historical rate of exchange at the time of capital contribution. All
translation adjustments resulting from the translation of the financial
statements into U.S. Dollars are dealt with as a separate component within
stockholders’ equity. Translation adjustments net of tax totaled ($36,845) and
$616,833 for the three months ended March 31, 2009 and 2008,
respectively.
 
 As of
March 31, 2009 and 2008, the exchange rate was 6.8339 RMB and 7.012 RMB per U.S.
Dollar, respectively.
 
 Revenue recognition - Revenue
is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, which
states that revenue should be recognized when the following criteria are met:
(1) persuasive evidence of an arrangement exists; (2) the service has
been rendered; (3) the selling price is fixed or determinable; and
(4) collection of the resulting receivable is reasonably
assured.
 
 Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.
 
 As of
March 31, 2009, the Company has no sales or contracts that included multiple
deliverables that would fall under the scope of Emerging Issues Task Force
(“EITF”) Issue 00-21, Revenue
Arrangements with Multiple Deliverables.
 
 Earnings per share -Basic net
earnings per common share is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common shares outstanding
during the period. Diluted net earnings per common share is determined using the
weighted-average number of common share shares outstanding during the period,
adjusted for the dilutive effect of common stock equivalents, using the treasury
stock method, consisting of shares that might be issued upon exercise of common
stock warrants. In periods where losses are reported, the weighted-average
number of common shares outstanding excludes common stock equivalents, because
their inclusion would be anti-dilutive.
 
 Taxation - Taxation on
profits earned in the PRC has been calculated on the estimated assessable
profits for the year at the rates of taxation prevailing in the PRC, in which
the Company operates, after taking into effect the benefits from any special tax
credits or “tax holidays” allowed in the country of operations.
 6
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 3.
              Summary
      of Significant Accounting Policies
(Continued)
 
 The
Company accounts for income tax under the provisions of Statement of Financial
Accounting Standards (“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 the
PRC that will exist once the tax holiday (See Note 10) expires. The Company
does not have any significant deferred tax asset or liabilities that relate to
tax jurisdictions not covered by the tax holiday.
  The
Company does not accrue United States income tax on unremitted earnings from
foreign operations, as it is the Company’s intention to invest these earnings in
the foreign operations indefinitely.
 
 Enterprise income
tax
 
 Under the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the State Council which came into effect on
January 1, 1994, income tax is payable by a “Wholly Foreign Owned Enterprise” at
a rate of 15% of their taxable income. Preferential tax treatment may, however,
be granted pursuant to any law or regulations from time to time promulgated by
the State Council. Commencing on January 10, 2006, XAL has received a 100%
exemption from enterprise income taxes, due to its classification as a Wholly
Foreign Owned Enterprise. On March 16, 2007, the PRC enacted a new Enterprise
Income Tax Law for the purpose of unifying the tax treatment of domestic and
foreign enterprises. This new law eliminates the preferential tax treatment for
new Wholly Foreign Owned Enterprises but allows previously granted exemptions to
stay in place through 2012, with the exception that the statutory tax rate will
increase by 2% per year, from 15% in 2006, to 25% by 2012. This exemption ended
on January 10, 2008, at which time XAL qualified under the current tax structure
for a 50% reduction in the statutory enterprise income tax rates for an
additional three years.
 
 Freestanding Financial Instruments
with Characteristics of Both Liabilities and Equity -In accordance with
SFAS 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity,the Company accounts for financial instruments as a liability if
it embodies an obligation to repurchase the issuer’s equity shares, or is
indexed to such an obligation, and that requires or may require the issuer to
settle the obligation by transferring assets. Freestanding financial instruments
are financial instruments that are entered into separately and apart from any of
the entity's other financial instruments or equity transactions, or that is
entered into in conjunction with some other transaction and is legally
detachable and separately exercisable. The liability recorded is the per share
price to be paid and is offset to equity.
 
 Stock Based Compensation -On
December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued
SFAS No. 123R, Share-Based Payment(“SFAS
No. 123R”) , which requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statements
based on the grant date fair value of the award. The Company has adopted the
requirements of SFAS No. 123R for the fiscal year beginning on January 1,
2006.
 
 Fair value of financial instruments -The Company applies the provisions of SFAS No. 107, Disclosures about Fair Value of
Financial Instruments(“SFAS No. 107”). SFAS No. 107 requires all
entities to disclose the fair value of financial instruments, both assets and
liabilities recognized and not recognized on the balance sheet, for which it is
practicable to estimate fair value.  SFAS No. 107 defines fair value
of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties.  As
of  March 31, 2009 and December 31, 2008 the fair value of cash,
accounts receivable, other receivables, accounts payable, commercial notes
payable, and accrued expenses approximated carrying value due to the short
maturity of the instruments, quoted market prices, or interest rates, which
fluctuate with market rates.
 7
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 3.
              Summary
      of Significant Accounting Policies
(Continued)
 
 Fair Value Measurements- In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS
No. 157 establishes a framework for measuring fair value in generally
accepted accounting principles, clarifies the definition of fair value within
that framework, and expands disclosures about the use of fair value
measurements. SFAS No. 157 applies to fair value measurements required by
existing accounting pronouncements and does not require any new fair value
measurements. The Company adopted SFAS No. 157 on January 1,
2008.
 
 On
January 1, 2009, the Company adopted FASB Staff Position No. FAS 157-2 for
non-financial assets and non-financial  liabilities that are
recognized or disclosed at fair value in the consolidated financial statements
on a nonrecurring basis as permitted by, which provided a deferral of such
provisions until 2009. The Company is in the process of evaluating the impact,
if any, of applying these provisions on its consolidated financial position and
results of operations.
 
 The
carrying value of financial assets and liabilities recorded at fair value is
measured on a recurring or nonrecurring basis. Financial assets and liabilities
measured on a non-recurring basis are those that are adjusted to fair value when
a significant event occurs. The Company had no financial assets or liabilities
carried and measured on a nonrecurring basis during the reporting periods.
Financial assets and liabilities measured on a recurring basis are those that
are adjusted to fair value each time a financial statement is prepared. The
Company’s had no financial assets and/or liabilities carried at fair value on a
recurring basis at March 31, 2009.
  The
availability of inputs observable in the market varies from instrument to
instrument and depends on a variety of factors including the type of instrument,
whether the instrument is actively traded, and other characteristics particular
to the transaction. For many financial instruments, pricing inputs are readily
observable in the market, the valuation methodology used is widely accepted by
market participants, and the valuation does not require significant management
discretion. For other financial instruments, pricing inputs are less observable
in the market and may require management judgment.
 
 Recent accounting
pronouncements
 
 In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement
No. 133 (“SFAS 161”). SFAS 161 changes the disclosure requirements
for derivative instruments and hedging activities. Entities are required to
provide enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged
items are accounted for under Statement 133 and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.. On January 1, 2009
the Company adopted SFAS 161, the adoption of this standard did not have a
material impact on the Company’s financial position, results of operations, or
cash flows.
 
 In June
2008, the EITF reached final consensuses on EITF Issue 08-4, Transition Guidance for Conforming
Changes to Issue No. 98-5. Certain conclusions reached in EITF Issue No.
98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, were nullified in EITF Issue No. 00-27,
Application of 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. On January 1, 2009 the Company adopted EITF
08-4, the adoption of this standard did not have a material impact on the
Company’s financial condition, results of operations or cash flows.
 8
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 3.
              Summary
      of Significant Accounting Policies
(Continued)
 
 In June
2008, the EITF reached final consensuses on EITF Issue 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity's Own Stock.  In
EITF Issue 07-5, the EITF reached the consensus that evaluation of whether an
equity-linked financial instrument (or embedded feature) is indexed to the
company's own stock should be based on a two-step approach. Under the two-step
approach, an equity-linked financial instrument (or embedded feature) is not
deemed indexed to the entity's own stock if the strike price is denominated in a
currency other than the issuer's functional currency (but the determination of
whether the instrument is indexed to the company's own stock is not affected by
the currency in which the underlying shares are traded). Also, market-based
employee stock valuation instruments are not considered to be indexed to the
entity's own stock (presumably because they are influenced by, among other
factors, employee behavior, which is not an input used to estimate the fair
value of the forward contract or option). An exercise contingency is a provision
entitling the entity (or the counterparty) to exercise an equity-linked
financial instrument or embedded feature based on changes in an underlying,
which includes the occurrence (or nonoccurrence) of a specified event.
Provisions that accelerate the timing of the entity's (or counterparty's)
ability to exercise an instrument or that extend the length of time that an
instrument is exercisable are exercise contingencies. On January 1, 2009 the
Company adopted EITF  07-5, the adoption of this standard did not have
a material impact on the Company’s financial condition, results of operations or
cash flows.
 
 In July
2008, the FASB issued FASB Staff Position (“FSP”) No. EITF 03-6-1, Unvested Share-Based Awards as
Participating Securities for EPS Purposes (FSP No. EITF
03-6-1).  FSP No. EITF 03-6-1 clarifies the circumstances under which
unvested share-based payment awards should be considered participating
securities for purposes of determining basic earnings per share (“EPS”). On
January 1, 2009 the Company adopted FSP No. EITF 03-6-1, the adoption of this
standard did not have a material impact on the Company’s financial condition,
results of operations or cash flows.
 
 In
December 2008, the FASB issued FSP no. FAS 132(R)-1, Employers’ Disclosures about
Postretirement Benefit Plan Assets. The FSP amends SFAS No. 132 (revised
2003), Employers’ Disclosures about Pensions and Other Postretirement Benefits,
to provide guidance on an employer's disclosures about plan assets of a defined
benefit pension or other postretirement plan. The disclosures about plan assets
required by FSP No. FAS 123(R)-1 are to be provided for fiscal years beginning
after December 15, 2009. The Company is currently assessing the impact of FSP
No. FAS 123(R)-1.
 
 In
April 2009, the FASB issued FSP SFAS No. 107-1, Interim Disclosures about Fair Value
of Financial Instruments, which amends SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, and APB Opinion No. 28, Interim Financial Reporting.
FSP SFAS No. 107-1 will require disclosures about fair value of financial
instruments in financial statements for interim reporting periods and in annual
financial statements of publicly-traded companies. This FSP also will require
entities to disclose the method(s) and significant assumptions used to estimate
the fair value of financial instruments in financial statements on an interim
and annual basis and to highlight any changes from prior periods. The effective
date for this FSP is interim and annual periods ending after June 15, 2009.
The Company is currently assessing the impact of FSP SFAS 107-1.
 
 In April
2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. The FSP amends the other-than-temporary
impairment guidance for debt securities to make the guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments on debt and equity securities. The FSP is effective for interim and
annual periods ending after June 15, 2009, which is June 30, 2009 for
the Company. The FSP is not anticipated to have a material impact on the
Company’s consolidated financial statements.
 9
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 3.
              Summary
      of Significant Accounting Policies
(Continued)
 
 In April
2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly The FSP
provides additional guidance for estimating fair value when the market activity
for an asset or liability has declined significantly. The FSP is effective for
interim and annual periods ending after June 15, 2009, which is
June 30, 2009 for the Company. The FSP is not anticipated to have a
material impact on the Company’s consolidated financial statements.
 
 4.
              Concentrations
      of Business and Credit Risk
 
 The
Company conducts all of its primary trade in the PRC.  There can be no
assurance that the Company will be able to successfully conduct its trade, and
failure to do so would have a material adverse effect on the Company’s financial
position, results of operations and cash flows. Also, the success of the
Company’s operations is subject to numerous contingencies, some of which are
beyond management’s control. These contingencies include general economic
conditions, price of raw material, competition, governmental and political
conditions, and changes in regulations. Because the Company is dependant on
foreign trade in the PRC, the Company is subject to various additional
political, economic and other uncertainties. Among other risks, the Company’s
operations will be subject to risk of restrictions on transfer of funds,
domestic and international customs, changing taxation policies, foreign exchange
restrictions, and political and governmental regulations.
 
 Substantially
all of the Company’s bank accounts are in banks located in the PRC and are not
covered by any type of protection similar to that provided by the FDIC on funds
held in U.S banks. Accounts held at U.S. financial institutions are insured by
the FDIC up to $250,000. As of March 31, 2009 $189,359 of the U.S. cash balances
are in excess of insured amounts.
 
 Milk
powder is historically 75% to 95% of the Company’s total sales. Dairy product
consumption in the PRC has historically been lower than in many other countries
in the world. Growing interest in milk products in the PRC is a relatively
recent phenomenon which makes the market for the Company’s products less
predictable.  Consumers may lose interest in the
products.  As a result, achieving and maintaining market acceptance
for the Company’s products will require substantial marketing efforts and the
expenditure of significant funds to encourage dairy consumption in general, and
the purchase of the Company’s products in particular.  There is
substantial risk that the market may not accept or be receptive to the Company’s
products.  Market acceptance of the Company’s current and proposed
products will depend, in large part, upon the Company’s ability to inform
potential customers that the distinctive characteristics of the Company’s
products make them superior to competitive products and justify their
pricing.  The Company’s current and proposed products may not be
accepted by consumers or able to compete effectively against other premium or
non-premium dairy products.  Lack of market acceptance would limit the
Company’s revenues and profitability.
 
 The
Company operates in the PRC, 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.
 
 In fiscal
2008, a number of milk powder products produced within the PRC were found to
contain unsafe levels of tripolycyanamide, also known as melamine, sickening
thousands of infants. This prompted the Chinese government to conduct a
nationwide investigation into how the milk powder was contaminated, and caused a
worldwide recall of certain milk powder products produced within the PRC. On
September 16, 2008, the PRC’s Administration of Quality Supervision, Inspection
and Quarantine (“AQSIQ”) revealed that it had tested samples from 175 dairy
manufacturers, and published a list of 22 companies whose products contained
melamine. The Company passed the emergency inspection and was not included on
AQSIQ’s list. Although the Company believes that the inevitable contraction in
the Chinese milk powder industry caused by this crisis will lead to increased
demand for the Company’s products, it can’t be certain that the illnesses caused
by contamination in the milk powder industry, whether or not related to the
Company’s products, won’t lead to decreased demand for milk powder products
produced within the PRC, thereby having a material adverse effect on the
Company’s business.
 10
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 4.
              Concentrations
      of Business and Credit Risk
(Continued)
 
 Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash and trade receivables, the balances of which are
stated on the balance sheet. Concentration of credit risk with respect to trade
receivables is limited due to the Company's large number of diverse customers in
different locations in the PRC. The Company does not require collateral or other
security to support financial instruments subject to credit risk.
 
 For the
three months ended March 31, 2009 and 2008, no single customer accounted for 10%
or more of sales.
 
 As of
March 31, 2009 and December 31, 2008, the Company had no insurance coverage of
any kind. Accrual for losses is not recognized until such time as an uninsured
loss has occurred.
 
 Payments
of dividends may be subject to some restrictions due to the fact that the
operating activities are conducted in subsidiaries residing in the
PRC.
 
 The
operations of the Company are located in the PRC. Accordingly, the Company’s
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
 
 5.
              Inventory
 
 As of
March 31, 2009 and December 31, 2008 inventory consists of the
following:
 
 March
      31,
                          2009
                        
                        
                        December
      31,
                          2008Raw
      materials
                        
                        $
                        954,281
                        
                        
                        $
                        557,128Work-in-process
                        
                        
                        362,395
                        
                        
                        
                        299,931Finished
      goods
                        
                        
                        36,988
                        
                        
                        
                        17,305Repair
      parts
                        
                        
                        8,749
                        
                        
                        
                        8,869$
                        1,362,413
                        
                        
                        $
                        883,233
  6.
              Other
      Current Assets
 
 As of
March 31, 2009 and December 31, 2008, other current assets consist of the
following:
 
 March
      31,
                      2009
                    
                    
                    December
      31,
                      2008Advances
      to milk suppliers
                    
                    $
                    331,464
                    
                    
                    $
                    388,406Advances
      to equipment supplier
                    
                    
                    3,707,124
                    
                    
                    
                    3,712,883Advances
      to staff
                    
                    
                    122,385
                    
                    
                    
                    76,712Deposit
      on contract
                    
                    
                    81,948
                    
                    
                    
                    74,614Prepaid
      expenses
                    
                    
                    51,655
                    
                    
                    
                    84,717$
                    4,294,576
                    
                    
                    $
                    4,337,332
 11
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 7.
              Property,
      Plant, and Equipment
 
 As of
March 31, 2009 and December 31, 2008, Property, Plant, and Equipment consist of
the following:
 
 March
      31,
                          2009
                        
                        
                        December
      31,
                          2008Building
                        
                        $
                        3,699,226
                        
                        
                        $
                        3,704,971Plant
      and Machinery
                        
                        
                        2,968,271
                        
                        
                        
                        2,972,883Motor
      vehicles
                        
                        
                        526,089
                        
                        
                        
                        526,906Dairy
      cows
                        
                        
                        244,805
                        
                        
                        
                        242,102Office
      equipment
                        
                        
                        61,530
                        
                        
                        
                        59,7397,499,921
                        
                        
                        
                        7,506,601Less:
      Accumulated depreciation
                        
                        
                        (1,526,560
                        )
                        
                        
                        (1,405,035
                        )$
                        5,973,361
                        
                        
                        $
                        6,101,566
  Depreciation
expenses totaled $123,659 and $88,906 for the three months ended March 31, 2009
and 2008, respectively, of which $89,845 and $74,045 were included as a
component of cost of goods sold for the three months ended March 31, 2009 and
2008, respectively.
 
 8.
              Construction-in-progress
 
 March 31,
                      2009
                    
                    
                    December 31,
                      2008Construction
      in progress
                    
                    $
                    2,540,640
                    
                    
                    $
                    2,482,339
 
 Construction-in-progress
represents construction and installations of the new plant and machinery for the
production facility in Hailun City.
 
 9.
              Intangible
      Assets
 
 March 31,
                          2009
                        
                        
                        December 31,
                          2008Land
      use rights
                        
                        $
                        1,354,280
                        
                        
                        $
                        1,356,384Patents
                        
                        
                        53,120
                        
                        
                        
                        53,2021,407,400
                        
                        
                        
                        1,409,586Less:
      Accumulated amortization
                        
                        
                        (38,879
                        )
                        
                        
                        (29,497
                        )$
                        1,368,521
                        
                        
                        $
                        1,380,089
  For the
three months ended March 31, 2009 and 2008, amortization expenses totaled $9,424
and $2,374, respectively.
 
 Amortization
expense is estimated to be $35,463 for each of the next five years.
 12
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 10.
              Income
      Taxes
 
 On May
30, 2005, AIDH executed a Share Transfer Agreement with XAL, a corporation
organized and existing under the laws of the PRC. XAL applied to be as a foreign
invested company right after the share transfer, which business license has been
approved as a foreign invested company on January 10, 2006. According to
taxation policy of the PRC, there is income tax exemption for two years and half
for three years suitable to a “Foreign Invested Company”, “Advanced Technology
Company”, or “Software Development Company”. XAL is considered an Advanced
Technology Company. Therefore the Company has received this income tax exemption
policy commencing on 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 at a rate 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
                          March 31,2009
                        
                        
                        2008U.S.
      Operations
                        
                        $
                        (510,600
                        )
                        
                        $
                        (374,000
                        )Chinese
      Operations
                        
                        
                        2,401,100
                        
                        
                        
                        457,000$
                        1,890,500
                        
                        
                        $
                        83,000
 
 The
components of the provision for income taxes are approximately as
follows:
  Three
      Months Ended
                          March 31,2009
                        
                        
                        2008Federal,
      State and Local
                        
                        $
                        -
                        
                        
                        $
                        -People’s
      Republic of China -Federal and Local
                        
                        
                        337,800
                        
                        
                        
                        80,600$
                        337,800
                        
                        
                        $
                        80,600
 
 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
                          March 31,2009
                        
                        
                        2008Income
      tax provision at Federal statutory rate
                        
                        $
                        642,800
                        
                        
                        
                        28,000State
      income taxes, net of Federal benefit
                        
                        
                        113,500
                        
                        
                        
                        5,000U.S.
      tax rate in excess of foreign tax rate
                        
                        
                        (168,100
                        )
                        
                        
                        (32,000
                        )Abatement
      of foreign income taxes
                        
                        
                        (452,600
                        )
                        
                        
                        (68,400
                        )Increase
      in valuation allowance
                        
                        
                        202,200
                        
                        
                        
                        148,000Tax
      provision
                        
                        $
                        337,800
                        
                        
                        $
                        80,600
 13
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 10.
              Income
      Taxes (Continued)
 
 As of
March 31, the Company has a U.S net operating loss carryforward of approximately
$3,779,000, which expires in 2027. The deferred tax asset associated with these
net operating loss carryforwards was fully reserved as of March 31,
2009.
 
 The
change in the valuation allowance as of March 31, 2009 and 2008 was $202,200 and
$148,000, respectively.
 
 The
effects of the tax exemption per share were as follows:
 
 Three
      Months Ended
                        March 31,2009
                      
                      
                      2008Tax
      savings
                      
                      $
                      452,600
                      
                      
                      $
                      68,400Benefit
      per share:Basic
                      
                      $
                      0.02
                      
                      
                      $
                      0.00Diluted
                      
                      $
                      0.02
                      
                      
                      $
                      0.00
 
 Had the
tax exemption not been in place for the three months ended March 31, 2009 and
2008, the Company estimates the following proforma financial statement
impact:
 
 Three
      Months Ended
                          March 31,2009
                        
                        
                        2008Net
      income before tax provision, as reported
                        
                        $
                        1,890,500
                        
                        
                        $
                        83,400Less
      Tax provision not exempted
                        
                        
                        337,800
                        
                        
                        
                        80,600Less
      Tax provision exempted
                        
                        
                        452,600
                        
                        
                        
                        68,400Proforma
      Net income (loss)
                        
                        $
                        1,100,100
                        
                        
                        $
                        (65,600
                        )Proforma
      Net income (loss) per shareBasic
                        
                        $
                        0.04
                        
                        
                        $
                        0.00Diluted
                        
                        $
                        0.04
                        
                        
                        $
                        0.00
 
 11.
              Employee
      Retirement Benefits and Post Retirement
Benefits
 
 According
to the Heilongjiang Provincial Regulations on State Pension Program, both
employees and employers have to contribute toward pensions. The pension
contributions range from 2% to 8% that was contributed by individuals
(employees), and the Company is required to make contributions to the state
retirement plan based on 20% of the employees’ monthly basic salaries. Employees
in the PRC are entitled to retirement benefits calculated with reference to
their basic salaries on retirement and their length of service in accordance
with a government managed benefits plan. The PRC government is responsible for
the benefit liability to these retired employees. During the three months ended
March 31, 2009 and 2008, respectively, the Company contributed $43,130 and
$26,849 in pension contributions.
 14
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 12.
              Accounts
      Payable and accrued Expenses
  At March
31, 2009 and 2008 accrued expenses consisted of:
 
 March 31,
                      2009
                    
                    
                    December 31,
                      2008Accounts
      payable
                    
                    $
                    2,971,246
                    
                    
                    $
                    3,264,066Liquidated
      damages
                    
                    $
                    1,201,998
                    
                    
                    
                    1,201,998Accrued
      payroll
                    
                    
                    47,104
                    
                    
                    
                    56,404Accrued
      interest
                    
                    
                    174,038
                    
                    
                    
                    105,287Accrued
      insurance
                    
                    
                    27,201
                    
                    
                    
                    24,192$
                    4,421,587
                    
                    
                    $
                    4,651,947
  13.
              Notes
      payable
  At March
31, 2009 and December 31, 2008 notes payable consisted of the
following:
  March
      31,
                                              2009
                                            
                                            
                                            December
      31,
                                              2008Notes
      dated June, 2008, due December 31, 2009 with a interest rate of 10%, net
      of debt discount of $30,086 and $40,113 at March 31, 2009 and December 31,
      2008, respectively
                                            
                                            $
                                            2,219,914
                                            
                                            
                                            $
                                            2,209,887Notes
      dated November, 2008 due November 10, 2009 with a interest rate of 10%,
      net of debt discount of $35,831 and $47,775 at March 31, 2009 and December
      31, 2008, respectively
                                            
                                            
                                            464,169
                                            
                                            
                                            
                                            452,225$
                                            2,684,083
                                            
                                            
                                            $
                                            2,662,112
 
 14.
              Put/Call
      Liability
 
 On
October 9, 2007, the Company entered into Put/Call Agreements with two (2) of
its stockholders (the “Put/Call Shareholders”), 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 Shareholders (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.
 15
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 14.
              Put/Call
      Liability (Continued)
 
 Term of the Call Option - The
Company may only exercise its Call Option by delivering a written notice (a
“Call Option Exercise Notice”) to the Put/Call 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 the Company to
repurchase the Put/Call Shares (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 of the
      Securities Act of 1933; or
 
 ·
              the
      Company fails to consummate a Qualified Offering within two (2) years of
      the date hereof (each of the aforementioned conditions, a “Put Right
      Trigger”).
  Term of the Put Option - The
Put/Call Shareholders 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 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 Shareholders, 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.
 
 On April
9, 2008 the Company and the Put/Call Shareholders executed a waiver and
amendment to the Put/Call Agreement reaffirming that the Put/Call Agreement was
still in full force and removing the following provision as a Put Right
Trigger:
 
 ·
              The
      Company fails to (i) file the Registration Statement within thirty (30)
      business days of the Closing Date (the “Filing Date”), (B) have the
      Registration Statement declared effective within ninety (90) calendar days
      from the Filing Date, or, if reviewed by the Commission, within one
      hundred eighty (180) calendar days after the Filing Date, or (C) keep the
      Registration Statement continuously effective until all of the Shares are
      available for sale without registration pursuant to Rule
      144(k).
 
 On March
3, 2009, the Company and the Put/Call Stockholders terminated the Put/Call
Agreement.
 
 The
termination of the Put/Call agreements was considered a type 1 event due to the
culmination of events that started with the waiver executed on April, 9, 2008,
and ending with the termination of the Put/Call Agreement on March 3,
2009.  As a type 1 event, the termination provided additional evidence
with respect to the valuation of the Put/Call Agreement as of December 31, 2008.
As of December 31, 2008, the Company reclassified the $3,169,444 value previous
recorded from liabilities to additional paid-in capital.
 16
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 15.
              Equity
 
 Registration
Rights Agreement
 
 On
October 9, 2007 and October 19, 2007, the Company entered into Registration
Rights Agreements with certain accredited investors (“Investors”), in connection
with private offerings (the “Offerings”) it consummated on such dates. Pursuant
to the Registration Rights Agreements, the Company agreed to register the shares
of common stock, and shares underlying warrants, purchased in the
Offerings.  Further, if the Company did not satisfy its registration
requirements, liquidated damages would accumulate at the rate of 1.5% of the
purchase price paid by the Investors  for each thirty (30) day period
during which a registration default continued.
 
 The
Company did not satisfy the registration requirements.  However, as of
October 20, 2008, the liquidated damages stopped accruing because the shares
covered by the Registration Rights Agreements could then be sold under Rule
144.
 
 There are
accrued liquidated damages of $1,201,998 at March 31, 2009 and December 31,
2008. Liquidated damages of $0 and $127,900 were accrued in the three months
ended March 31, 2009 and 2008.
 
 Per the
Registration Rights Agreements, the Company can pay the $1,201,998 in liquidated
damages in cash or Company common stock.  The Company plans to satisfy
its obligation by issuing 667,777 shares of the Company’s common stock, based on
the closing price of its common stock of $1.80 on the Over-the-Counter Bulletin
Board, on October 20, 2008.
 
 Warrants
 
 Information
with respect to stock warrants outstanding as of March 31, 2009 are as
follows:
  Exercise Price
                        
                        
                        Outstanding
                          December
                          31, 2008
                        
                        
                        Granted
                        
                        
                        Expired or
                          Exercised
                        
                        
                        Outstanding
                          March
                          31, 2009
                        
                        Expiration
                          Date$
                        0.94
                        
                        
                        
                        373,334
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        373,334
                        
                        10/09/2010$
                        1.50
                        
                        
                        
                        1,333,333
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        1,333,333
                        
                        10/09/2009$
                        2.04
                        
                        
                        
                        804,884
                        
                        
                        
                        -0-
                        
                        
                        
                        (177,000
                        )
                        
                        
                        627,884
                        
                        10/09/2010$
                        2.04
                        
                        
                        
                        569,346
                        
                        
                        
                        -0-
                        
                        
                        
                        (6,457
                        )
                        
                        
                        562,889
                        
                        10/19/2010$
                        1.63
                        
                        
                        
                        195,000
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        195,000
                        
                        6/12/2011$
                        1.63
                        
                        
                        
                        75,000
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        75,000
                        
                        6/20/2011$
                        3.26
                        
                        
                        
                        2,061,227
                        
                        
                        
                        -0-
                        
                        
                        
                        (169,480
                        )
                        
                        
                        1,891,747
                        
                        10/09/2009$
                        3.26
                        
                        
                        
                        2,846,746
                        
                        
                        
                        -0-
                        
                        
                        
                        (6,457
                        )
                        
                        
                        2,840,289
                        
                        10/19/2009$
                        2.61
                        
                        
                        
                        75,000
                        
                        
                        
                        -0-
                        
                        
                        
                        -0-
                        
                        
                        
                        75,000
                        
                        11/10/2011
 
 As of
March 31, 2009 all outstanding warrants are exercisable.
 
 Warrant
Tender Offer
 
 As of
April 24, 2008, the Company commenced an offer (“Warrant Tender Offer”) to the
holders (“Warrantholders”) of the Company’s then outstanding warrants, pursuant
to which the Warrantholders were permitted to tender their Warrants for shares
of the Company’s Common Stock at a reduced exercise price as
follows:
 
 ·
              With
      respect to warrants having an exercise price of $0.94 per share, a holder
      accepting the Offer was permitted to exercise some or all of such warrants
      at $0.75 per share of Common Stock;
 17
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 15.
              Equity
      (Continued)
 
 ·
              With
      respect to warrants having an exercise price of $1.50 per share, a holder
      accepting the Offer was permitted to exercise some or all of such warrants
      at $1.20 per share of Common Stock;
  ·
              With
      respect to warrants having an exercise price of $2.04 per share, a holder
      accepting the Offer was permitted to exercise some or all of such warrants
      at $1.63 per share of Common Stock;
and
 
 ·
              With
      respect to warrants having an exercise price of $3.26 per share, a holder
      accepting the Offer was permitted to exercise some or all of such warrants
      at $2.61 per share of Common Stock.
  On March
2, 2009, the Company closed on its Offer to existing warrant holders to exercise
their warrants on amended terms. In connection with the Offer:
  ·
              A
      total of 183,457 warrants were tendered at the reduced exercise price of
      $1.63 per share (originally $2.04 per share), for an aggregate exercise
      price of $299,034; and
  ·
              A
      total of 175,937 warrants were tendered at the reduced exercise price of
      $2.61 per share (originally $3.26 per share), for an aggregate exercise
      price of $459,196.
  As a
result, (a) a total of 359,394 shares of the Company’s common stock were issued
in connection with the exercise of such warrants and (b) the Company received
gross proceeds of $758,230 as payment of the exercise prices.
  16.
              Common
      Welfare Reserves
 
 The
Company is required to transfer 10% of its net income, as determined in
accordance with PRC accounting rules and regulations, to the general reserve.
The balance of these reserves at March 31, 2009 and December 31, 2008, was
$2,062,907 and $1,314,861, respectively. These amounts are restricted and are
included in retained earnings.
 
 This fund
can only be utilized on capital items for the collective benefit of the
Company’s employees, such as construction of dormitories, cafeteria facilities,
and other staff welfare facilities. The fund is non-distributable other than
upon liquidation.
  17.
              Earnings
      Per Share
 
 SFAS 128
requires a reconciliation of the numerator and denominator of the basic and
diluted earnings per share ("EPS") computations.
 
 For the
three months ended March 31, 2009, dilutive shares include outstanding warrants
to purchase 373,334 shares of common stock at an exercise price of $0.94;
warrants to purchase 1,333,333 shares at an exercise price of $1.50. Warrants to
purchase 6,627,203 share of common stock were not included in dilutive shares as
the effect would have been anti-dilutive.
 
 For the
three months ended March 31, 2008, dilutive shares include stock options to
purchase 235,200 shares if common stock at $0.42 share. Warrants to purchase
7,974,476 share of common stock were not included in dilutive shares as the
effect would have been anti-dilutive.
 18
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 17.
              Earnings
      Per Share (Continued)
 
 
 The
following reconciles the components of the EPS computation:
 
 Income
                                    
                                    
                                    Shares
                                    
                                    
                                    Per Share(Numerator)
                                    
                                    
                                    (Denominator)
                                    
                                    
                                    AmountFor
      the three months ended March 31, 2009:Net
      income
                                    
                                    $
                                    1,552,706Basic
      EPS income available to common shareholders
                                    
                                    $
                                    1,552,706
                                    
                                    
                                    
                                    29,415,137
                                    
                                    
                                    $
                                    0.05Effect
      of dilutive securities:Stock
      options
                                    
                                    
                                    —
                                    
                                    
                                    
                                    95,714Diluted
      EPS income available to common shareholders
                                    
                                    $
                                    1,552,706
                                    
                                    
                                    
                                    29,510,851
                                    
                                    
                                    $
                                    0.05For
      the three months ended March 31, 2008:Net
      income
                                    
                                    $
                                    2,818Basic
      EPS income available to common shareholders
                                    
                                    $
                                    2,818
                                    
                                    
                                    
                                    29,296,832
                                    
                                    
                                    $
                                    0.00Effect
      of dilutive securities:Warrants
                                    
                                    
                                    —
                                    
                                    
                                    
                                    216,814Diluted
      EPS income available to common shareholders
                                    
                                    $
                                    2,818
                                    
                                    
                                    
                                    29,513,646
                                    
                                    
                                    $
                                    0.00
 
 18.
              Equity
      Incentive Plan
 
 On March
2, 2009, the Company’s board of directors and majority stockholders adopted the
Emerald Dairy Inc. 2009 Equity Incentive Plan (the “Plan”) to attract and retain
the best available personnel, provide additional incentives to employees,
directors and consultants and promote the success of the Company’s business.
1,500,000 shares of the Company’s common stock have been reserved for issuance
under the Plan.
 
 Eligibility
 
 The
Company may grant awards to its employees, directors and consultants, including
those of the Company’s subsidiaries. However, the Company may grant options that
are intended to qualify as incentive stock options (“ISOs”) only to its
employees and employees of its subsidiaries.
 
 Acceleration of Awards upon
Corporate Transactions.
 
 The
outstanding awards will terminate and/or accelerate upon occurrence of certain
significant corporate transactions, including amalgamations, consolidations,
liquidations or dissolutions, sales of substantially all or all of the Company’s
assets, reverse takeovers or acquisitions resulting in a change of
control.
 
 Exercise Price and Term of
Awards.
 
 In
general, the Plan administrator will determine the exercise price of an option
in the award agreement. The exercise price may be a fixed price, or it may be a
variable price related to the fair market value of the Company’s ordinary
shares. If the Company grants an ISO to an employee, the exercise price may not
be less than 100% of the fair market value of its common stock on the date of
the grant, except that if the grantee, at the time of that grant, owns shares
representing more than 10% of the voting power of all classes of the Company’s
shares of common stock, the exercise price may not be less than 110% of the fair
market value of its common stock on the date of that grant. If the Company
grants a non-qualified share option to a grantee, the exercise price may not be
less than 100% of the fair market value of its common stock on the date of
grant.
 19
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 18.
              Equity
      Incentive Plan (Continued)
 
 The term
of each award under the Plan will be specified in the award agreement, but may
not exceed ten years from the earlier of the adoption or the approval of the
plan, unless sooner terminated.
 
 The
Company follows the provisions of SFAS No. 123(R). Total share-based
compensation costs included on the Condensed Consolidated Statements of
Operations were $18,508 and none during the three months ended March 31,
2009 and March 31, 2008, respectively. All share-based compensation costs
are included in selling expenses and administrative expenses.
  The
Company estimates the fair value of stock options using a Black-Scholes option
pricing valuation model, consistent with the provisions of SFAS 123(R) and SEC
Staff Accounting Bulletin No. 107 (SAB "107"). Key inputs and assumptions used
to estimate the fair value of stock options include the grant price of the
award, the expected option term, volatility of the Company’s stock, the
risk-free rate and the Company’s dividend yield. Estimates of fair value are not
intended to predict actual future events or the value ultimately realized by
grantees, and subsequent events are not indicative of the reasonableness of the
original estimates of fair value made by the Company.
   The fair
value of each stock option is estimated on the date of the grant using the
Black-Scholes option pricing model. No dividends were assumed due to the nature
of the Company’s current business strategy. The following table presents the
weighted average assumptions used for options granted:
  March 2,
      2009Number
      of options
                    
                    
                    703,200Risk
      free interest rate
                    
                    
                    .67
                    %Expected
      life (year)
                    
                    
                    2Expected
      volatility
                    
                    
                    252.69
                    %Weighted
      average fair value per option
                    
                    $
                    0.34
 
 Share
Options
 
 A summary
of the Company’s outstanding share option award grants as of March 31, 2009, and
changes during the three months then ended are presented below:
 
 Shares
                      
                      Weighted-Average
      Exercise Price
                      
                      Weighted-Average
      Remaining Contractual Term
                      
                      Aggregate
      Intrinsic Value(in
      years)
                      
                      (in
      millions)Outstanding
      at December 31, 2008
                      -0-
                      
                      $
                      --Granted
                      703,200
                      
                      
                      0.42Exercised
                      -0-
                      
                      
                      --Expired
                      -0-
                      
                      
                      --Forfeited
                      -0-
                      
                      
                      --Outstanding
      at March 31, 2009
                      703,200
                      
                      $
                      0.42
                      
                      9.93
                      
                      $
                      161,736Non-vested
      and expected to vest at March 31, 2009
                      703,200
                      
                      $
                      0.42
                      
                      9.93
                      
                      $Exercisable
      at March 31, 2009
                      -0-
                      
                      $
                      --
                      
                      3.7
 
 As of
March 31, 2009, there was $220,693 of total unrecognized compensation
costs related to non-vested Company share options granted under Company share
option plans. The cost is expected to be recognized over a weighted-average
period of 1.27 years.
 20
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 19.
              Commitments
      and Contingencies
 
 The
Company has various purchase commitments for materials, supplies and services
incident to the ordinary conduct of business, generally for quantities required
for the Company’s business and at prevailing market prices. No material annual
loss is expected from these commitments.
 
 The
Company has contracted for construction of a second production facility in
Hailun City, Heilongjiang Province, PRC.  The contract is for
$8,428,080, of which $2,039,920 has been paid, and $334,574 has been accrued in
accounts payable.  The remaining $6,053,586 is to be paid in 2009 for
completion of the facility.
 
 The
Company has contracted to purchase equipment from a supplier for the second
processing facility for $5,295,891 of which $3,707,124 has been
paid.  The remaining $1,588,767 will be paid on delivery of the
equipment in 2009.
 
 The
Company has advances to milk suppliers of $331,464 which will be offset against
future milk purchases from those suppliers (see Note 6, “Other Current
Assets”).
 
 In order
for the Company to conduct its current operations, a milk powder production
license is required from the State General Administration of Quality Supervision
and Inspection and Quarantine of the PRC (the “Administration”). The Company’s
current license expired in December 2008. The Administration will inspect the
quality of the Company’s production process in 2009. Depending on the results of
this inspection, the State General Administration will either (i) grant the
Company a license renewal, or (ii) advise the Company of material deficiencies
it has discovered and schedule another inspection for 2010. The Company expects
that it will pass the inspection. If it does not, it will have an opportunity to
cure any deficiencies prior to the follow up inspection that would have been
scheduled for 2010. Other than the foregoing, no government approvals are
required to conduct the Company’s principal operations, and the Company is not
aware of any probable governmental regulation of the Company’s business sectors
in the near future. Although management believes that the Company is in material
compliance with the statutes, laws, rules and regulations of every
jurisdiction in which it operates, no assurance can be given that the Company’s
compliance with the applicable statutes, laws, rules and regulations will
not be challenged by governing authorities or private parties, or that such
challenges will not lead to a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
 
 The
Company and its subsidiaries are self-insured, and they do not carry any
property insurance, general liability insurance, or any other insurance that
covers the risks of their business operations. As a result any material loss or
damage to its properties or other assets, or personal injuries arising from its
business operations would have a material adverse effect on the Company’s
financial condition and operations.
 
 The
Company is not involved in any legal matters arising in the normal course of
business. While incapable of estimation, in the opinion of the management, the
individual regulatory and legal matters in which it might involve in the future
are not expected to have a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
 
 The
Company’s employees were required to pay an employee deposit upon commencement
of employment, which was standard in the PRC. As of January 1, 2009 these
deposits are no longer allowed in the PRC and all amounts were returned to the
employees. As of December 31, 2008, the Company held employee deposits in the
aggregate amount of  $248,424 which were reflected in advances from
employees in the financials statements.
 
 19.
              Operating
      Leases
 
 The
Company leases various distribution facilities. All leases are on an annual
basis and commence on January 1, of each year. The Company also leases office
space which expires September, 2009.  For the three months ended March
31, 2009 and 2008, the Company incurred rental expense of $39,293 and $31,520,
respectively. As of March, 2009, the Company had outstanding lease commitments
totaling $108,310, all of which are due within the next year.
 21
 Emerald
Dairy, Inc and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 March
31, 2009 and 2008
 
 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 powder, soybean powder, and rice powder,
the Company’s chief operating decision maker reviews and evaluates one set of
combined financial information deciding how to allocate resources and in
assessing performance.
 
 For the
three months ended March 31, 2009 and 2008, the Company’s sales revenue from
various products are as follows:
 
 Three
      Months Ended
                          March 31,2009
                        
                        
                        2008Milk
      powder
                        
                        $
                        9,270,354
                        
                        
                        $
                        8,103,303Soybean
      milk powder
                        
                        
                        287,039
                        
                        
                        
                        252,416Rice
      powder
                        
                        
                        320,090
                        
                        
                        
                        197,546Sub-contract
      processing
                        
                        
                        979,069
                        
                        
                        
                        1,881,194$
                        10,856,552
                        
                        
                        $
                        10,434,459


22


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





Forward
Looking Statements





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





Overview





We are a producer of milk powder, rice
powder and soybean milk powder, which currently comprise approximately 95%, 3%
and 2%of our
sales, respectively. Through our network of over 800 salespeople, our products
are distributed throughout 20 provinces in the People’s Republic of China
(“PRC”), and sold in over 5,800 retail outlets.





Our products are marketed under two
brand names:





·
            “Xing
      An Ling,” which is designed for 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 23% through 2011. 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.





Because of our close proximity to our
sources of fresh milk, we are able to complete the production process in
approximately 30 hours, which is faster than competitors of ours that are not
similarly situated.  We produced approximately 7,000 tons of milk
powder at our facility in Be’ian City, Heilongjiang Province, PRC in fiscal
2007, up from approximately 5,000 tons in fiscal 2006. In 2008, by adding a
third shift to the existing two shifts working schedule, we produced
approximately 9,000 tons of milk powder.  In addition, in July 2008,
through our wholly-owned subsidiary, Hailun Xinganling Dairy Co., Ltd. (“HXD”),
we commenced construction of a new production facility in Hailun City,
Heilongjiang Province, PRC, which we expect will enable us to produce an
additional 9,000 tons of milk powder in 2009 and a total of 18,000 tons of milk
powder annually in 2010. As a result, we believe we will have the capacity to
produce approximately 27,000 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 an aggregate of approximately
5% of our overall sales.





23


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





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




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




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




Recent
Developments




Reverse Merger, Private Placements and
Related Transactions





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





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





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.




24




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





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





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





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





Construction of New Production
Facility





On May 22, 2008, we organized our
wholly-owned subsidiary, HXD, under the laws of the PRC. In July 2008, HXD
commenced construction on a production facility to be located in Hailun City,
Heilongjiang Province, PRC. Initially, the new facility will have one production
line, which will have the capacity to produce 9,000 tons of milk power annually.
A second production line can be added at this new facility, which, when
completed, would enable us to produce an additional 9,000 tons of milk powder
per year, giving us a total annual production capacity of 27,000 tons of milk
powder. We anticipate that production at this new facility will commence in the
third quarter of fiscal 2009, assuming we obtain the $6.0 million we require to
complete construction and fully equip the first production line. The cost to add
the second production line, would be an additional $15.0 million. We plan to
raise the funds needed for the new facility from the capital market through
private or public equity and/or debt offerings. There can be no assurance that
that any additional financing will become available to us, and if available, on
terms acceptable to us.





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





25


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





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





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





Warrant Tender Offer





As of
April 24, 2008, we commenced an offer (the “Warrant Tender Offer”) to the
holders of our then outstanding warrants, pursuant to which the holders had the
opportunity to 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 Warrant Tender Offer could 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 Warrant Tender Offer could 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 Warrant Tender Offer could 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 Warrant Tender Offer could 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 it
believed this would provide sufficient incentive to the holders to exercise
their warrants early, even though they had no obligation to do so.




26




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





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




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




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





Adoption of 2009 Equity Incentive
Plan





On March 2, 2009, our board of
directors adopted our 2009 Equity Incentive Plan (the “Plan”) to attract and
retain the best available personnel, provide additional incentives to employees,
directors and consultants and promote the success of our business. On March 11,
2009 (the “Record Date”), we obtained the written consent of the holders of
15,414,577 shares of our common stock, which as of the Record Date represented
approximately 52.7% of our outstanding voting securities, to adopt the Plan.
1,500,000 shares of the Company’s common stock have been reserved for issuance
under the Plan.





Following the adoption of the Plan, our
board of directors approved the grant of an aggregate of 703,200 stock option
awards to our executive officers and directors. The rights and obligations under
the Stock Options are further described in “- Liquidity and Capital Resources –
Stock Options” below.





Trends
and Uncertainties





Economic Downturn





The recent worldwide economic downturn
and market instability have made the business climate more volatile and more
costly. Although all of our business operations are currently conducted in
China, our general business strategy may be adversely affected by unpredictable
and unstable market conditions.  If the current equity and credit
markets deteriorate further, or do not improve, it may make any necessary debt
or equity financing more difficult, more costly, and more dilutive. Failure to
secure any necessary financing in a timely manner and on favorable terms could
have a material adverse effect on our growth strategy, financial performance and
stock price and could require us to delay or abandon our expansion
plans.





Narrowing of Gap in Milk
Consumption





The Chinese government has initiated
programs to promote milk consumption and is providing incentives to increase
dairy production. In addition to improving the overall health of its populous,
the government views increased dairy production as a means of improving
employment in rural areas thus improving social stability. The programs are
designed to narrow the significant gap between 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 and 2007 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 2008 to 2012, to reach $32 billion by
2012.




27


On its website, the Dairy Association
of China estimates that the infant formula market segment, which is the market
segment we target, has grown even faster in recent years, at a rate of 20%-30%
per year. We believe the following three factors are the main drivers of the
infant formula market:





·
            Increased
      household income made infant formula more affordable in
    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.  In
recent years, our production capabilities have not been able to keep up with
demand for our products. We have commenced construction of a new production
facility with an initial annual production capacity of 9,000 tons of milk
powder, which is expected to start production in the third quarter of 2009. We
expect that this increase in production capacity of approximately 100% will
result in the doubling of our sales revenues, with a corresponding increase in
cost of goods sold and sales and administrative expenses.





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





Product Pricing and Raw Material
Supply





Historically we have been able to
obtain sufficient raw milk and other raw materials to meet our production needs.
The price of raw milk is affected by regional market in Heilongjiang Province,
PRC, while other raw materials are affected by global markets. We expect that
the raw materials we require to produce our products will continue to be
available to us for the foreseeable future. However, we believe the recent
worldwide increases in the cost and availability of commodities, such as rice
and oil, will lead to increases in prices for such commodities. To some extent,
we believe we will be able to increase the prices for our products to pass on
higher raw material costs to consumers. However, there is no guarantee that we
will be able to raise prices to the full extent necessary to cover rises in
costs for raw materials, which could have a negative material impact on our
financial condition and results of operations.





Brand Name and Product
Quality





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




28




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 2009. 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.





Factors Affecting Raw Milk
Production





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





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




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




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




Contamination of Milk Powder Products
Produced in China





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





29


Results
of Operations





Three-Month
Period Ended March 31, 2009 Compared to Three-Month Period Ended March 31,
2008





The
following summarizes changes in our operations for the three months ended March
31, 2009 and 2008.  Net income increased by $1,549,888, from $2,818 in
the three months ended March 31, 2008, to $1,552,706 for the three months ended
March 31, 2009. The increase in net income during the three months ended March
31, 2009, as compared to the same time period in the prior year, was due to
decreases in selling expenses and an increase in gross profit, which offset an
increase in our operating expenses as further described below.




Sales
and Cost of Goods Sold





For the Three
      Months
                      Ended March
      31,2009
                    
                    2008Sales
                    
                    $
                    10,856,552
                    
                    
                    $
                    10,434,459Cost of Goods
      Sold
                    
                    
                    5,848,675
                    
                    
                    
                    6,011,234Gross
      Profit
                    
                    $
                    5,007,877
                    
                    
                    $
                    4,423,225





Sales. Sales volume decreased
by 150 metric tons, or 6.7%, period on period, to 2,100 metric tons for the
three months ended March 31, 2009, from 2,250 metric tons for the three months
ended March 31, 2008. However, sales revenues increased by $422,093, or
4.0%, from $10,434,459 in the three months ended March 31, 2008, to $10,856,552
for the three months ended March 31, 2009. This increase was primarily due to an
increase in the average selling price for all of our products, by $532 per
metric ton, as compared to the three months ended March 31, 2008, because we
produced more of our high end product line in fiscal 2009.





Sales by product
line.A break-down of our sales by product line for the three
months ended March 31, 2009 and 2008 is as follows:





Three
      Months Ended March 31,2009
                              
                              
                              2008
                              
                              
                              Period-on-periodProduct category
                              
                              Quantity
                                (tons)
                              
                              
                              $ Amount
                              
                              
                              % of sales
                              
                              
                              Quantity
                                (tons)
                              
                              
                              $ Amount
                              
                              
                              % of
                                sales
                              
                              
                              Qty.
                                VarianceMilk
      powder
                              
                              
                              1,529
                              
                              
                              
                              9,270,354
                              
                              
                              
                              85.4
                              
                              
                              
                              1,496
                              
                              
                              
                              8,093,235
                              
                              
                              
                              77.6
                              
                              
                              
                              33Rice
      powder
                              
                              
                              56
                              
                              
                              
                              320,090
                              
                              
                              
                              2.9
                              
                              
                              
                              49
                              
                              
                              
                              258,070
                              
                              
                              
                              2.5
                              
                              
                              
                              7Soybean
      powder
                              
                              
                              153
                              
                              
                              
                              287,039
                              
                              
                              
                              2.7
                              
                              
                              
                              117
                              
                              
                              
                              201,970
                              
                              
                              
                              1.9
                              
                              
                              
                              36Subcontracting
                              
                              
                              362
                              
                              
                              
                              979,069
                              
                              
                              
                              9.0
                              
                              
                              
                              588
                              
                              
                              
                              1,881,184
                              
                              
                              
                              18.0
                              
                              
                              
                              (226
                              )Total
                              
                              
                              2,100
                              
                              
                              
                              10,856,552
                              
                              
                              
                              100.0
                              
                              
                              
                              2,250
                              
                              
                              
                              10,434,459
                              
                              
                              
                              100.0
                              
                              
                              
                              (150
                              )




There
were various changes to the break-down of sales among our product lines over the
three months ended March 31, 2009, as we increased production in most all lines,
but attempted to adjust our sales mix to higher margin products, and away from
subcontracting. Soybean powder accounted for 2.6% of our sales mix for the
three months ended March 31, 2009, at an average selling price of $1,876 per
metric ton, as compared to 1.9% of our sales mix in the three months ended March
31, 2008, at an average selling price of $1,727 per metric ton. Milk powder
accounted for 85.4% of first quarter 2009 sales mix, at an average selling price
of $6,063 per metric ton, as compared to 77.6% of first quarter 2008, at an
average selling price of $4,351 per metric ton. We decreased our subcontract
production during the three months ended March 31, 2009 to 9.0% of the sales
mix, at an average selling price of $2,705 per metric ton, as compared to 18.0%
of the sales mix in the three months ended March 31, 2008, at an average sales
price of $3,199 per metric ton.




30




A
breakdown of our average selling price by product line for the three months
ended March 31, 2009 and 2008 is as follows:




Three
      Months Ended
                              March
      31,Average selling prices
                            
                            2009
                            
                            
                            2008
                            
                            
                            Variance$
                            
                            
                            $
                            
                            
                            $
                            
                            
                            
                            %Milk
      powder
                            
                            
                            6,063
                            
                            
                            
                            5,410
                            
                            
                            
                            653
                            
                            
                            
                            12.1Rice
      powder
                            
                            
                            5,716
                            
                            
                            
                            5,267
                            
                            
                            
                            449
                            
                            
                            
                            8.5Soybean
      powder
                            
                            
                            1,876
                            
                            
                            
                            1,727
                            
                            
                            
                            149
                            
                            
                            
                            8.6Subcontracting
                            
                            
                            2,705
                            
                            
                            
                            3,199
                            
                            
                            
                            (494
                            )
                            
                            
                            (15.4
                            )Total
                            
                            
                            5,170
                            
                            
                            
                            4,638
                            
                            
                            
                            532
                            
                            
                            
                            11.5




Cost of Goods
Sold.  Cost of goods sold decreased by $162,559, or 2.7%, from
$6,011,234 in the three months ended March 31, 2008, to $5,848,675 for the three
months ended March 31, 2009. This decrease was directly related to our reduction
in subcontracting work during the three months ended March 31, 2009. Overall our
cost per metric ton increased by $113, or 4.2%, to $2,785 per metric ton in the
three months ended March 31, 2009, as compared to $2,672 per metric ton in three
months ended March 31, 2008, due to increases in our sales and the price of raw
materials we use to produce our products.





A
breakdown of cost of sales by product line for the years ended March 31, 2009
and 2008 is as follows:




Three
      Months Ended March 31,2009
                      
                      
                      2008
                      
                      
                      Variance$
                      
                      
                      $
                      
                      
                      $
                      
                      
                      
                      %Cost of salesMilk
      powder
                      
                      
                      4,632,692
                      
                      
                      
                      4,161,982
                      
                      
                      
                      470,710
                      
                      
                      
                      11.3Rice
      powder
                      
                      
                      125,525
                      
                      
                      
                      101,204
                      
                      
                      
                      89,048
                      
                      
                      
                      88.0Soybean
      powder
                      
                      
                      215,280
                      
                      
                      
                      126,232
                      
                      
                      
                      24,321
                      
                      
                      
                      19.2Subcontracting
                      
                      
                      875,178
                      
                      
                      
                      1,621,816
                      
                      
                      
                      (746,638
                      )
                      
                      
                      (46.0
                      )Total
                      
                      
                      5,848,675
                      
                      
                      
                      6,011,234
                      
                      
                      
                      (162,559
                      )
                      
                      
                      (2.7
                      )Cost per units sold(per
      ton)Milk
      powder
                      
                      
                      3,030
                      
                      
                      
                      2,782
                      
                      
                      
                      248
                      
                      
                      
                      8.9Rice
      powder
                      
                      
                      2,242
                      
                      
                      
                      2,065
                      
                      
                      
                      177
                      
                      
                      
                      8.6Soybean
      powder
                      
                      
                      1,407
                      
                      
                      
                      1,079
                      
                      
                      
                      328
                      
                      
                      
                      30.4Subcontracting
                      
                      
                      2,418
                      
                      
                      
                      2,758
                      
                      
                      
                      (340
                      )
                      
                      
                      (12.3
                      )Average
      cost per unit sold
                      
                      
                      2,785
                      
                      
                      
                      2,672
                      
                      
                      
                      113
                      
                      
                      
                      4.2




Gross Profit. Gross profit was
$5,007,877, or 46.1% of our sales for the three months ended March 31, 2009, as
compared to gross profit of $4,423,225, or 42.4%, for the three months ended
March 31, 2008. During the three months ended March 31, 2009, our gross margin
on milk powder increased to 50.0%, from 48.6% in the same period of the prior
year, due to an increase in the average sales price of 12.1%, while there was a
8.9% increase in the cost per metric ton from the three months ended March 31,
2008. The gross margin for soybean powder declined 12.5% to 25.0% in the
three months ended March 31, 2009, as compared to 37.5% in the three months
ended March 31, 2008, due to an increase in the average cost per ton of 30.4% in
the three months ended March 31, 2009 as compared to the same period in
2008.




31


A
breakdown of gross margin by product line for the years March 31, 2009 and 2008
is as follows:




Three
      Months Ended March 31,2009
                        
                        
                        2008
                        
                        
                        Period-on-periodProduct category
                        
                        $ Amount
                        
                        
                        Gross
                          Margin %
                        
                        
                        $ Amount
                        
                        
                        Gross
                          Margin %
                        
                        
                        Margin
                          VarianceMilk
      powder
                        
                        
                        4,637,662
                        
                        
                        
                        50.0
                        
                        
                        
                        3,931,253
                        
                        
                        
                        48.6
                        
                        
                        
                        1.4Rice
      powder
                        
                        
                        71,759
                        
                        
                        
                        60.8
                        
                        
                        
                        156,866
                        
                        
                        
                        60.8
                        
                        
                        
                        --Soybean
      powder
                        
                        
                        194,565
                        
                        
                        
                        25.0
                        
                        
                        
                        75,738
                        
                        
                        
                        37.5
                        
                        
                        
                        (12.5
                        )Subcontracting
                        
                        
                        103,891
                        
                        
                        
                        10.6
                        
                        
                        
                        259,368
                        
                        
                        
                        13.8
                        
                        
                        
                        (3.2
                        )Total
                        
                        
                        5,007,877
                        
                        
                        
                        46.1
                        
                        
                        
                        4,423,225
                        
                        
                        
                        42.4
                        
                        
                        
                        3.7




Operating
Expenses





For the Three
      Months
                      Ended March
      31,2009
                    
                    
                    2008Operating ExpensesSelling
      and administrative expenses
                    
                    $
                    3,026,704
                    
                    
                    $
                    4,329,338Depreciation
      and amortization
                    
                    
                    43,238
                    
                    
                    
                    14,861Total
      operating expenses
                    
                    $
                    3,069,942
                    
                    
                    $
                    4,344,199





Selling Expenses. Selling
expenses overall decreased by $1,390,678, or 37.3%, from $3,731,332 in the three
months ended March 31, 2008, to $2,340,653 for the three months ended March 31,
2009. The major factors in the decrease in selling expenses are as
follows:





·
            Advertising
      decreased by $1,317,833, or 84.3%, to $245,758 in 2009, from $1,563,591 in
      2008, due to a less aggressive marketing campaign in
  2009.




·
            Promotion
      expenses decreased by $462,460, or 60.3%, to $303,867 in 2009, from
      $766,327 in 2008, as we reduced our marketing as compared to
      2008.




·
            Transportation
      expenses decreased by $11,536, or 4.6%, to $237,506 in 2009, from $249,042
      in 2008, as a result of our shipping costs decreasing in 2009 as compared
      to 2008.




These
decreases were partially offset by an increase in outdoor promotion expenses of
$120,245, or 292.7%, to $161,320 in 2009, from $41,075 in 2008, as part of our
marketing campaign to increase brand awareness and sales.




32


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 $88,047, or 14.7%, from $598,004 in three
months ended March 31, 2008, to $686,051 for the three months ended March 31,
2009. The major factors in the increase in administrative expenses are as
follows:





·
            Increase
      of consultation expenses of $47,843, to $48,750 in 2009, from $907 in
      2008, as a result of our hiring consultants to assist with internal
      control assessment and other management
  assessments.




·
            Increase
      in legal and accounting expenses of $169,938, or 206.3%, to $252,322 in
      2009, from $82,384 in 2008, due to increased costs related to public
      company reporting
requirements.




These
increases were partially offset by liquidated damages of $127,900 incurred in
2008, as a result of our failure to satisfy certain registration requirements.
No liquidated damages were incurred in 2009.




Provision
for Income Taxes





For the Three
      Months
                    Ended March
      31,2009
                  
                  
                  2008Provision
      for Income TaxesCurrent
                  
                  $
                  337,830
                  
                  
                  $
                  80,580Deferred
                  
                  
                  —
                  
                  
                  
                  —$
                  337,830
                  
                  
                  $
                  80,580





Provision for Income Taxes.
Income taxes increased by $257,250, or 319.0%, from $80,580 for the three months
ended March 31, 2008, to $337,830 for the three months ended March 31, 2009.
This increase was due to the increase in our taxable income in our operating
subsidiaries.





Liquidity
and Capital Resources





Uses
of Capital





For the Three
      Months Ended
                    March
      31,2009
                  
                  
                  2008Net
      cash provided by operating activities
                  
                  $
                  70,044
                  
                  
                  $
                  1,194,399Net
      cash used in investing activities
                  
                  
                  (4,933
                  )
                  
                  
                  (27,469
                  )Net
      cash provided (used in) by financing activities
                  
                  $
                  758,230
                  
                  
                  $
                  (284,439
                  )





Net Cash Provided By Operating
Activities.For the three months ended March 31, 2009, $70,044
was provided by operating activities, compared with $1,194,399 provided by
operating activities for the three months ended March 31, 2008. Our net cash
flows provided from operating activities during 2009 decreased due to the
following factors:




33




·
            Trade
      accounts receivable increased by $634,734, due to the increased level of
      sales during the year.




·
            Inventory
      increased by $480,552, due to reduced sales of our products during the
      Chinese New Year.




·
            Advances
      to suppliers and other receivables decreased by $36,018, due the increase
      in our level of production during
2008.




·
            Accounts
      payable and accrued expenses increased by $223,133 at March 31, 2009, as
      compared to the same period in 2008, due to increases in production of
      products and expenses.




Net Cash Used In Investing
Activities.For the three months ended March 31, 2009, we used
$4,933 in investing activities, compared with $27,469 used in investing
activities for the three months ended March 31, 2008. The $4,933 was for the
purchase of office equipment and other general equipment.





Net Cash Provided By Financing
Activities.For the three months ended March 31, 2009,
$758,230 was provided by financing activities, compared with $284,439 used in
financing activities for the three months ended March 31, 2008. We raised
$758,230 through the exercise of warrants during the three months ended March
31, 2009, in connection with the consummation of the Warrant Tender Offer as
further described in “- Recent Developments – Warrant Tender Offer”
above.





General




In recent
years, the Chinese government has initiated programs to promote milk consumption
and is providing incentives to increase dairy production. Over the same period,
our products have become increasing popular in mainland China due to our
continued sales and marketing efforts. As a result, we have experienced
tremendous growth well above the industry average during recent years. Sales
increased from approximately $7.9 million in 2005 to approximately $44.3 million
in 2008, a 461% increase over three years. Net income increased from
approximately $0.7 million in 2005 to approximately $2.3 million in 2008, a 220%
increase over three years..





Cash and cash equivalents at March 31,
2009 increased by 11.0% to $8,154,392, from $7,343,588 at December 31, 2008.
Working capital increased from approximately $1.4 million in 2005 to
approximately $10.7 million in 2008, including cash generated from operations,
as well as funds raised from private offerings of promissory notes and warrants
we consummated in fiscal 2008. Based upon our short term liabilities, we believe
our cash and cash equivalents are adequate to satisfy our working capital needs
and sustain our ongoing operations for the next twelve months.





Production
capacity has been the bottle neck for our growth in recent years, because
production has not been able to keep up with demand. Our growth strategy for the
next three years will be primarily focused on expanding production capacity and
strengthening sales efforts. Management plans to achieve this strategy by
increasing our production capacity, sales staff, and advertising
expenditures.





In July 2008, we commenced construction
of a new production facility. The first phase of this project is expected to
cost an aggregate of approximately $20.0 million, including land use rights,
construction expenses and equipment costs. Upon completion of the first phase,
the new facility will have one production line, which will have the capacity to
produce 9,000 tons of milk power annually. We anticipate that production at this
new facility will commence in the third quarter of fiscal 2009, assuming we
obtain the remaining $6.0 million we require to complete construction and fully
equip the first production line. In the second phase, a second production line
may be added at this new facility, which, when completed, would enable us to
produce an additional 9,000 tons of milk powder per year, giving us a total
annual production capacity of 27,000 tons of milk powder. The cost to add the
second production line, would be an additional $15.0 million.





34


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





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





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





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





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




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




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





We have no sources for the additional
financing we may need to complete the construction of our new processing
facility. There can be no assurance that that any additional financing will
become available to us, and if available, on terms acceptable to
us.





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





35


Currently, we spend approximately 8% -
12% of total revenues on advertising and promotional plans through out the year.
We spent approximately $3.0 million, $1.9 million and $0.8 million on
advertising and promotion in fiscal 2008, 2007 and 2006, respectively. We plan
to keep spending an aggregate of between $4.0 million and $5.0 million on
advertising and promotion in fiscal 2009, which will still fall within our
standard budget for advertising and promotion of 8% - 12% of total revenues. The
funds for advertising and promotion will generally come out of our
earnings.





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





Registration Rights and Liquidated
Damages





In connection with the October
Offerings, as further described in “- Recent Developments - Reverse Merger,
Private Placements and Related Transactions” above, we entered into Registration
Rights Agreements (each, a “Registration Rights Agreement,” and collectively the
“Registration Rights Agreements”) with Mr. Winfield, the Initial Purchasers and
the Additional Purchasers (collectively, the “Investors”), pursuant to which we
agreed that within thirty (30) business days of the respective closing date (the
“Filing Date”), we would file a registration statement with the Securities and
Exchange Commission (the “Commission”) (the “Registration Statement”) covering
the resale of (i) the shares of common stock purchased in the October Offerings
(the “Purchased Shares”), and (ii) the common stock issuable upon exercise of
Warrant W-1, Warrant W-2, the Class A Warrants, and the Class B Warrants
(collectively (i), (ii), (iii) and (iv), the “Registrable Securities”). Further,
we agreed to use our best efforts to (i) cause the Registration Statement to be
declared effective within ninety (90) calendar days from the Filing Date, or, if
reviewed by the Commission, within one hundred eighty (180) calendar days after
the Filing Date, and (ii) keep the Registration Statement continuously effective
until all of the Registrable Securities have been sold, or may be sold without
volume restrictions pursuant to Rule 144.





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





36


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.





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





Share Repurchase and Put/Call
Agreements





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





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





·
            either
      (a) a registration statement (“Registration Statement”) covering the
      resale of the Put/Call Shares had been declared effective by the SEC, and
      had been kept continuously effective by us, or (b) all of the Put/Call
      Shares were available for sale without registration pursuant to Rule 144
      under the Securities Act of 1933 (“Rule 144”);
  and




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




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





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




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




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




37


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





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





Warrants





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





Warrant W-1 represents the right to
purchase 266,667 shares of our common stock, at an exercise price of $0.94 per
share. Warrant 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.





Prior to the exercise of 183,457 of the
Class A Warrants in our Warrant Tender Offer (as previously described), 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; except that, as of March 2,
2009, the exercise price of 235,583 of these warrants was reduced from $2.04 to
$1.63, as partial consideration for services rendered in connection with a
consulting agreement the Company entered into with one of these
parties.





38


Prior to the exercise of 175,937 of the
Class B Warrants in our Warrant Tender Offer (as further described below), 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.





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





As of April 24, 2008, we commenced the
Warrant Tender Offer, pursuant to which the holders of the 2007 Warrants had the
opportunity to tender their 2007 Warrants for exercise prices reduced by 20%.
The Warrant Tender Offer is further described in “Recent Developments - Warrant
Tender Offer” above. On March 2, 2009, we closed on the Warrant Tender
Offer.  In connection with the Warrant Tender Offer:





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




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




39


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





If all of the remaining 2007 Warrants
(including warrants issued to finders and placement agents) were exercised for
cash pursuant to their terms, we would receive $20,299,513 in
proceeds.





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





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





If all of the June Warrants (including
warrants issued to a placement agent) were exercised for cash pursuant to their
terms, we would receive $440,000 in proceeds.





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





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





If all of the November Warrants
(including warrants issued to a placement agent) were exercised for cash
pursuant to their terms, we would receive $195,750 in proceeds.




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





40





Promissory
Notes





In the June Note Offering, further
described in “- Recent Developments - Sale of Notes and Warrants” above, we also
issued the June Notes. As amended on December 31, 2008, the June Notes bear
interest at a rate of 10% until they become due and payable on December 31,
2009. Any amount of principal or interest which is not paid when due will bear
interest at a rate of 12%. We may prepay the entire amount due under the June
Notes at any time without penalty, upon 15 days prior written notice. Each
holder of the June Notes has the right to be prepaid any amounts due under his,
her or its June Note from the proceeds of any future offering we consummate
resulting in gross proceeds of $4,500,000 or more. So long as we have any
obligation under the June Notes, there are limitations on our ability to: (a)
pay dividends or make other distributions on our capital stock; (b) redeem,
repurchase or otherwise acquire any of our securities; (c) create, incur or
assume any liability for borrowed money (except as is related to the completion
of the construction of our new production facility); (d) sell, lease or
otherwise dispose of any significant portion of its assets; (e) lend money, give
credit or make advances; or (f) assume, guarantee, endorse, contingently agree
to purchase or otherwise become liable upon the obligation of any other person
or entity. It shall be deemed an “Event of Default” under each June Note if: (a)
we fail to pay principal or interest when due on the June Note; (b) we breach
any material covenant or other material term or condition contained in the June
Note or securities purchase agreement entered into in connection with the June
Note Offering (the “June Purchase Agreement”), and such breach continues for a
period of thirty (30) days after written notice thereof; (c) any representation
or warranty we made under the June Note or the June Purchase Agreement shall be
false or misleading in any material respect; (d) we, or any subsidiary of ours,
shall make an assignment for the benefit of creditors, or apply for or consent
to the appointment of a receiver or trustee, or such a receiver or trustee shall
otherwise be appointed; (e) a money judgment shall be entered against us, or any
subsidiary of ours, for more than $250,000, that remains in effect for a period
of twenty (20) days; (f) bankruptcy, insolvency, reorganization or liquidation
proceedings or other similar proceedings shall be instituted by or against us,
or any subsidiary of ours, which are not dismissed within sixty (60) days; or
(g) we fail to maintain the listing of our common stock on at least one of the
OTCBB, the Nasdaq National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the American Stock Exchange. Upon the occurrence of any Event
of Default under a June Note, unless such Event of Default shall have been
waived in writing by the holder, the holder may consider the June Note
immediately due and payable, without presentment, demand, protest or notice of
any kind, and the holder may immediately enforce any and all of its rights and
remedies provided in the June Note or any other right or remedy afforded by
law.





In the November Note Offering, further
described in “- Recent Developments - Sale of Notes and Warrants” above, we also
issued the November Note. The November Note bears interest at a rate of 10%
until it becomes due and payable on November 10, 2009. Any amount of principal
or interest which is not paid when due will bear interest at a rate of 12%. We
may prepay the entire amount due under the November Note at any time without
penalty, upon 15 days prior written notice. The holder of the November Note has
the right to be prepaid any amounts due under his November Note from the
proceeds of any future offering we consummate resulting in gross proceeds of
$6,500,000 or more. So long as we have any obligation under the November Note,
there are limitations on our ability to: (a) pay dividends or make other
distributions on our capital stock; (b) redeem, repurchase or otherwise acquire
any of our securities; (c) sell, lease or otherwise dispose of any significant
portion of its assets; (d) lend money, give credit or make advances; or (e)
assume, guarantee, endorse, contingently agree to purchase or otherwise become
liable upon the obligation of any other person or entity. It shall be deemed an
“Event of Default” under the November Note if: (a) we fail to pay principal or
interest when due on the November Note; (b) we breach any material covenant or
other material term or condition contained in the November Note or securities
purchase agreement entered into in connection with the November Note Offering
(the “November Purchase Agreement”), and such breach continues for a period of
thirty (30) days after written notice thereof; (c) any representation or
warranty we made under the November Note or the November Purchase Agreement
shall be false or misleading in any material respect; (d) we, or any subsidiary
of ours, shall make an assignment for the benefit of creditors, or apply for or
consent to the appointment of a receiver or trustee, or such a receiver or
trustee shall otherwise be appointed; (e) a money judgment shall be entered
against us, or any subsidiary of ours, for more than $250,000, that remains in
effect for a period of twenty (20) days; (f) bankruptcy, insolvency,
reorganization or liquidation proceedings or other similar proceedings shall be
instituted by or against us, or any subsidiary of ours, which are not dismissed
within sixty (60) days; or (g) we fail to maintain the listing of our common
stock on at least one of the OTCBB, the Nasdaq National Market, the Nasdaq
SmallCap Market, the New York Stock Exchange, or the American Stock Exchange.
Upon the occurrence of any Event of Default under the November Note, unless such
Event of Default shall have been waived in writing by the holder, the holder may
consider the November Note immediately due and payable, without presentment,
demand, protest or notice of any kind, and the holder may immediately enforce
any and all of its rights and remedies provided in the Note or any other right
or remedy afforded by law.





41


Stock
Options





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





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





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





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.





42


Contractual
Obligations and Commercial Commitments





Our
contractual obligations, as of March 31, 2009, were as follows:




Payments Due By PeriodContractual
      obligations
                      
                      Total
                      
                      
                      Less than
                        1 year
                      
                      
                      1-3 years
                      
                      
                      After
                        3-5 years
                      
                      
                      More than
                        5 yearsEquipment
      purchase
                      
                      $
                      1,588,767
                      
                      
                      $
                      1,588,767
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Construction
      contract
                      
                      
                      6,388,159
                      
                      
                      
                      6,388,159
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Debt
      Obligations
                      
                      
                      3,123,301
                      
                      
                      
                      3,123,301
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Advertising
      contract
                      
                      
                      655,584
                      
                      
                      
                      655,584
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Operating
      leases
                      
                      
                      108,310
                      
                      
                      
                      108,310
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Total:
                      
                      $
                      11,864,121
                      
                      
                      $
                      11,864,121
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —





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 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, 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.





43


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 yearsDairy
      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.





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.




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.





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 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.





44


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





We
account 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.





We do not
have any long-term deferred tax assets or liabilities in China that will exist
once the tax holiday  expires (See Note 10 to the footnotes to
financial statements included in Item 1 of this report). We do not have any
significant deferred tax asset or liabilities that relate to tax jurisdictions
not covered by the tax holiday.





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 Enterprise at a rate of 15% of their
taxable income. Preferential tax treatment may, however, be granted pursuant to
any law or regulations from time to time promulgated by the State
Council.  XAL enjoyed a 100% exemption from enterprise income taxes
starting on January 10, 2006 due to its classification as a “Wholly Foreign
Owned Enterprise.” On March 16, 2007, the PRC enacted a new Enterprise Income
Tax Law for the purpose of unifying the tax treatment of domestic and foreign
enterprises. This new law eliminates the preferential tax treatment for new
Wholly Foreign Owned Enterprises but allows previously granted exemptions to
stay in place through 2012, with the exception that the statutory tax rate will
increase by 2% per year from 15% in 2006 to 25% by 2012. This exemption ended on
January 10, 2008, at which time XAL will qualify under the current tax structure
for a 50% reduction 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 carryforwards, 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 noncurrent
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 March 31, 2009 for U.S. or additional foreign
withholding taxes on approximately $13,558,000 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.





45


In 2006,
the Financial Accounting Standards Board (FASB) issued FIN 48, which clarifies
the application of Statement of Financial Accounting Standards (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 March 31, 2009, 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 March 31, 2009, 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 PRC 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.





Warrants





We
evaluate our warrants on an ongoing basis considering the provisions of SFAS No.
150, “Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity,” which establishes standards for issuers of financial instruments
with characteristics of both liabilities and equity related to the
classification and measurement of those instruments. The warrants are evaluated
considering the provisions of SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities, considering
EITF Issue No. 00-19, “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock” and EITF 07-5, “Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity's Own Stock.”




46


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 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.





Retirement
benefit costs





According
to the PRC’s regulations on pensions, we contribute to a defined contribution
retirement program organized by the municipal government in the province in
which we were registered and all qualified employees are eligible to participate
in the program. Contributions to the program are calculated at 23.5% of the
employees’ salaries above a fixed threshold amount and the employees contribute
2% to 8% while we contribute the balance contribution of 21.5% to 15.5%. We have
no other material obligation for the payment of retirement benefits beyond the
annual contributions under this program.





Stock
Based Compensation





On
December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”(“SFAS No. 123R”) ,
which requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
the grant date fair value of the award. We have adopted the requirements of SFAS
No. 123R for the fiscal year beginning on January 1, 2006.





Fair
value of financial instruments





We apply
the provisions of SFAS No. 107, “Disclosures about Fair Value of
Financial Instruments”.  SFAS No. 107 requires all entities to
disclose the fair value of financial instruments, both assets and liabilities
recognized and not recognized on the balance sheet, for which it is practicable
to estimate fair value.  SFAS No. 107 defines fair value of a
financial instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties. As of March 31, 2009 and
2008 the fair value of cash, accounts receivable, other receivables, accounts
payable, commercial notes payable, and accrued expenses approximated carrying
value due to the short maturity of the instruments, quoted market prices, or
interest rates, which fluctuate with market rates.





Fair
Value Measurements





In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.” SFAS No. 157 establishes a framework for measuring
fair value in generally accepted accounting principles, clarifies the definition
of fair value within that framework, and expands disclosures about the use of
fair value measurements.  SFAS No. 157 applies to fair value
measurements required by existing accounting pronouncements and does not require
any new fair value measurements.  We adopted SFAS No. 157 on January
1, 2008.





On
January 1, 2009, we adopted SFAS Staff Position No. FAS 157-2 for non-financial
assets and non-financial liabilities that are recognized or disclosed at fair
value in the consolidated financial statements on a nonrecurring basis as
permitted by FAS 157-2, which provided a deferral of such provisions until
2009. We are in the process of evaluating the impact, if any, of applying
these provisions on its consolidated financial position and results of
operations.





47


The
carrying value of financial assets and liabilities recorded at fair value is
measured on a recurring or nonrecurring basis. Financial assets and
liabilities measured on a non-recurring basis are those that are adjusted to
fair value when a significant event occurs. We had no financial assets or
liabilities carried and measured on a nonrecurring basis during the reporting
periods. Financial assets and liabilities measured on a recurring basis are
those that are adjusted to fair value each time a financial statement is
prepared. We had no financial assets and/or liabilities carried at fair
value on a recurring basis at March 31, 2008.





The
availability of inputs observable in the market varies from instrument to
instrument and depends on a variety of factors including the type of instrument,
whether the instrument is actively traded, and other characteristics particular
to the transaction. For many financial instruments, pricing inputs are
readily observable in the market, the valuation methodology used is widely
accepted by market participants, and the valuation does not require significant
management discretion. For other financial instruments, pricing inputs are
less observable in the market and may require management judgment.





Recent accounting
pronouncements





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





In June
2008, the Emerging Issues Task Force (EITF) reached final consensuses on EITF
Issue 08-4, “Transition
Guidance for Conforming Changes to Issue No. 98-5.” Certain conclusions
reached in EITF Issue No.
98-5, “Accounting for Convertible Securities with Beneficial Conversion Features
or Contingently Adjustable Conversion Ratios,” were nullified in EITF
Issue No. 00-27, “Application
of 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. On January 1,
2009, we adopted EITF 08-4. The adoption of this standard did not have a
material impact on our financial condition, results of operations, or cash
flows.





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





48


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





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





In
April 2009, the FASB issued FSP SFAS No. 107-1, “Interim Disclosures about Fair Value
of Financial Instruments,” which amends SFAS No. 107, “Disclosures about Fair Value of
Financial Instruments,” and APB Opinion No. 28, “Interim Financial Reporting.”
FSP SFAS No. 107-1 will require disclosures about fair value of financial
instruments in financial statements for interim reporting periods and in annual
financial statements of publicly-traded companies. This FSP also will require
entities to disclose the method(s) and significant assumptions used to estimate
the fair value of financial instruments in financial statements on an interim
and annual basis and to highlight any changes from prior periods. The effective
date for this FSP is interim and annual periods ending after June 15, 2009.
We are currently assessing the impact of FSP SFAS 107-1.





In April
2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments.” The FSP amends the
other-than-temporary impairment guidance for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities. The FSP is
effective for interim and annual periods ending after June 15, 2009, which
is June 30, 2009 for the Company. The FSP is not anticipated to have a
material impact on our consolidated financial statements.




In April
2009, the FASB issued FSP No. FAS 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.” The FSP
provides additional guidance for estimating fair value when the market activity
for an asset or liability has declined significantly. The FSP is effective for
interim and annual periods ending after June 15, 2009, which is
June 30, 2009 for the Company. The FSP is not anticipated to have a
material impact on the Company’s consolidated financial statements.





Off-Balance
Sheet Arrangements





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





49


Item
3. Quantitative and Qualitative Disclosures about Market Risk





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





Item
4.  Controls and Procedures.





Disclosure
Controls and Procedures





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





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





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




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




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




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




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





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





50


The material weaknesses identified by
Windes were as follows:





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




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




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





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




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




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




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




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




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




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




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





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





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





51


Changes
in Internal Control Over Financial Report





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





Based
upon 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.




52




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 March
31, 2009, and subsequent period through the date hereof, we did not consummate
any unregistered sales of equity securities, except as follows:





Warrant
Tender Offer





As of April 24, 2008, we commenced an
offer (“Warrant Tender Offer”) to certain holders of our, pursuant to which the
holders could tender their warrants for shares of our common stock at a reduced
exercise prices.





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





·
            an
      aggregate of 183,457 warrants were tendered by a total of 10 warrant
      holders at the reduced exercise price of $1.63 per share (originally $2.04
      per share), for an aggregate exercise price of $299,035;
    and




·
            an
      aggregate of 175,937 warrants were tendered by a total of 8 warrant
      holders at the reduced exercise price of $2.61 per share (originally $3.26
      per share) for an aggregate exercise price of
  $459,196.




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





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





Issuance of Options Under Our 2009
Equity Incentive Plan





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





Following the adoption of the Plan, our
board of directors approved the grant of stock option awards to our executive
officers and directors, as set forth in the table below:




53





Name
            
            Title
            
            Stock
              Option
      AwardsYang
      Yong Shan
            
            Chief
      Executive Officer, President and Chairman of the Board
            
            360,000Shu
      Kaneko
            
            Chief
      Financial Officer, Secretary and Director
            
            300,000Niu
      Wan Chen
            
            Vice
      President of Sales and Director
            
            15,200Qin
      Si Bo
            
            Vice
      President of Production and Director
            
            15,200Yuan
      Yong Wei
            
            Vice
      President of Operation and Director
            
            12,800





The amounts shown in the table reflect
the number of shares of our common stock issuable upon exercise of the stock
options awarded. Each option has an exercise price of $0.42 per share, which was
the closing price of our common stock on the OTCBB on March 2, 2009, the
date on which the options were granted. Each option has a term of ten (10) years
from the date of grant and will vest with respect to 25% of the shares
underlying the option on each of September 2, 2009, March 2, 2010, September 2,
2010 and March 2, 2011.





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





Item
3.  Defaults Upon Senior Securities.





In the three-month period ended March
31, 2009, and subsequent period through the date hereof, we did not default upon
any senior securities.





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





In the three-month period ended March
31, 2009, and subsequent period through the date hereof, the we did not submit
any matters to a vote of our security holders, except as follows:





On March
11, 2009, we obtained the written consent of the holders of 15,414,577 shares of
our common stock, which as of such date represented approximately 52.7% of our
outstanding voting securities, to adopt our 2009 Equity Incentive Plan. The Plan
was effective as of March 2, 2009, the date it was adopted by our board of
directors, subject to approval by our shareholders within one year of such date.
Reference is made to the disclosure set forth in the Current Report on Form 8-K,
filed on March 6, 2009, which disclosure is incorporated herein by
reference.





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
March 31, 2009, or subsequent period through the date hereof, which was not so
reported.





54




Item
6.  Exhibits





Exhibit No.
              
              
              Description of Exhibit4.1
              
              2009
      Equity Incentive Plan -- Incorporated by reference from our Current Report
      on Form 8-K, filed on March 6, 200931.1
              
              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





55




SIGNATURES









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









EMERALD
      DAIRY INC.Dated:
      May 15, 2009
            
            By:
            
            /s/ Yang Yong ShanYang
      Yong Shan
              Chairman,
      Chief Executive Officer and
              PresidentDated:
      May 15, 2009
            
            By:
            
            /s/ Shu KanekoShu
      Kaneko
              Chief
      Financial Officer and Secretary








56