**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:September
                30, 2008ORo
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE ACT OF 1934For
                the transition period from _______________ to ______________Commission
                file number:000-52174


**




EMERALD
                DAIRY INC.(Exact
                Name of Registrant as Specified in its
                Charter)




Nevada
            80-0137632(State
                or Other Jurisdiction of Incorporation or
              Organization)
            (I.R.S.
                Employer Identification No.)




11990
                Market Street, Suite 205
              Reston,
                Virginia
            20190(Address
                of Principal Executive Offices)
            (Zip
                Code)(703)
                867-9247(Registrant’s
                Telephone Number, Including Area Code)___________________________________________________________(Former
                Name, Former Address and Former Fiscal Year, if Changed Since Last
                Report)




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


Yes x No o








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


Yes o No x




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





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





Large
                accelerated filero
            Accelerated
                fileroNon-accelerated
                filero
            Smaller
                reporting companyx








**QUARTERLY
      REPORT ON FORM 10-QSB**


**OF
      EMERALD DAIRY INC. AND SUBSIDIARIES**


**FOR
      THE PERIOD ENDED SEPTEMBER 30, 2008**





**TABLE
      OF CONTENTS**





**PAGE****PART I**
            **-**
            **FINANCIAL
                INFORMATION**Item
                1.
            
            Financial
                Statements
            
            1Condensed
                Consolidated Balance Sheets as of September 30, 2008 (Unaudited)
                and
                December 31, 2007
            
            1Condensed
                Consolidated Statements of Income for the Three and Nine Months Ended
                September 30, 2008 and 2007 (Unaudited)
            
            2Condensed
                Consolidated Statements of Cash Flows for the Nine Months Ended September
                30, 2008 and 2007 (Unaudited)
            
            3Footnotes
                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
            
            53Item
                4T.
            
            Controls
                and Procedures
            
            53**PART II**
            **-**
            **OTHER
                INFORMATION**
            
            56Item
                1.
            
            Legal
                Proceedings
            
            56Item
                1A.
            
            Risk
                Factors
            
            56Item
                2.
            
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            56Item
                3.
            
            Defaults
                Upon Senior Securities
            
            56Item
                4.
            
            Submission
                of Matters to a Vote of Security Holders
            
            57Item
                5.
            
            Other
                Information
            
            57Item
                6.
            
            Exhibits
            
            58Signatures
            
            59




i


**PART
      I. FINANCIAL INFORMATION**





**Item
      1. Financial Statements**


**Emerald
                  Dairy Inc. and Subsidiaries****Condensed
                  Consolidated Balance Sheet****September
                  30, 2008 and December 31,
                  2007**
  **2008**
              
              **2007****(Unaudited)**
              
              **(Audited)****ASSETS****Current
                  Assets**Cash
                  and cash equivalents
              
              $
              3,748,746
              
              $
              6,560,931Trade
                  accounts receivable
              
              
              6,702,729
              
              
              5,096,828Inventory
              
              
              1,313,621
              
              
              1,000,427Other
                  current assets
              
              
              5,444,970
              
              
              3,936,751**Total
                  current assets**
              
              
              17,210,066
              
              
              16,594,937**Property,
                  plant and equipment**Property,
                  plant and equipment, net
              
              
              5,700,404
              
              
              3,320,081Contruction
                  in progress
              
              
              2,743,133
              
              
              -8,443,537
              
              
              3,320,081**Intangible
                  assets, net**
              
              
              1,384,357
              
              
              115,228$
              27,037,960
              
              $
              20,030,246**LIABILITIES
                  AND STOCKHOLDERS' EQUITY****Current
                  Liabilities**Accounts
                  and accrued expenses
              
              $
              4,420,313
              
              $
              2,395,190Notes
                  payable, net of debt discount of $95,917 at September 30,
                  2008
              
              
              2,154,083
              
              
              273,973Other
                  current liabilities
              
              
              859,308
              
              
              614,977Loan
                  from shareholder
              
              
              209,482
              
              
              196,526**Total
                  current liabilities**
              
              
              7,643,186
              
              
              3,480,666**Put/Call
                  Liability**
              
              
              3,169,444
              
              
              3,169,444**Stockholders'
                  Equity**Preferred
                  stock ($0.001 par value, 10,000,000 shares authorized,
                  noneissued
                  and outstanding at September 30, 2008 and December 31,
                  2007)
              
              
              -
              
              
              -Common
                  stock ($0.001 par value, 100,000,000 shares authorized,31,243,776
                  issued and outstanding at September 30, 2008 andDecember
                  31, 2007)
              
              
              31,244
              
              
              31,241Treasury
                  Stock (1,944,444 shares at September 30, 2008 andDecember
                  31, 2007)
              
              
              (1,944
              )
              
              (1,944
              )Additional
                  paid-in capital
              
              
              4,923,348
              
              
              4,666,244Retained
                  earnings (of which $1,340,713 and $659,903 are restricted
                  atSeptember
                  30, 2008 and December 31, 2007 for common welfare
                  reserves)
              
              
              9,301,130
              
              
              7,791,895Accumulated
                  other comprehensive income
              
              
              1,971,552
              
              
              892,700**Total
                  stockholders' equity**
              
              
              16,225,330
              
              
              13,380,136$
              27,037,960
              
              $
              20,030,246
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
  1


**Emerald
                  Dairy Inc. and Subsidiaries****Condensed
                  Consolidated Statements of Income****For
                  the Three and Nine Months Ended September 30, 2008 and
                  2007****(Unaudited)**


**Three
                  months ended**
              
              **Nine
                  months ended****September
                  30,**
              
              **September
                  30,**
              
              **September
                  30,**
              
              **September
                  30,****2008**
              
              **2007**
              
              **2008**
              
              **2007****Sales**
              
              $
              11,221,019
              
              $
              8,443,361
              
              $
              32,560,256
              
              $
              20,971,555**Cost
                  of Goods Sold**
              
              
              6,552,835
              
              
              5,422,899
              
              
              19,845,232
              
              
              13,853,290**Gross
                  Profit**
              
              
              4,668,184
              
              
              3,020,462
              
              
              12,715,024
              
              
              7,118,265**Operating
                  Expenses**Selling
                  and administrative expenses
              
              
              3,319,484
              
              
              1,561,700
              
              
              10,283,634
              
              
              3,985,432Depreciation
                  and amortization
              
              
              41,905
              
              
              12,999
              
              
              72,336
              
              
              36,844**Total
                  operating expenses**
              
              
              3,361,389
              
              
              1,574,699
              
              
              10,355,970
              
              
              4,022,276**Other
                  Income (Expense)**Interest
                  income
              
              
              2,455
              
              
              965
              
              
              12,061
              
              
              3,597Interest
                  expense
              
              
              (231,517
              )
              
              (5,460
              )
              
              (274,923
              )
              
              (14,050
              )Total
                  other income (expense)
              
              
              (229,062
              )
              
              (4,495
              )
              
              (262,862
              )
              
              (10,453
              )**Net
                  Income Before Provision for Income Tax**
              
              
              1,077,733
              
              
              1,441,268
              
              
              2,096,192
              
              
              3,085,536**Provision
                  for Income Taxes**Current
              
              
              269,666
              
              
              65,942
              
              
              586,957
              
              
              148,594269,666
              
              
              65,942
              
              
              586,957
              
              
              148,594**Net
                  Income**
              
              $
              808,067
              
              $
              1,375,326
              
              $
              1,509,235
              
              $
              2,936,942**Basic
                  Earnings Per Share**
              
              $
              0.03
              
              $
              0.06
              
              $
              0.05
              
              $
              0.12**Basic
                  Weighted Average Shares Outstanding**
              
              
              29,299,332
              
              
              24,305,546
              
              
              29,299,332
              
              
              24,305,546**Diluted
                  Earnings Per Share**
              
              $
              0.03
              
              $
              0.06
              
              $
              0.05
              
              $
              0.12**Diluted
                  Weighted Average Shares Outstanding**
              
              
              29,563,708
              
              
              24,305,546
              
              
              29,563,708
              
              
              24,305,546**The
                  Components of Other Comprehensive Income**Net
                  Income
              
              $
              808,067
              
              $
              1,375,326
              
              $
              1,509,235
              
              $
              2,936,942Foreign
                  currency translation adjustment
              
              
              259,312
              
              
              165,260
              
              
              1,634,624
              
              
              321,927Income
                  tax related to other comprehensive income
              
              
              (88,166
              )
              
              (56,188
              )
              
              (555,772
              )
              
              (109,455
              )**Comprehensive
                  Income**
              
              $
              979,213
              
              $
              1,484,398
              
              $
              2,588,087
              
              $
              3,149,414




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




2


**Emerald
                  Dairy Inc. and Subsidiaries****Condensed
                  Consolidated Statements of Cash Flows****For
                  the Nine Months Ended September 30, 2008 and
                  2007**


2008
              
              2007**Cash
                  flows from operating activities****Net
                  Income**
              
              $
              1,509,235
              
              $
              2,936,942**Adjustments
                  to reconcile net cash provided by****operating
                  activities**Depreciation
                  and amortization
              
              
              309,749
              
              
              166,973Amortization
                  of loan discount
              
              
              114,683**Net
                  change in assets and liabilities**Trade
                  accounts receivable
              
              
              (1,290,662
              )
              
              (749,786
              )Inventory
              
              
              (251,318
              )
              
              (810,073
              )Other
                  current assets
              
              
              2,480,834
              
              
              (248,040
              )Accounts
                  payable and accrued expenses
              
              
              1,876,980
              
              
              212,269Advances
                  from employees
              
              
              206,295
              
              
              14,452Taxes
                  payable
              
              
              -
              
              
              39,728**Net
                  cash used in operating activities**
              
              
              4,955,796
              
              
              1,562,465**Cash
                  flows from investing activities**Deposit
                  on equipment purchase
              
              
              (3,699,058
              )
              
              -Construction
                  in progress
              
              
              (2,743,133
              )
              
              -Purchases
                  of fixed assets and intangibles
              
              
              (3,746,727
              )
              
              (689,983
              )**Net
                  cash used in investing activities**
              
              
              (10,188,918
              )
              
              (689,983
              )**Cash
                  flows from financing activities**Sale
                  of stock for cash
              
              
              -
              
              
              2,000,000Repayments
                  of notes payable
              
              
              (290,918
              )
              
              -Advances
                  on notes payable
              
              
              2,250,000
              
              
              266,667Loans
                  from shareholders
              
              
              -
              
              
              -**Net
                  cash provided by financing activities**
              
              
              1,959,082
              
              
              2,266,667**Effect
                  of exchange rate**
              
              
              461,855
              
              
              14,690**Net
                  increase (decrease) in cash**
              
              
              (2,812,185
              )
              
              3,153,839**Cash
                  and cash equivalents at beginning of period**
              
              
              6,560,931
              
              
              641,164**Cash
                  and cash equivalents at end of period**
              
              $
              3,748,746
              
              $
              3,795,003




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




3




**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**


**1.**
            **Description
                of Business**





Emerald
      Dairy, Inc. (the Company), a Nevada corporation, is a producer of milk powder,
      rice powder and soybean milk powder in the People’s Republic of China through
      its wholly owned subsidaries.





American
      International Dairy Holdings, Inc., a Nevada corporation, was formed in 2005
      for
      the purpose of acquiring the stock in Heilonjiang Xing An Ling Dairy, Co. On
      May
      30, 2005, AIDH, pursuant to the Share Transfer Agreement acquired Heilonjiang
      Xing An Ling Dairy Co. Limited, (XAL) a corporation formed on September 8,
      2003
      in Heilonjiang Providence, The People’s Republic of China, (PRC). This
      transaction was treated as a recapitalization of XAL for financial reporting
      purposes. The effect of this recapitalization was rolled back to the inception
      of XAL for financial reporting purposes.





XAL
      is a
      dairy company engaged in manufacturing of milk, soybean and rice powder. Through
      the Company’s network of over 600 salespeople, the Company’s products are
      distributed throughout 20 provinces in the People’s Republic of China, and sold
      in over 5,600 retail outlets.





Prior
      to
      September 23, 2006, XAL owned 57.69% of Heilonjiang Beian Nongken Changxing
      LvBao Dairy Limited Liability Company (“LvBao”) with the remaining balance being
      held by the Company’s sole shareholder. On September 23, 2006, the remaing
      42.31% ownership in LvBao was transferred to XAL and was treated as an
      additional capital contribution. The effect of this contribution by the sole
      shareholder was rolled back to September 8, 2003 for financial reporting
      purposes. LvBao was formed on January 20, 2000 and is engaged in manufacturing
      and sales of dairy products.





On
      May
      22, 2008, the Company formed a new wholly-owned subsidiary,
      Hailun Xinganling Dairy Co., Ltd. (“HXD”), under the laws of the PRC. In July
      2008, HXD commenced construction of a production facility in Hailun City,
      Heilonjiang Province, PRC. It is anticipated that HXD will engage in the
      manufacture of the Company's milk, soybean and rice powder products at this
      new
      facility





**2.**
            **Basis
                of Preparation of Financial
                Statements**





XAL,
      LvBao and HXD maintain their books and accounting records in Renminbi (“RMB”).





The
      accompanying unaudited condensed consolidated financial statements have been
      prepared in accordance with generally accepted accounting principles for interim
      financial information and with the instructions to Form 10-Q. Accordingly,
      they
      do not include all of the information and footnotes required by generally
      accepted accounting principles for complete financial statements and related
      notes. The accompanying unaudited condensed consolidated financial statements
      and related notes should be read in conjunction with the audited consolidated
      financial statements of the Company and notes thereto for the year ended
      December 31, 2007.





In
      the
      opinion of management, the accompanying unaudited condensed consolidated
      financial statements contain all adjustments (which include only normal
      recurring adjustments) necessary to present fairly the balance sheets of Emerald
      Dairy Inc. and subsidiaries as of September 30, 2008 and the results of their
      operations for the three and nine months ended September 30, 2008 and 2007,
      and
      cash flows for the nine months ended September 30, 2008 and 2007. The results
      of
      operations for the three and nine months ended September 30, 2008 and 2007
      are
      not necessarily indicative of the results to be expected for the entire
      year.





The
      financial statements have been prepared in order to present the consolidated
      financial position and consolidated results of operations in accordance with
      accounting principles generally accepted in the United States of America (“US
      GAAP”) and are expressed in terms of US dollars (see paragraph “Foreign
      Currency” below).





The
      consolidated financial statements include the accounts of the Company and its
      wholly owned subsidiaries, XAL, LvBao and HXD. All inter-company transactions
      and balances were eliminated.




4


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**3.**
            **Summary
                of Significant Accounting
                Policies**





**Use
      of estimates** - The
      preparation of these consolidated financial statements in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make estimates and assumptions that affected the reported
      amounts of assets and liabilities and disclosure of contingent assets and
      liabilities at the dates of the consolidated financial statements and the
      reported amounts of net sales and expenses during the reported periods.





Significant
      estimates and assumptions by management including, among others, values and
      lives assigned to acquired intangible assets, reserves for customer returns
      and
      allowances, uncollectible accounts receivable, slow moving, obsolete and/or
      damaged inventory and stock warrant valuation. Actual results may differ from
      these estimates.





**Cash
      and cash equivalents -** The **** Company
      considers all highly liquid debt instruments purchased with maturity period
      of
      three months or less to be cash equivalents. Substantially all of the Company’s
      cash is held in bank accounts in The Peoples Republic of China and is not
      protected by FDIC insurance or any other similar insurance. Accounts held at
      United States financial institutions are insured by the Federal Deposit
      Insurance Corporation up to $250,000. As of September 30, 2008, no U.S. balances
      are in excess of insured amounts.





**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.





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




Assets
      and liabilities denominated in foreign currencies at the balance sheet date
      are
      translated at the exchange rates prevailing at the balance sheet date. The
      registered equity capital denominated in the functional currency is translated
      at the historical rate of exchange at the time of capital contribution. All
      translation adjustments resulting from the translation of the financial
      statements into the reporting currency (“US Dollars”) are dealt with as a
      separate component within stockholders’ equity. Translation adjustments net of
      tax totaled $171,146 and $1,078,852, for the three and nine months ended
      September 30, 2008, respectively. Translation adjustments totaled $109,072
      and
      $212,472 for the three and nine months ended September 30, 2007,
      respectively.





As
      of
      September 30, 2008 and 2007, the exchange rate was 6.8485 Yuan and 7.3 Yuan
      per
      U.S. Dollar, respectively.





**Revenue
      recognition** -
      Revenue is recognized in accordance with Staff Accounting Bulletin No. 104,
      Revenue Recognition, which states that revenue should be recognized when the
      following criteria are met: (1) persuasive evidence of an arrangement
      exists; (2) the service has been rendered; (3) the selling price is
      fixed or determinable; and (4) collection of the resulting receivable is
      reasonably assured.





Interest
      income is recognized when earned, taking into account the average principal
      amounts outstanding and the interest rates applicable.





As
      of
      September 30, 2008, the Company has no sales or contracts that included multiple
      deliverables that would fall under the scope of EITF 00-21, “Revenue
      Arrangements with Multiple Deliverables.”




5


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**3.**
            **Summary
                of Significant Accounting Policies
                (Continued)**





**Shipping
      and handling costs -** Shipping
      and handling costs are billed to the customer in sales transactions and are
      reported in sales. Costs incurred by the Company for shipping and handling
      are
      included in costs of goods sold.





**Earnings
      per share -** Basic
      net
      earnings per common share is computed by dividing net earnings applicable to
      common shareholders by the weighted-average number of common shares outstanding
      during the period. Diluted net earnings per common share is determined using
      the
      weighted-average number of common share shares outstanding during the period,
      adjusted for the dilutive effect of common stock equivalents, using the treasury
      stock method, consisting of shares that might be issued upon exercise of common
      stock warrants. In periods where losses are reported, the weighted-average
      number of common shares outstanding excludes common stock equivalents, because
      their inclusion would be anti-dilutive.





**Taxation
      -** Taxation
      on profits earned in the PRC has been calculated on the estimated assessable
      profits for the year at the rates of taxation prevailing in the PRC in which
      the
      Company operates after taking into effect the benefits from any special tax
      credits or “tax holidays” allowed in the country of operations.





The
      Company accounts for income tax under the provisions of SFAS 109 *Accounting
      for Income Taxes,* which
      requires recognition of deferred tax assets and liabilities for the expected
      future tax consequences of the events that have been included in the financials
      statements or tax returns. Deferred income taxes are recognized for all
      significant temporary differences between tax and financial statements bases
      of
      assets and liabilities. Valuation allowances are established against net
      deferred tax assets when it is more likely than not that some portion or all
      of
      the deferred tax asset will not be realized.





The
      Company does not have any long-term deferred tax assets or liabilities in China
      that will exist once the tax holiday (See Note 10) expires. The Company does
      not
      have any significant deferred tax asset or liabilities that relate to tax
      jurisdictions not covered by the tax holiday.





The
      Company does not accrue United States income tax on unremitted earnings from
      foreign operations, as it is the Company’s intention to invest these earnings in
      the foreign operations indefinitely.





***Enterprise
      income tax***





Under
      the
      Provisional Regulations of The People’s Republic of China Concerning Income Tax
      on Enterprises promulgated by the State Council which came into effect on
      January 1, 1994, income tax is payable by a Wholly Foreign Owned Enterprises
      at
      a rate of 15% of their taxable income. Preferential tax treatment may, however,
      be granted pursuant to any law or regulations from time to time promulgated
      by
      the State Council. XAL enjoyed a 100% exemption from enterprise income taxes
      starting on January 10, 2006 due to its classification as a “Wholly Foreign
      Owned Enterprise.” On March 16, 2007, The People’s Republic of China enacted a
      new Enterprise Income Tax Law for the purpose of unifying the tax treatment
      of
      domestic and foreign enterprises. This new law eliminates the preferential
      tax
      treatment for new Wholly Foreign Owned Enterprises but allows previously granted
      exemptions to stay in place through 2012, with the exception that the statutory
      tax rate will increase by 2% per year from 15% in 2006 to 25% by 2012. This
      exemption ended on January 10, 2008, at which time XAL will qualify under the
      current tax structure for a 50% reduction in the statutory enterprise income
      tax
      rates for an additional three years.





**Freestanding
      Financial Instruments with Characteristics of Both Liabilities and Equity -** In
      accordance with SFAS 150, *Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and
      Equity,* the
      Company accounts for financial instruments as a liability if it embodies an
      obligation to repurchase the issuer’s equity shares, or is indexed to such an
      obligation, and that requires or may require the issuer to settle the obligation
      by transferring assets. Freestanding financial instruments are financial
      instruments that are entered into separately and apart from any of the entity's
      other financial instruments or equity transactions, or that is entered into
      in
      conjunction with some other transaction and is legally detachable and separately
      exercisable. The liability recorded is the per share price to be paid and is
      offset to equity.




6


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**3.**
            **Summary
                of Significant Accounting Policies
                (Continued)**





**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. Under SFAS No. 123R, the
      Company must determine the appropriate fair value model to be used for valuing
      share-based payments, the amortization method for compensation cost and the
      transition method to be used at date of adoption. The transition methods include
      prospective and retroactive adoption options. Under the retroactive option,
      prior periods may be restated either as of the beginning of the year of adoption
      or for all periods presented. The prospective method requires that compensation
      expense be recorded for all unvested stock options and restricted stock at
      the
      beginning of the first quarter of adoption of SFAS No. 123R, while the
      retroactive methods would record compensation expense for all unvested stock
      options and restricted stock beginning with the first period restated. 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
      carrying amounts of certain financial instruments, including cash, accounts
      receivable, other receivables, accounts payable, commercial notes payable,
      and
      accrued expenses approximate their fair values as of September 30, 2008 and
      December 31, 2007 because of the relatively short-term maturity of these
      instruments.





**Recent
      accounting pronouncements**





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





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





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





7


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**3.**
            **Summary
                of Significant Accounting Policies
                (Continued)**





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




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




In
      March 2008, the FASB issued SFAS No. 161, *Disclosures
      about Derivative Instruments and Hedging Activities—an amendment of FASB
      Statement No. 133* (SFAS
      161). FAS 161 changes the disclosure requirements for derivative instruments
      and
      hedging activities. Entities are required to provide enhanced disclosures about
      (a) how and why an entity uses derivative instruments, (b) how
      derivative instruments and related hedged items are accounted for under
      Statement 133 and its related interpretations, and (c) how derivative
      instruments and related hedged items affect an entity’s financial position,
      financial performance, and cash flows. The guidance in SFAS 161 is effective
      for
      financial statements issued for fiscal years and interim periods beginning
      after
      November 15, 2008, with early application encouraged. This Statement
      encourages, but does not require, comparative disclosures for earlier periods
      at
      initial adoption. The Company is currently assessing the impact of SFAS
      161.





In
      May
      2008, the FASB issued SFAS 162,*The
      Hierarchy of Generally Accepted Accounting Principles*(SFAS
      162). SFAS 162 is intended to improve financial reporting by identifying a
      consistent framework, or hierarchy, for selecting accounting principles to
      be
      used in the preparation of financial statements of nongovernmental entities
      that
      are presented in conformity with U.S. generally accepted accounting principles
      (GAAP). SFAS 162 directs the GAAP hierarchy to the entity, not the independent
      auditors, as the entity is responsible for selecting accounting principles
      for
      financial statements that are presented in conformity with GAAP. SFAS 162 is
      effective 60 days following the Securities and Exchange Commission's approval
      of
      the Public Company Accounting Oversight Board amendments to remove the GAAP
      hierarchy from the auditing standards. The Company does not expect SFAS 162
      to
      have a material impact on its future consolidated results of operations or
      its
      financial position.





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. The EITF reached
      a consensus on Issue No. 08- 4,
      which
      provides such guidance and requires that (1) conforming changes made to Issue
      No. 98-5 resulting from Issue No. 00-27 and SFAS No. 150 be effective for
      financial statements of fiscal years ending after December 15, 2008, with early
      application allowed, and (2) the effect of applying the conforming changes
      be
      presented retrospectively (with the cumulative effect of the change reported
      in
      retained earnings as of the beginning of the first period presented). The
      Company is currently assessing the impact of EITF Issue 08-4.




8


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**3.**
            **Summary
                of Significant Accounting Policies
                (Continued)**





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. EITF 07-5 is effective for financial statements issued for fiscal
      years beginning after December 15, 2008, and interim periods within those fiscal
      years. The Company is currently assessing the impact of EITF
      07-5.





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). FSP
      No.
      EITF 03-6-1is
      effective for fiscal years beginning after December 15, 2008 (and for interim
      periods within such years). The Company is currently assessing the impact of
      FSP
      No. FAS 157-3.





In
      October 2008, the FASB issued FASB Staff Position (FSP)
      No.
      FAS 157-3,*Determining
      the Fair Value of a Financial Asset in a Market That Is Not
      Active.*The FSP
      amends Statement of Financial Accounting Standards (SFAS)
      No. 157,*Fair
      Value Measurements*,
      by
      clarifying the application of SFAS
      No.
      157when the
      market for a financial asset is inactive. Specifically, the FSP clarifies how
      (1) management's internal assumptions should be considered in measuring fair
      value when observable data are not present, (2) observable market information
      from an inactive market should be taken into account, and (3) the use of broker
      quotes or pricing services should be considered in assessing the relevance
      of
      observable and unobservable data to measure fair value. The
      guidance in FSP No. FAS 157-3 is effective immediately and applies as well
      to
      prior periods for which financial statements have not been issued. The Company
      is currently assessing the impact of FSP No. FAS 157-3.





**4.**
            **Concentrations
                of Business and Credit
                Risk**





Substantially
      all of the Company’s bank accounts are in banks located in the PRC and are not
      covered by any type of protection similar to that provided by the FDIC on funds
      held in U.S banks. Accounts held at U.S. financial institutions are insured
      by
      the Federal Deposit Insurance Corporation up to $250,000. As of September 30,
      2008 none of the U.S. cash balances are in excess of insured amounts.





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




9


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**4.**
            **Concentrations
                of Business and Credit Risk
                (Continued)**





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.





Financial
      instruments that potentially subject the Company to concentration of credit
      risk
      consist principally of cash and trade receivables, the balances of which are
      stated on the balance sheet. Concentration of credit risk with respect to trade
      receivables is limited due to the Company's large number of diverse customers
      in
      different locations in China. The Company does not require collateral or other
      security to support financial instruments subject to credit risk.





For
      the
      nine months ended September 30, 2008 and 2007, no single customer accounted
      for
      10% or more of sales revenues.





As
      of
      September 30, 2008, the Company had no insurance coverage of any kind. Accrual
      for losses is not recognized until such time as an uninsured loss has
      occurred.





Payments
      of dividends from foreign subsidiaries may be subject to some restrictions.





The
      operations of the Company are located in the PRC. Accordingly, the Company’s
      business, financial condition, and results of operations may be influenced
      by
      the political, economic, and legal environments in the PRC, as well as by the
      general state of the PRC economy.





**5.**
            **Inventory**





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





2008
            
            2007Raw
                materials
            
            $
            956,077
            
            $
            634,018Work-in-process
            
            
            312,994
            
            
            349,334Finished
                goods
            
            
            35,385
            
            
            8,490Repair
                parts
            
            
            9,165
            
            
            8,585$
            1,313,621
            
            $
            1,000,427




10


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**6.**
            **Other
                current assets**





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





2008
            
            2007Advances
                to milk suppliers
            
            $
            340,298
            
            $
            652,398Advances
                to equipment suppliers
            
            
            3,699,058
            
            
            -Deposit
                on building purchase
            
            
            -
            
            
            1,101,370Deposit
                on new facility site
            
            
            574,821
            
            
            539,725Deposit
                on contract
            
            
            675,247
            
            
            1,534,247Other
                Receivables
            
            
            50,000
            
            
            50,000Advances
                to staff
            
            
            10,478
            
            
            18,924Prepaid
                expenses
            
            
            95,068
            
            
            40,087$
            5,444,970
            
            $
            3,936,751




**7.**
            **Property,
                Plant, and Equipment**





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





2008
            
            2007Building
            
            $
            3,223,921
            
            $
            1,007,475Plant
                and Machinery
            
            
            2,941,371
            
            
            2,512,451Motor
                vehicles
            
            
            524,944
            
            
            459,547Dairy
                cows
            
            
            236,622
            
            
            211,220Office
                equipment
            
            
            54,062
            
            
            52,6966,980,920
            
            
            4,243,389Less:
                Accumulated depreciation
            
            
            (1,280,516
            )
            
            (923,308
            )$
            5,700,404
            
            $
            3,320,081




Depreciation
      expenses totaled $106,862 and $290,164 for the three and nine months ended
      September 30, 2008, respectively, and $61,561 and $166,973 for the three and
      nine months ended September 30, 2007, respectively. $84,542 and $237,413 were
      included as a component of cost of goods sold for the three and nine months
      ended September 30, 2008, respectively, and $48,562 and $130,129 for the three
      and nine months ended September 30, 2007, respectively.





**8.**
            **Intangible
                Assets**





September
                30,
              2008
            
            December
                31,
              2007Land
                use rights
            
            $
            1,351,333
            
            $
            66,839Patents
            
            
            53,004
            
            
            49,7271,404,337
            
            
            116,566Less:
                Accumulated amortization
            
            
            (19,980
            )
            
            (1,338
            )$
            1,384,357
            
            $
            115,228




11


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**8.**
            **Intangible
                Assets (Continued)**





For
      the
      three and nine months ended September 30, 2008, amortization expenses totaled
      $11,398 and $19,58, respectively. There was no amortization for the nine months
      ended September 30, 2007.





**9.**
            **Construction
                in progress**




September
                30,
              2008
            
            December
                31,
              2007Construction
                in progress
            
            $
            2,743,133
            
            $
            -





Construction-in-progress
      represents construction and installations of the new plant and machinery for
      the
      production facility in Hailun City.





**10.**
            **Income
                Taxes**





On
      May
      30, 2005, American International Dairy Holdings, Inc. executed a Share Transfer
      Agreement with Heilonjiang Xing An Ling Dairy Co., Ltd., a corporation organized
      and existing under the laws of People’s Republic of China. XAL applied to be as
      a foreign invested company right after the share transfer, which business
      license has been approved as a foreign invested company on January 10, 2006.
      According to Chinese taxation policy, there is income tax exemption for 2 years
      and half for 3 years suitable to foreign invested company, advanced Technology
      Company or software Development Company. XAL is considered an Advanced
      Technology Company. Therefore the Company receives this income tax exemption
      policy from January 10, 2006 the date approval as a foreign invested company.
      The Company received a 100% tax holiday as of January 10, 2006. On January
      10,
      2008 the Company’s tax exemption was reduced to 50% of the prevailing tax rate
      and will continue at this reduced rate for three additional years.





LvBao
      is
      currently subject to the Enterprise income tax of 33%.





A
      reconciliation of the provision for income taxes with amounts determined by
      the
      U.S. federal income tax rate to income before income taxes is as
      follows.





The
      components of net income (loss) before provision for income tax consist of
      following:





Three
                Months
              Ended September 30,
            
            Nine
                Months
              Ended September 30,2008
            
            2007
            
            2008
            
            2007U.S.
                Operations
            
            $
            (874,000
            )
            $
            (39,000
            )
            $
            (2,065,000
            )
            $
            (92,000
            )Chinese
                Operations
            
            
            1,952,000
            
            
            1,480,000
            
            
            4,161,000
            
            
            3,178,000$
            1,078,000
            
            $
            1,441,000
            
            $
            2,096,000
            
            $
            3,086,000




12


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**10.**
            **Income
                Taxes (Continued)**





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




Three
                Months
              Ended September 30,
            
            Nine
                Months
              Ended September 30,2008
            
            2007
            
            2008
            
            2007Federal,
                State and Local
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Peoples
                Republic of China -Federal and Local
            
            
            269,700
            
            
            65,900
            
            
            586,900
            
            
            148,600$
            269,700
            
            $
            65,900
            
            $
            586,900
            
            $
            148,600




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 September 30,
            
            Nine
                Months
              Ended September 30,2008
            
            2007
            
            2008
            
            2007Income
                tax provision at Federal statutory rate
            
            $
            366,400
            
            $
            490,000
            
            $
            712,700
            
            $
            1,049,100State
                income taxes, net of Federal benefit
            
            
            64,600
            
            
            86,500
            
            
            125,800
            
            
            185,200U.S.
                tax rate in excess of foreign tax rate
            
            
            (136,700
            )
            
            (103,600
            )
            
            (291,300
            )
            
            (222,400
            )Abatement
                of foreign income taxes
            
            
            (370,900
            )
            
            (422,000
            )
            
            (778,000
            )
            
            (899,700
            )Increase
                in valuation allowance
            
            
            346,300
            
            
            15,000
            
            
            817,700
            
            
            36,400$
            269,700
            
            $
            65,900
            
            $
            586,900
            
            $
            148,600




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





The
      change in the valuation allowance as of September 30, 2008 and 2007 was $817,700
      and $36,400, respectively.





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




Three
                Months
              Ended September 30,
            
            Nine
                Months
              Ended September 30,2008
            
            2007
            
            2008
            
            2007Tax
                Saving
            
            $
            370,900
            
            $
            422,000
            
            $
            778,000
            
            $
            899,700Benefit
                per share:Basic
            
            $
            0.01
            
            $
            0.02
            
            $
            0.03
            
            $
            0.04Diluted
            
            $
            0.01
            
            $
            0.02
            
            $
            0.03
            
            $
            0.04




13


**Emerald
        Dairy, Inc. and Subsidiaries**
 **Footnotes
        to Condensed Consolidated Financial Statements**
 **September
        30, 2008 and 2007**




Had
      the
      tax exemption not been in place for the three and nine months ended June 30,
      2008 and 2007, the Company estimates the following proforma financial statement
      impact.





Three
                Months
              Ended September 30,
            
            Nine
                Months
              Ended September 30,2008
            
            2007
            
            2008
            
            2007Net
                income before tax provision, as reported
            
            $
            1,078,000
            
            $
            1,441,000
            
            $
            2,096,000
            
            $
            3,086,000Less
                Tax provision not exempted
            
            
            269,700
            
            
            65,900
            
            
            586,900
            
            
            148,600Less
                Tax provision exempted
            
            
            370,900
            
            
            422,000
            
            
            778,000
            
            
            899,700$
            437,400
            
            $
            953,100
            
            $
            731,100
            
            $
            2,037,700




**11.**
            **Employee
                Retirement Benefits and Post Retirement
                Benefits**





According
      to the Heilonjiang Provincial regulations on state pension program, both
      employees and employers have to contribute toward pensions. The pension
      contributions range from 2% to 8% that was contributed by individuals
      (employees), and the Company is required to make contributions to the state
      retirement plan based on 20% of the employees’ monthly basic salaries. Employees
      in the PRC are entitled to retirement benefits calculated with reference to
      their basic salaries on retirement and their length of service in accordance
      with a government managed benefits plan. The PRC government is responsible
      for
      the benefit liability to these retired employees. During the three and nine
      months ended September 30, 2008 and 2007, respectively, the Company contributed
      $28,883, $83,970, $24,335 and $69,378 in pension contributions.





**12.**
            **Notes
                payable**




In
      June,
      2008 the Company sold 8% promissory notes maturing December 31, 2008 and
      three-year warrants to purchase 225,000 shares of common stock at an exercise
      price of $2.61 for $2,250,000. Any amount of principal or interest outstanding
      after December 31, 2008 will bear interest at a rate of 12%. In accordance
      with
      Accounting Principles Board Opinion No. 14, "Accounting for Convertible Debt
      and
      Debt Issued with Stock Purchase Warrants", the proceeds from issuance of the
      notes were allocated to the notes and warrants based upon their relative fair
      values. This allocation resulted in allocating $210,600 to the warrants to
      be
      treated as loan discount to be amortized over the life of the notes. During
      the
      three and nine months ended September 30, 2008, $95,917 and $114,683,
      respectively, of the loan discount was amortized to interest expense. The
      following assumptions were used to calculate the fair value of the warrants
      using the Black - Scholes Model





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





The
      notes
      may be prepaid in their entirety without penalty upon 15 day notice. So long
      as
      the Company has any obligation under the notes, there are limitations on its
      ability to: (a) pay dividends or make other distributions on its capital stock;
      (b) redeem, repurchase or otherwise acquire any of its securities; (c) create,
      incur or assume any liability for borrowed money; (d) sell, lease or otherwise
      dispose of any significant portion of its assets; (e) lend money, give credit
      or
      make advances; or (f) assume, guarantee, endorse, contingently agree to purchase
      or otherwise become liable upon the obligation of any other person or
      entity.





14


**Emerald
        Dairy, Inc. and Subsidiaries**
 **Footnotes
        to Condensed Consolidated Financial Statements**
 **September
        30, 2008 and 2007**


**12.**
            **Notes
                payable (Continued)**




In
      connection with the sale of the notes the Company paid a placement agent
      $122,500 in fees and delivered 45,000 three- year warrants to purchase 45,000
      shares of common stock at an exercise price of $2.61. The warrants were valued
      at $46,507 using a Black-Scholes Model and together with the fee were treated
      as
      deferred issuance costs to be amortized over the life of the notes. Amortization
      of the deferred issuance costs for the three and nine months ended September
      30,
      2008 was $82,718 and 97,367, respectively. The following assumptions were used
      to calculate the fair value of the warrants:





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





In
      connection with the sale of the June 20, 2008 notes the Company paid legal
      fees
      of $15,000 that were treated as deferred issuance costs and are being amortized
      over the life of the notes.





**13.**
            **Related-Party
                Transactions**




On
      May
      28, 2006, the Company purchased and obtained legal titles to machinery,
      facilities, housing and 100 cows from a stockholder of the Company for a note
      of
      $209,305, which approximated historical cost of these assets. The note does
      not
      bear interest and is due on demand.





**14.**
            **Put/Call
                Liability**





On
      October 9, 2007, the Company entered into Put/Call Agreements with two (2)
      of
      its stockholders (the “Put/Call Stockholders”), pursuant to which the Put/Call
      Shareholders granted the Company an option to repurchase an aggregate of
      1,944,444 shares (the “Put/Call Shares”) from the Put/Call Stockholders (the
“Call Option”), for an exercise price of $1.63 per share (the “Call Option
      Price”), if the following conditions have been met (the “Call Option
      Conditions”):





·
            Either
                (i) a registration statement (“Registration Statement”) covering the
                resale of the Put/Call Shares has been declared effective by the
                Commission, and has been kept continuously effective by the Company,
                or
                (B) all of the Put/Call Shares are available for sale without registration
                pursuant to Rule 144(k); and




·
            The
                closing price of a share of Common Stock of the Company as traded
                on the
                Over-the-Counter Bulletin Board (or such other exchange or stock
                market on
                which the Common Stock may then be listed or quoted) equals or exceeds
                $4.08 (appropriately adjusted for any stock split, reverse stock
                split,
                stock dividend or other reclassification or combination of the Common
                Stock occurring after the date hereof) for at least ten (10) consecutive
                trading days immediately preceding the date that the Call Option
                Exercise
                Notice is given by the Company.





**Term
      of the Call Option** ,
      the
      Company may only exercise its Call Option by delivering a written notice (a
      “Call Option Exercise Notice”) to the Put/Call Stockholders within thirty (30)
      days of such time as all of the Call Option Conditions have been met. The Call
      Option may be exercised for all, but not less than all, of the Put/Call Shares.
      The repurchase shall be consummated within ninety (90) days following the date
      of the Call Option Exercise Notice.




15


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**14.**
            **Put/Call
                Liability (Continued)**





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





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





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





·
            the
                Company fails to (i) file the Registration Statement within thirty
                (30)
                business days of the Closing Date (the “Filing Date”), (B) have the
                Registration Statement declared effective within ninety (90) calendar
                days
                from the Filing Date, or, if reviewed by the Commission, within one
                hundred eighty (180) calendar days after the Filing Date, or (C)
                keep the
                Registration Statement continuously effective until all of the Shares
                are
                available for sale without registration pursuant to Rule 144(k);
                or




·
            the
                Company fails to consummate a Qualified Offering within two (2) years
                of
                the date hereof (each of the aforementioned conditions, a “Put Right
                Trigger”).




**Term
      of the Put option** ,
      the
      Put/Call Stockholders shall exercise their Put Right by giving written notice
      (“Put Exercise Notice”) of their exercise of the Put Right to the Company within
      thirty (30) days of a Put Right Trigger. The Put/Call Stockholders may only
      exercise their Put Right as to all, but not less than all, of the Put/Call
      Shares. Upon exercise of the Put Right by the Shareholder, the repurchase of
      the
      Put/Call Shares by the Company shall be consummated within ninety (90) days
      following the date of the Put Exercise Notice.




In
      accordance with SFAS 150 *Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and
      Equity* the
      Company recorded the value of the Put/Call agreement of $3,169,444 as a
      liability as of October 9, 2007. The value of the Put/Call agreement was based
      on the fair market value of the underlying common stock of $1.63 at October
      9,
      2007. As of September 30, 2008 there has been no change in the Put/Call
      liability as the fair market value of the underlying common stock has not
      changed.





On
      April
      9, 2008 the company and the Put/Call Stockholders executed a waiver and
      amendment to the Put/Call Agreement reaffirming that the Put/Call Agreement
      is
      still in full force and removing the following provision as a Put Right
      Trigger:





·
            The
                Company fails to (i) file the Registration Statement within thirty
                (30)
                business days of the Closing Date (the “Filing Date”), (B) have the
                Registration Statement declared effective within ninety (90) calendar
                days
                from the Filing Date, or, if reviewed by the Commission, within one
                hundred eighty (180) calendar days after the Filing Date, or (C)
                keep the
                Registration Statement continuously effective until all of the Shares
                are
                available for sale without registration pursuant to Rule
                144(k).




16


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**15.**
            **Equity**





**Registration
      Rights Agreement**





On
      October 9, 2007 and October 19, 2007, the Company entered into Registration
      Rights Agreements (each, a “Registration Rights Agreement,” and collectively the
“Registration Rights Agreements”) with the accredited investors,( the
“Investors”), pursuant to which it agreed that within thirty (30) business days
      of the Closing Date (the Filing Date), the Company will file a registration
      statement (the Registration Statement) with the Securities and Exchange
      Commission (the “Commission”) covering the resale of (i) the shares of Common
      Stock purchased in the above placements (collectively, the “Offerings”) (the
“Purchased Shares”), (ii) the Common Stock issuable upon exercise of the
      warrants issued in the Offerings (the “Registrable Securities”). Further, the
      Company agreed to use its best efforts to (i) cause the Registration Statement
      to be declared effective within ninety (90) calendar days from the Filing Date,
      or, if reviewed by the Commission, within one hundred eighty (180) calendar
      days
      after the Filing Date, and (ii) keep the Registration Statement continuously
      effective until all of the Registrable Securities have been sold, or may be
      sold
      without volume restrictions pursuant to Rule 144.




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





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





As
      of
      September 30, 2008 there were accrued liquidated damages of $1,116,498.
      Additional liquidated damages of $414,000 and $966,799 were accrued in the
      three
      and nine months ended September 30, 2008. The Company has
      not paid out any of the accrued liquidated damages, which are payable in
      cash or shares of its common stock, or a combination thereof, at its
      sole discretion.  Additionally, the Company will accrue $4,500 per day in
      liquidated damages until such time as the requirements described above have
      been
      satisfied.





17


**Emerald
        Dairy, Inc. and Subsidiaries**
 **Footnotes
        to Condensed Consolidated Financial Statements**
 **September
        30, 2008 and 2007**


**15.**
            **Equity
                (Continued)**





**Warrants**





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




Exercise
                Price
            
            
            Outstanding
              December
                31, 2007
            
            
            Granted
            
            
            Expired
                or Exercised
            
            
            Outstanding
                September 30, 2008
            
            
            Expiration
                Date$0.94
            
            
            373,334
            
            
            -0-
            
            
            -0-
            
            
            373,334
            
            
            10/09/2010$1.50
            
            
            1,333,333
            
            
            -0-
            
            
            -0-
            
            
            1,333,333
            
            
            10/09/2009$2.04
            
            
            804,884
            
            
            -0-
            
            
            -0-
            
            
            804,884
            
            
            10/09/2010$2.04
            
            
            569,346
            
            
            -0-
            
            
            -0-
            
            
            569,346
            
            
            10/19/2010$2.61
            
            
            -0-
            
            
            195,000
            
            
            -0-
            
            
            195,000
            
            
            6/12/2011$2.61
            
            
            -0-
            
            
            75,000
            
            
            -0-
            
            
            75,000
            
            
            6/20/2011$3.26
            
            
            2,061,227
            
            
            -0-
            
            
            -0-
            
            
            2,061,227
            
            
            10/09/2009$3.26
            
            
            2,846,746
            
            
            -0-
            
            
            -0-
            
            
            2,846,746
            
            
            10/19/2009





**Warrant
      Tender Offer**





As
      of
      April 24, 2008, we commenced an offer (“Offer”) to the holders
      (“Warrantholders”) of our then outstanding warrants, pursuant to which the
      Warrantholders may tender their Warrants for shares of our Common Stock at
      a
      reduced exercise price as follows:





·
            With
                respect to warrants having an exercise price of $0.94 per share,
                a holder
                accepting the Offer may exercise some or all of such warrants at
                $0.75 per
                share of Common Stock;




·
            With
                respect to warrants having an exercise price of $1.50 per share,
                a holder
                accepting the Offer may exercise some or all of such warrants at
                $1.20 per
                share of Common Stock;




·
            With
                respect to warrants having an exercise price of $2.04 per share,
                a holder
                accepting the Offer may exercise some or all of such warrants at
                $1.63 per
                share of Common Stock; and




·
            With
                respect to warrants having an exercise price of $3.26 per share,
                a holder
                accepting the Offer may exercise some or all of such warrants at
                $2.61 per
                share of Common Stock.




A
      Warrantholder may tender less than the full number of its warrants. If a
      Warrantholder tenders less than all of its warrants, the remaining warrants
      not
      tendered will remain outstanding until they expire by their current terms or
      are
      exercised.  In
      addition, a Warrantholder may change its election and withdraw from the Offer. If
      a
      Warrantholder accepts our Offer, the exercise price for the tendered warrants
      must be paid in cash.  The
      Offer
      will expire on November 21, 2008, as extended, unless we sooner extend or
      terminate the period of time during which the offer is open, by giving oral
      or
      written notice of such extension or termination.





**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 Company voluntarily contributed an additional 5% in the nine months ended
      September 30, 2008. The balance of these reserves at September 30, 2008 and
      December 31, 2007, was $1,340,713 and $659,903, respectively. These amounts
      are
      restricted and are included in retained earnings.





18


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**16.**
            **Common
                Welfare Reserves
                (Continued)**





This
      fund
      can only be utilized on capital items for the collective benefit of the
      Company’s employees, such as construction of dormitories, cafeteria facilities,
      and other staff welfare facilities. The fund is non-distributable other than
      upon liquidation.




**17.**
            **Other
                Comprehensive Income**





SFAS
      No.
      130, *Reporting
      Comprehensive Income* ,
      requires the reporting of comprehensive income in addition to net income from
      operations. Comprehensive income is a more inclusive financial reporting
      methodology that includes disclosure of certain financial information that
      historically has not been recognized in the calculation of net
      income.





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





**18.**
            **Earnings
                Per Share**





SFAS
      128
      requires a reconciliation of the numerator and denominator of the basic and
      diluted earnings per share (EPS) computations.





For
      the
      three and nine months ended September 30, 2008, dilutive shares include
      outstanding warrants to purchase 373,334 shares of common stock at an exercise
      price of $0.94 and warrants to purchase 1,333,333 shares at an exercise price
      of
      $1.50. Warrants to purchase 6,552,193 share of common stock were not included
      in
      dilutive shares as the effect would have been anti-dilutive.





There
      were no dilutive shares for the three and nine months ended September 30,
      2007.





The
      following reconciles the components of the EPS computation:





Income
            
            Shares
            
            Per
                Share(Numerator)
            
            (Denominator)
            
            AmountFor
                the three months ended September 30, 2008:Net
                income
            
            $
            808,067Basic
                EPS income available to common shareholders
            
            $
            808,067
            
            
            29,299,332
            
            $
            0.03Effect
                of dilutive securities:Warrants
            
            
            —
            
            
            264,376Diluted
                EPS income available to common shareholders
            
            $
            808,067
            
            
            29,563,708
            
            $
            0.03For
                the three months ended September 30, 2007:Net
                income
            
            $
            1,375,326Basic
                EPS income available to common shareholders
            
            $
            1,375,326
            
            
            24,305,546
            
            $
            0.06Effect
                of dilutive securities:Warrants
            
            
            —
            
            
            —Diluted
                EPS income available to common shareholders
            
            $
            1,375,326
            
            
            24,305,546
            
            $
            0.06




19


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**18.**
            **Earnings
                Per Share (Continued)**





Income
            
            Shares
            
            Per
                Share(Numerator)
            
            (Denominator)
            
            AmountFor
                the nine months ended September 30, 2008:Net
                income
            
            $
            1,509,235Basic
                EPS income available to common shareholders
            
            $
            1,509,235
            
            
            29,299,332
            
            $
            0.05Effect
                of dilutive securities:Warrants
            
            
            —
            
            
            264,376Diluted
                EPS income available to common shareholders
            
            $
            1,509,235
            
            
            29,563,708
            
            $
            0.05For
                the nine months ended September 30, 2007:Net
                income
            
            $
            2,936,942Basic
                EPS income available to common shareholders
            
            $
            2,936,942
            
            
            24,305,546
            
            $
            0.12Effect
                of dilutive securities:Warrants
            
            
            —
            
            
            —Diluted
                EPS income available to common shareholders
            
            $
            2,936,942
            
            
            24,305,546
            
            $
            0.12





**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.





In
      2007
      the Company placed a deposit of $574,821 with a governmental agency allowing
      the
      Company to negotiate a possible purchase of an additional processing facility.
      No agreement as to the purchase of the facility has been reached.





The
      Company has contracted to purchase equipment from a supplier for a second
      processing facility for $5,284,369 of which $3,699,058 has been
      advanced.





The
      Company has advances to milk suppliers of $340,298 which will be offset against
      future milk purchases from those suppliers.





No
      government approvals are required to conduct the Company’s principal operations,
      and the Company is not aware of any probable governmental regulation of our
      business sectors in the near future. Although management believes that the
      Company is in material compliance with the statutes, laws, rules and
      regulations of every jurisdiction in which it operates, no assurance can be
      given that the Company’s compliance with the applicable statutes, laws,
      rules and regulations will not be challenged by governing authorities or
      private parties, or that such challenges will not lead to a material adverse
      effect on the Company’s financial position, results of operations, or cash
      flows.





The
      Company and its subsidiaries are self-insured, and they do not carry any
      property insurance, general liability insurance, or any other insurance that
      covers the risks of their business operations. As a result any material loss
      or
      damage to its properties or other assets, or personal injuries arising from
      its
      business operations would have a material adverse effect on the Company’s
      financial condition and operations.




20


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**19.**
            **Commitments
                and Contingencies
                (Continued)**





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.





**20.**
            **Operating
                Leases**





The
      Company leases various distribution facilities. All leases are on an annual
      basis and commence on January 1, of each year. For the three and nine months
      ended September 30, 2008 and 2007, the Company incurred rental expense of
      $30,811, $94,771, $6,138 and $62,883, respectively. As of September 30, 2008,
      the Company had outstanding lease commitments totaling $29,052, all of which
      are
      due within the next year.





**21.**
            **Subsequent
                events**





On
      November 10, 2008, we sold to one “accredited investor,” for
      a
      purchase price of $500,000, a
      10%
      promissory note (the “10% 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
      10%
      Note will bear interest at a rate of 10% until they become 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 10% Note at any time without penalty, upon 15 days prior written
      notice. The holder of the 10% Note has the right to be prepaid any amounts
      due
      under his 10% 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 10% Note, there are limitations on our ability to: (a)
      pay
      dividends or make other distributions on its capital stock; (b) redeem,
      repurchase or otherwise acquire any of its securities; (c) 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 10% Note if: (a)
      we fail to pay principal or interest when due on the 10% Note; (b) we breach
      any
      material covenant or other material term or condition contained in the 10%
      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 10% 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 ninety (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 10% Note, unless such
      Event of Default shall have been waived in writing by the holder, the holder
      may
      consider the 10% 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.





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.




21


**Emerald
      Dairy, Inc. and Subsidiaries**


**Footnotes
      to Condensed Consolidated Financial Statements**


**September
      30, 2008 and 2007**





**22.**
            **Segment
                reporting**





The
      Company operates in one operating segment in accordance with the provisions
      of
      SFAS No. 131, “Disclosures about Segments of an Enterprise and Related
      Information”. Although the Company has key product lines of milk, soybean milk,
      and rice powder, the Company’s chief operating decision maker reviews and
      evaluates one set of combined financial information deciding how to allocate
      resources and in assessing performance.





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





Three
                Months
              Ended September 30,
            
            Nine
                Months
              Ended September 30,2008
            
            2007
            
            2008
            
            2007Milk
                powder
            
            $
            9,362,555
            
            $
            6,514,022
            
            $
            26,144,060
            
            $
            15,898,010Soybean
                milk powder
            
            
            221,124
            
            
            177,986
            
            
            644,233
            
            
            495,204Rice
                powder
            
            
            275,722
            
            
            303,290
            
            
            813,645
            
            
            785,162Sub-contract
                processing
            
            
            1,361,618
            
            
            1,448,063
            
            
            4,958,318
            
            
            3,793,179$
            11,221,019
            
            $
            8,443,361
            
            $
            32,560,256
            
            $
            20,971,555




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 96%, 2% and 2% of our sales, respectively. Through our
      network of over 600 salespeople, our products are distributed throughout 20
      provinces in the People’s Republic of China (“PRC”), and sold in over 5,600
      retail outlets.





Our
      products are marketed under two brand names:





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




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




The
      Chinese government has initiated programs to promote milk consumption and is
      providing incentives to increase dairy production. The dairy market today in
      China is over $13.0 billion and is expected to grow at a rate of 15% per year
      for the foreseeable future. We focus on the infant formula segment of the
      market, which is expected to grow even faster, at a rate of approximately 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. In addition, we have received a Product Exemption
      from Quality Surveillance Inspection waiver from the State General
      Administration. Only companies that have passed their product quality
      inspections for five consecutive years are awarded this certificate of
      waiver.





Because
      of our close proximity to its sources of fresh milk, we are able to complete
      the
      production process in approximately 30 hours, which is faster than competitors
      of ours that are not similarly situated. We produced approximately 7,000 tons
      of
      milk powder at our facility in Be’ian City, Heilonjiang Province, PRC in fiscal
      2007, up from approximately 5,000 tons in fiscal 2006. In 2008, by adding a
      third shift to the existing two shifts working schedule, we plan on producing
      approximately 9,000 tons of milk powder. In addition, in July 2008, through
      our
      wholly-owned subsidiary, Hailun Xinganling Dairy Co., Ltd. (“HXD”), we commenced
      construction of a new production facility in Hailun City, Heilonjiang Province,
      PRC, which will enable us to produce an additional 9,000 tons of milk powder
      annually, beginning in fiscal 2009. As a result, we believe we will have the
      capacity to produce almost 20,000 tons of milk powder per year by fiscal 2010.
      It is expected that our production of rice powder and soymilk powder will also
      increase in volume, while continuing to comprise approximately 2% and 2% of
      our
      overall sales, respectively.





23


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





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




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




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




**Recent
      Developments**




***Reverse
      Merger, Private Placements and Related Transactions***





Prior
      to
      October 9, 2007, we were a public shell company, as defined by Securities Act
      Rule 405 and Exchange Act Rule 12b-2, without material assets or activities.
      On
      October 9, 2007, we completed a reverse merger (the “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, $.001 par
      value per share (“Common Stock”), (ii) warrants to purchase 266,667 shares of
      our Common Stock, at an exercise price of $0.94 per share (“Warrant W-1”), and
      (iii) warrants to purchase 1,333,333 shares of our Common Stock, at an exercise
      price of $1.50 per share (“Warrant W-2”), for an aggregate purchase price of
      $1,000,000 (the “First Offering”). In addition, we sold 2,061,227 units of our
      securities to certain additional “accredited investors” (the “Initial
      Purchasers”), consisting of (i) 2,061,227 shares of our Common Stock,
      (ii) warrants to purchase 412,245 of our Common Stock, at an exercise price
      of $2.04 per share (the “Class A Warrants”), and (iii) warrants to purchase
      2,061,227 of our common stock, at an exercise price of $3.26 per share (the
      “Class B Warrants”), for an aggregate purchase price of $3,359,800 (the “Initial
      Placement of the Second Offering”). The rights and obligations under Warrant
      W-1, Warrant W-2, the Class A Warrants, and the Class B Warrants are further
      described in “- Liquidity and Capital Resources - Warrants” below.





24


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





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





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





In
      connection with the First Offering and Second Offering (collectively, the
“October Offerings”), we engaged finders and placement agents to whom we paid
      fees in the aggregate of $700,452, and granted (i) warrants to purchase an
      aggregate of 106,667 shares of our Common Stock, at an exercise price of $0.94
      per share, the terms and conditions of which are identical to the those of
      Warrant W-1, and (ii) warrants to purchase 392,639 shares of our Common Stock,
      at an exercise price of $2.04, the terms and conditions of which are identical
      to the those of the Class A Warrants.





***Warrant
      Tender Offer***





As
      of
      April 24, 2008, we commenced an offer (“Offer”) to the holders
      (“Warrantholders”) of our then outstanding warrants, pursuant to which the
      Warrantholders may tender their Warrants for shares of our Common Stock at
      a
      reduced exercise price as follows:





·
                With
                    respect to warrants having an exercise price of $0.94 per share,
                    a holder
                    accepting the Offer may exercise some or all of such warrants
                    at $0.75 per
                    share of Common Stock;




·
                With
                    respect to warrants having an exercise price of $1.50 per share,
                    a holder
                    accepting the Offer may exercise some or all of such warrants
                    at $1.20 per
                    share of Common Stock;




·
            With
                respect to warrants having an exercise price of $2.04 per share,
                a holder
                accepting the Offer may exercise some or all of such warrants at
                $1.63 per
                share of Common Stock; and




·
            With
                respect to warrants having an exercise price of $3.26 per share,
                a holder
                accepting the Offer may exercise some or all of such warrants at
                $2.61 per
                share of Common Stock.




A
      Warrantholder may tender less than the full number of its warrants. If a
      Warrantholder tenders less than all of its warrants, the remaining warrants
      not
      tendered will remain outstanding until they expire by their current terms or
      are
      exercised.  In
      addition, a Warrantholder may change its election and withdraw from the Offer. If
      a
      Warrantholder accepts our Offer, the exercise price for the tendered warrants
      must be paid in cash.  The
      Offer
      will expire on November 21, 2008, as extended, unless we sooner extend or
      terminate the period of time during which the Offer is open, by giving oral
      or
      written notice of such extension or termination.





25


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





***Sale
      of Notes and Warrants***





In
      June
      2008, we conducted a private offering of up to a maximum of (i) $3,000,000
      of
      our 8% promissory notes (the “8% 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, an
      8%
      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, an 8% Note in the principal amount of $750,000, and June Warrants
      to
      purchase 75,000 shares of our Common Stock. The rights and obligations under
      the
      8% Notes are further described in “- Liquidity and Capital Resources -
      Promissory Notes” below. The rights and obligations under the June Warrants are
      further described in “- Liquidity and Capital Resources - Warrants”
below.





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





On
      November 10, 2008, we sold to one “accredited investor,” for
      a
      purchase price of $500,000, a
      10%
      promissory note (the “10% 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 10% 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.





***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, Heilonjiang Province, PRC. When completed, the new
      facility will have the capacity to produce approximately 9,000 tons of infant
      formula milk powder annually, expandable to 18,000 tons annually. We anticipate
      that production will begin at this facility in the second quarter of
      2009.





26


**Trends
      and Uncertainties**





***Narrowing
      of Gap in Milk Consumption***





The
      Chinese government has initiated programs to promote milk consumption and is
      providing incentives to increase dairy production. In addition to improving
      the
      overall health the populous, the government views increased dairy production
      as
      a solution to improve employment in rural areas thus improving social stability.
      It is expected that there will be a steady narrowing of the significant gap
      between China’s per capita milk consumption of 15kg per person and the global
      average of 100 kg per person.





***Industry
      Growth***





The
      dairy
      market today in China is over $13.0 billion. According to the website of the
      China National Bureau of Statistics, between 2000 to 2005 the dairy industry
      in
      China experienced an average growth of 16% per year. English-language copies
      of
      the reports of the China National Bureau of Statistics are available on its
      website, free of charge. The dairy industry in China is projected to grow at
      rate of 15% per year from 2006 to 2012, to reach $32 billion by 2012.




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. Production capacity has been the bottle neck for our growth in
      recent years, because production has not been able to keep up with demand.
      We
      have commenced construction of a new production facility with annual production
      capacity of 9,000 tons of milk powder, which is expected to start production
      in
      the second quarter of 2009. We expect that this increase in production capacity
      of approximately 100% will result in the doubling of our sales revenues, with
      a
      corresponding increase in cost of goods sold and sales and administrative
      expenses.





This
      project is expected to cost an aggregate of approximately $20.0 million,
      including land use rights, construction expenses and equipment costs. Management
      will need to raise $10.0 million to $15.0 million to fund the construction
      of
      new production facility. We plan to apply the net proceeds we received from
      the
      June Note Offering and November Note Offering, further described in “— Recent
      Developments—Sale of Notes and Warrants” above, and any proceeds we receive from
      the Offer, further described in “—Recent Developments—Warrant Tender Offer”
above, toward the construction of this new production facility. Other than
      that,
      we have no additional commitments for additional financing we may need to
      complete the construction of our new processing facility. There can be no
      assurance that that any additional financing will become available to us, and
      if
      available, on terms acceptable to us.




27


***Product
      Pricing and Raw Material Supply***





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





***Brand
      Name and Product Quality***





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





***Organic
      Label Milk Products***





Currently,
      there are no organic label milk powder products in the mainland China market.
      In
      February 2008, we obtained organic label certification from Guangdong Zhongjian
      Certification Co., Ltd. We plan to create an organic label product line
      beginning in fiscal 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.




28


***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.




**Results
      of Operations**





***Three
      Months Ended September 30, 2008 Compared to Three Months Ended September 30,
      2007***





The
      following summarizes changes in our operations for the three months ended
      September 30, 2008 and 2007. Net income decreased by $567,259, or 41.2%, from
      $1,375,326 in the three months ended September 30, 2007 to $808,067 for the
      three months ended September 30, 2008. The decrease in net income during the
      three months ended September 30, 2008, as compared to the same time period
      in
      the prior year, was due to an increase in our operating expenses, which offset
      an increase in our gross profit as further described below.





***Sales
      and Cost of Goods Sold***





**For
                the Three Months**
              **Ended
                September 30,****2008**
            
            **2007****Sales**
            
            $
            11,221,019
            
            $
            8,443,361**Cost
                of Goods Sold**
            
            
            6,552,835
            
            
            5,422,899**Gross
                Profit**
            
            $
            4,668,184
            
            $
            3,020,462





**Sales.** Sales
      volume increased by 211 metric tons, or 9.9%, period on period, to 2,343
      metric tons for the three months ended September 30, 2008, from 2,132 metric
      tons for the three months ended September 30, 2007. As a result, sales revenues
      increased by $2,777,658, or 32.9%, from $8,443,361 in the three months ended
      September 30, 2007, to $11,221,019 for the three months ended September 30,
      2008. This increase was due to the following factors:




·
              We
                  expanded the market areas in the twenty provinces in which we sell
                  our
                  products and our products are now sold in over 5,600 retail
                  outlets;
  ·
              Our
                  products have became increasing popular in mainland China due to
                  our
                  continued sales and marketing efforts;
                  and
  ·
              The
                  average selling price for all products has increased by $829 per
                  metric
                  ton, or 20.9%, as compared to the three months ended September
                  30,
                  2007.
  29


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




**Three
                Months Ended September 30,****2008**
            
            **2007**
            
            **Period-on-period****Product category******
            
            **Quantity**
                **(tons)**
            
            **$  Amount******
            
            **% of sales**
            
            **Quantity**
                **(tons)**
            
            **$ Amount******
            
            **% of sales**
            
            **Quantity**
                **Variance**Milk
                powder
            
            
            1,621
            
            
            9,362,555
            
            
            83.4
            
            
            1,442
            
            
            6,514,022
            
            
            77.2
            
            
            179Rice
                powder
            
            
            50
            
            
            275,722
            
            
            2.5
            
            
            57
            
            
            303,290
            
            
            3.6
            
            
            (7
            )Soybean
                powder
            
            
            120
            
            
            221,125
            
            
            2.0
            
            
            104
            
            
            177,986
            
            
            2.1
            
            
            16Subcontracting
            
            
            552
            
            
            1,361,617
            
            
            12.1
            
            
            529
            
            
            1,448,0631
            
            
            17.1
            
            
            23Total
            
            
            2,343
            
            
            11,221,019
            
            
            100.0
            
            
            2,132
            
            
            8,443,361
            
            
            100.0
            
            
            211





There
      were very few changes to the break-down of sales among our products over the
      three months ended September 30, 2008, as compared to the three months ended
      September 30, 2007. Soybean powder only accounted for 2.0% of our sales mix
      for
      the three months ended September 30, 2008, at an average selling price of $1,840
      per metric ton, as compared to 2.1% of our sales mix in the three months ended
      September 30, 2007, at an average selling price of $1,717 per metric ton. Milk
      powder accounted for 83.4% of the sales mix for the quarter ended September
      30,
      2008, at an average selling price of $5,778 per metric ton, as compared to
      77.2%
      of the quarter ended September 2007, at an average selling price of $4,516
      per
      metric ton. We decreased our subcontract production during the quarter ended
      September 30, 2008 to 12.1% of the sales mix, at an average selling price of
      $2,465 per metric ton, as compared to 17.1% of the sales mix in the same quarter
      in 2007, at an average sales price of $2,737 per metric ton.





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




**Three
                Months  Ended**
              **September 30,****Average selling prices
                (per ton)**
            
            
            **2008**
            
            
            **2007**
            
            
            **Variance**$
            
            
            $
            
            
            $
            
            
            %Milk
                powder
            
            
            5,778
            
            
            4,516
            
            
            1,262
            
            
            27.9Rice
                powder
            
            
            5,546
            
            
            5,334
            
            
            212
            
            
            4.0Soybean
                powder
            
            
            1,840
            
            
            1,717
            
            
            123
            
            
            7.2Subcontracting
            
            
            2,465
            
            
            2,737
            
            
            (272
            )
            
            (9.9
            )Average
                total selling price
            
            
            4,790
            
            
            3,960
            
            
            830
            
            
            20.9





**Cost
      of Goods Sold.** Cost of
      goods sold increased by $1,129,936, or 20.8%, from $5,422,899 in the three
      months ended September 30, 2007, to $6,552,835 for the three months ended
      September 30, 2008. In addition, our cost per metric ton increased by $253,
      or
      10.0%, to $2,797 per metric ton in the quarter ended September 30, 2008, as
      compared to $2,554 per metric ton in quarter ended September 30, 2007. This
      increase in cost per metric ton was the result of an increase in the price
      of
      raw materials we use to produce our products.




30


A
      breakdown of cost of sales by product line for the three months ended September
      30, 2008 and 2007 is as follows:





**Three
                Months Ended September 30,****2008**
            
            **2007**
            
            **Variance**$
            
            $
            
            $
            
            %**Cost
                of sales**Milk
                powder
            
            
            5,201,835
            
            
            4,007,782
            
            
            1,194,053
            
            
            29.8Rice
                powder
            
            
            89,718
            
            
            100,880
            
            
            (11,162
            )
            
            (11.1
            )Soybean
                powder
            
            
            148,324
            
            
            112,160
            
            
            36,164
            
            
            32.2Subcontracting
            
            
            1,112,958
            
            
            1,202,077
            
            
            (89,119
            )
            
            (7.4
            )Total
            
            
            6,552,835
            
            
            5,422,899
            
            
            1,129,936
            
            
            20.8**Cost
                per units sold (per ton)**Milk
                powder
            
            
            3,209
            
            
            2,779
            
            
            430
            
            
            15.5Rice
                powder
            
            
            1,794
            
            
            1,770
            
            
            24
            
            
            1.4Soybean
                powder
            
            
            1,236
            
            
            1,078
            
            
            158
            
            
            14.7Subcontracting
            
            
            2,016
            
            
            2,272
            
            
            (256
            )
            
            (11.3
            )Average
                cost per unit sold
            
            
            2,797
            
            
            2,544
            
            
            253
            
            
            10.0





**Gross
      Profit.** Gross
      profit was $4,668,184, or 41.6% of our sales for the three months ended
      September 30, 2008, compared to gross profit of $3,020,462, or 35.8% for the
      three months ended September 30, 2007. During the quarter ended September 30,
      2008 our gross margin on milk powder increased 5.9% due to an increase in the
      average sales price of 27.9% from quarter ended September 30, 2007, partially
      offset by a 15.5% increase in the cost per metric ton from the quarter ended
      September 30, 2007. The gross margin for soybean powder decreased 4.1% to 32.9%
      in quarter ended September 30, 2008, as compared from 37.0% in quarter ended
      September 30, 2007 due to increase in the average sales price of 7.2% in quarter
      ended September 30, 2008, as compared to 2007, offset by an increase of 32.2%
      in
      the cost per metric ton from the quarter ended September 30, 2008 to the quarter
      ended September 30, 2007.





A
      breakdown of gross margin by product line for the three months ended September
      30, 2008 and 2007 is as follows:





**Three
                Months Ended September 30,****2008**
            
            **2007**
            
            **Period-on-period****Product category**
            
            **$  Amount**
            
            **Gross**
              **Margin
                %**
            
            **$ Amount**
            
            **Gross**
              **Margin
                %**
            
            **Margin**
              **Variance**Milk
                powder
            
            
            4,160,720
            
            
            44.4
            
            
            2,506,240
            
            
            38.5
            
            
            5.9Rice
                powder
            
            
            186,004
            
            
            67.5
            
            
            202,410
            
            
            66.7
            
            
            0.8Soybean
                powder
            
            
            72,801
            
            
            32.9
            
            
            65,826
            
            
            37.0
            
            
            (4.1
            )Subcontracting
            
            
            248,659
            
            
            18.3
            
            
            245,986
            
            
            17.0
            
            
            1.3Total
            
            
            4,668,184
            
            
            41.6
            
            
            3,020,462
            
            
            35.8
            
            
            5.8




31


***Operating
      Expenses***





**For
                the Three Months**
              **Ended
                September 30,****2008**
            
            **2007****Operating
                Expenses**Selling
                expenses
            
            $
            2,452,994
            
            $
            1,355,483Administrative
                expenses
            
            
            866,490
            
            
            206,217Depreciation
                and amortization
            
            
            41,905
            
            
            12,999Total
                operating expenses
            
            $
            3,361,389
            
            $
            1,574,699





**Selling
      Expenses** .
      Selling
      expenses overall increased by $1,097,511, or 210.4%, from $1,355,483 in the
      quarter ended September 30, 2007, to $2,452,994 for the quarter ended September
      30, 2008. The major factors in the increase in selling expenses are as
      follows:


·
              Advertising
                  increased by $532,271, or 2,193.2%, to $556,540 in 2008, from $24,269
                  in
                  2007, due to our marketing campaign to increase brand awareness
                  and
                  sales.
 
 ·
              Selling
                  salaries increased by $139,368, or 38.2%, to $504,465 in 2008,
                  from
                  $365,096 in 2007, as the amounts we paid to our sales staff rose
                  due to
                  increased sales.
 
 ·
              Travelling
                  expenses incurred by the sales staff increased by $95,852, or 50.0%,
                  to
                  $287,516 in 2008, from $191,663 in 2007, due to the expansion of
                  our sales
                  network.
 
 ·
              Transportation
                  expenses increased by $71,660, or 34.4%, to $279,800 in 2008, from
                  $208,140 in 2007, as a result of shipping more product in 2008
                  as compared
                  to 2007.
 
 ·
              Entertainment
                  expenses increased by $52,244, or 45.4%, to $167,260 in 2008, from
                  $115,016 in 2007, as a result of the increase in the sales staff
                  and
                  network.




**Administrative
      Expenses** .
      Administrative expenses increased by $660,273, or 320.2%, from $206,217 in
      the
      quarter ended September 30, 2007, to $866,490 for the quarter ended September
      30, 2008. The major factors in the increase in administrative expenses are
      as
      follows:


·
              Liquidated
                  damages incurred in 2008 of $414,000 related to registration rights
                  agreements we entered into, which were not similarly incurred in
                  2007.
 
 ·
              Increase
                  in legal and accounting fees in 2008 of $68,707, or 178.4%, to
                  $107,213,
                  as compared to $38,506 in 2007, due to costs associated with audits
                  and
                  SEC filings not required prior to the reverse merger we consummated
                  in
                  October 2007.
 
 ·
              Consultant
                  expenses incurred of $26,243, which were not similarly incurred
                  in
                  2007.
 
 ·
              Increase
                  of administrative salaries of $20,784, or 49.4%, to 62,886 in 2008,
                  from
                  $42,102 in 2007, related to 6 additional administrative personnel
                  hired
                  during 2008.
  ·
              Increase
                  in entertainment expenses of $22,565, or 66.7%, to $56,418 in 2008,
                  from
                  $33,853 in 2007, due to increased travel and entertainment by
                  administrative personnel to develop financing and funding for our
                  growth.
  32
 ·
              Increase
                  of travel expenses of $24,430, or 85.5%, to $53,000 in 2008, from
                  $28,569
                  in 2007, due to the increase in travel by administrative personnel
                  to
                  develop financing and funding for our
                  growth.




***Provision
      for Income Taxes***





**For
                the Three Months**
              **Ended
                September 30,****2008**
            
            **2007****Provision
                for Income Taxes**Current
            
            $
            269,666
            
            $
            65,942Deferred
            
            
            —
            
            
            —$
            269,666
            
            $
            65,942





**Provision
      for Income Taxes** .
      Income
      taxes increased by $203,724, or 308.9%, from $65,942 in the three months ended
      September 30, 2007, to $269,666 for the three months ended September 30, 2008.
      This increase was due to the increase in our pre-tax income and the reduction
      in
      the tax exemption for XAL to 50% of the statutory enterprise income tax rate
      from 100% as of January 1, 2008.





***Nine
      Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
      2007***





The
      following summarizes changes in our operations for the nine months ended
      September 30, 2008 and 2007. Net income decreased by $1,427,707, or 48.6%,
      from
      $2,936,942 in the nine months ended September 30, 2007, to $1,509,235 for the
      nine months ended September 30, 2008. The decrease in net income during the
      nine
      months ended September 30, 2008, as compared to the same time period in the
      prior year, was due to an increase in our operating expenses, which offset
      an
      increase in our gross profit as further described below.





***Sales
      and Cost of Goods Sold***





**For
                the Nine Months**
              **Ended
                September 30,****2008**
            
            **2007****Sales**
            
            $
            32,560,256
            
            $
            20,971,555**Cost
                of Goods Sold**
            
            
            19,845,232
            
            
            13,853,290**Gross
                Profit**
            
            $
            12,715,024
            
            $
            7,118,265





**Sales.** Sales
      volume increased by 917 metric tons, or 15.7%, period on period to 6,761 metric
      tons for the nine months ended September 30, 2008, from 5,844 metric tons for
      the nine months ended September 30, 2007. As a result, sales revenues increased
      by $11,588,701, or 55.3%, from $20,971,555 in the nine months ended September
      30, 2007, to $32,560,256 for the nine months ended September 30, 2008. This
      increase was due to the following factors:


·
              We
                  expanded the market areas in the twenty provinces in which we sell
                  our
                  products and our products are now sold in over 5,600 retail
                  outlets;
 
 33
  ·
              Our
                  products have became increasing popular in mainland China due to
                  our
                  continued sales and marketing efforts;
                  and
  ·
              The
                  average selling price for all products has increased by $1,227
                  per metric
                  ton, or 34.2%, as compared to the nine months ended September 30,
                  2007.


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





**Nine
                Months Ended September 30,****2008**
            
            **2007**
            
            **Period-on-period****Product category**
            
            **Quantity**
              **(tons)**
            
            **$  Amount**
            
            **% of sales**
            
            **Quantity**
              **(tons)**
            
            **$ Amount**
            
            **% of**
              **sales**
            
            **Qty.**
              **Variance**Milk
                powder
            
            
            4,543
            
            
            26,144,060
            
            
            80.3
            
            
            3,936
            
            
            15,898,010
            
            
            75.8
            
            
            607Rice
                powder
            
            
            147
            
            
            813,645
            
            
            2.5
            
            
            1492
            
            
            785,162
            
            
            3.7
            
            
            (2
            )Soybean
                powder
            
            
            350
            
            
            644,233
            
            
            2.0
            
            
            295
            
            
            495,204
            
            
            2.4
            
            
            55Subcontracting
            
            
            1,721
            
            
            4,958,318
            
            
            15.2
            
            
            1,464
            
            
            3,793,1791
            
            
            18.1
            
            
            257Total
            
            
            6,761
            
            
            32,560,256
            
            
            100.0
            
            
            5,844
            
            
            20,971,555
            
            
            100.0
            
            
            917





There
      were very few changes to the break-down of sales among our products over the
      nine months ended September 30, 2008, as compared to the nine months ended
      September 30, 2007. Soybean powder only accounted for 2.0% of our sales mix
      for
      the nine months ended September 30, 2008, at an average selling price of $1,840
      per metric ton, as compared to 2.4% of our sales mix in the nine months ended
      September 30, 2007, at an average selling price of $1,677 per metric ton. Milk
      powder accounted for 80.3% of sales mix in the nine months ended September
      30,
      2008, at an average selling price of $5,755 per metric ton, as compared to
      75.8%
      of the sales mix in nine months ended September 30, 2007, at an average selling
      price of $4,040 per metric ton. Our subcontract production during the nine
      months ended September 30, 2008 decreased to 15.2% of the sales mix, at an
      average selling price of $2,880 per metric ton, as compared to 18.1% of the
      sales mix in the nine months ended September 30, 2007, at an average sales
      price
      of $2,591 per metric ton.





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





**Nine
                Months  Ended**
              **September 30,****Average selling prices
                (per ton)**
            
            **2008**
            
            **2007**
            
            **Variance**$
            
            $
            
            $
            
            %Milk
                powder
            
            
            5,755
            
            
            4,039
            
            
            1,715
            
            
            42.5Rice
                powder
            
            
            5,535
            
            
            5,270
            
            
            265
            
            
            5.0Soybean
                powder
            
            
            1,841
            
            
            1,679
            
            
            162
            
            
            9.6Subcontracting
            
            
            2,881
            
            
            2,591
            
            
            290
            
            
            11.2Average
                total selling price
            
            
            4,816
            
            
            3,589
            
            
            1,227
            
            
            34.2





34


**Cost
      of Goods Sold.** Cost of
      goods sold increased by $5,991,942, or 43.3%, from $13,853,290 in the nine
      months ended September 30, 2007, to $19,845,232 for the nine months ended
      September 30, 2008. This increase was related to an increase in sales during
      quarter of 55.3%. In addition, our cost per metric ton increased by $564, or
      23.8%, to $2,935 per metric ton in the quarter ended September 30, 2008, as
      compared to $2,371 per metric ton in quarter ended September 30,
      2007.





A
      breakdown of cost of sales by product line for the nine months ended September
      30, 2008 and 2007 is as follows:





**Nine
                Months Ended September 30,****2008**
            
            **2007**
            
            **Variance**$
            
            $
            
            $
            
            %**Cost
                of sales**Milk
                powder
            
            
            14,893,859
            
            
            10,124,336
            
            
            4,769,523
            
            
            47.1Rice
                powder
            
            
            262,169
            
            
            256,957
            
            
            5,212
            
            
            2.0Soybean
                powder
            
            
            423,707
            
            
            303,566
            
            
            120,141
            
            
            39.6Subcontracting
            
            
            4,265,497
            
            
            3,168,431
            
            
            1,097,066
            
            
            34.6Total
            
            
            19,845,232
            
            
            13,853,290
            
            
            5,991,942
            
            
            43.3**Cost
                per units sold(per ton)**Milk
                powder
            
            
            3,278
            
            
            2,572
            
            
            706
            
            
            27.4Rice
                powder
            
            
            1,783
            
            
            1,725
            
            
            58
            
            
            3.4Soybean
                powder
            
            
            1,211
            
            
            1,029
            
            
            182
            
            
            17.7Subcontracting
            
            
            2,478
            
            
            2,164
            
            
            314
            
            
            14.5Average
                cost per unit sold
            
            
            2,935
            
            
            2,371
            
            
            564
            
            
            23.8





**Gross
      Profit.** Gross
      profit was $12,715,024, or 39.1%, of our sales for the nine months ended
      September 30, 2008, compared to gross profit of $7,118,265, or 33.9%, for the
      nine months ended September 30, 2007. During the nine months ended September
      30,
      2008 our gross margin on milk powder increased 6.7%, due to an increase in
      the
      average sales price of 42.5% from nine months ended September 30, 2007,
      partially offset by a 27.4% increase in the cost per metric ton from the nine
      months ended September 30, 2007. The gross margin for soybean powder decreased
      4.5%, to 34.2% in the nine months ended September 30, 2008, as compared to
      38.7%
      in nine months ended September 30, 2007. This decrease was due to a 9.7%
      increase in the average sales price in nine months ended September 30, 2008,
      as
      compared to 2007, offset by an increase of 17.7% in the cost per metric ton
      in
      nine months ended September 30, 2008, as compared to 2007.





A
      breakdown of gross margin by product line for the nine months ended September
      30, 2008 and 2007 is as follows:





**Nine Months Ended September 30,****2008**
            
            **2007**
            
            **Period-on-period****Product category**
            
            **$  Amount**
            
            **Gross**
              **Margin %**
            
            **$ Amount**
            
            **Gross**
              **Margin %**
            
            **Margin**
              **Variance**Milk
                powder
            
            
            11,250,201
            
            
            43.0
            
            
            5,773,674
            
            
            36.3
            
            
            6.7Rice
                powder
            
            
            551,476
            
            
            67.8
            
            
            528,205
            
            
            67.3
            
            
            0.5Soybean
                powder
            
            
            220,526
            
            
            34.2
            
            
            191,638
            
            
            38.7
            
            
            (4.5
            )Subcontracting
            
            
            692,821
            
            
            14.0
            
            
            624,748
            
            
            116.5
            
            
            (2.5
            )Total
            
            
            12,715,024
            
            
            39.1
            
            
            7,118,265
            
            
            33.9
            
            
            5.1





35


***Operating
      Expenses***





**For the Nine Months Ended**
              **September 30,****2008**
            
            **2007****Operating
                Expenses**Selling
                expenses
            
            $
            7,834,865
            
            $
            3,427,327Administrative
                expenses
            
            
            2,448,769
            
            
            558,105Depreciation
                and amortization
            
            
            72,336
            
            
            36,844Total
                operating expenses
            
            $
            10,355,970
            
            $
            4,022,276





**Selling
      Expenses** .
      Selling
      expenses overall increased by $4,407,538, or 128.6%, from $3,427,327 in the
      nine
      months ended September 30, 2007, to $7,834,865 for the nine months ended
      September 30, 2008. The major factors in the increase in selling expenses are
      as
      follows:





·
            Advertising
                increased by $2,593,060, or 3,295.6%, to $2,671,743 in 2008, from
                $78,683
                in 2007, due to our marketing campaign to increase brand awareness
                and
                sales.





·
            Selling
                salaries increased by $461,354, or 47.4%, to $1,435,092 in 2008,
                from
                $973,738 in 2007, the amounts we paid to our sales staff rose due
                to
                increased sales.





·
            Travelling
                expenses incurred by the sales staff increased by $355,948, or 79.4%,
                to
                $804,259 in 2008, from $448,311 in 2007, due to the expansion of
                our sales
                network.





·
            Transportation
                expenses increased by $199,137 or 33.2%, to $799,680, in 2008 from
                $600,543 in 2007, as a result of shipping more product in 2008 as
                compared
                to 2007.





·
            Entertainment
                expenses increased by $190,235, or 68.7%, to $467,311 in 2008, from
                $277,076 in 2007, as a result of the increase in the sales staff
                and
                network.





**Administrative
      Expenses** .
      Administrative expenses increased by $1,890,664, or 338.8%, from $558,105 in
      the
      nine months ended September 30, 2007, to $2,448,769 for the nine months ended
      September 30, 2008. The major factors in the increase in administrative expenses
      are as follows:





·
            Liquidated
                damages incurred in 2008 of $901,199 related to registration rights
                agreements we entered into, which were not similarly incurred in
                2007.





·
            Increase
                in legal and accounting fees in 2008 of $365,414, or 424.9%, to $451,419,
                as compared to $86,006 in 2007, due to costs associated with audits
                and
                SEC filings not required prior to the reverse merger we consummated
                in
                October 2007.





·
            Increase
                in consultant expenses of $76,015, or 1,025.1%, to $83,430 in 2008,
                as
                compared to $7,415 in 2007, for services related to possible financing
                and
                funding.





·
            Increase
                of administrative salaries of $162,022, or 147.1%, to $272,138 in
                2008,
                from $110,116 in 2007, related to 10 additional administrative personnel
                hired during 2008.





·
            Increase
                in entertainment expenses of $76,150, or 89.9%, to $160,880 in 2008,
                from
                $84,731 in 2007, due to increased travel and entertainment by
                administrative personnel to develop financing and funding for our
                growth.





36


·
            Increase
                of travel expenses of $75,010, or 98.2%, to $151,417 in 2008, from
                $76,407
                in 2007, due to the increase in travel by administrative personnel
                to
                develop financing and funding for our
                growth.





***Provision
      for Income Taxes***





**For the Nine Months Ended**
              **September 30,****2008**
            
            **2007****Provision
                for Income Taxes**Current
            
            $
            586,957
            
            $
            148,594Deferred
            
            
            —
            
            
            —$
            586,957
            
            $
            148,594





**Provision
      for Income Taxes** .
      Income
      taxes increased by $438,363, or 295.0%, from $148,594 in the nine months ended
      September 30, 2007, to $586,957 for the nine months ended September 30, 2008.
      This increase was due to the increase in our pre-tax income and the reduction
      in
      the tax exemption for XAL to 50% of the statutory enterprise income tax rate
      from 100% as of January 1, 2008.





**Liquidity
      and Capital Resources**





***Uses
      of Capital***





**For the Nine Months Ended**
              **September 30,****2008**
            
            **2007****Net
                cash provided by operating activities**
            
            $
            4,955,796
            
            $
            1,562,465**Net
                cash used in investing activities**
            
            
            (10,188,918
            )
            
            (689,983
            )**Net
                cash provided by (used in) financing activities**
            
            $
            1,959,082
            
            $
            2,266,667





**Net
      Cash Provided By Operating Activities.** For
      the
      nine months ended September 30, 2008, $4,955,796 was provided by operating
      activities, compared with $1,562,465 provided by operating activities for the
      nine months ended September 30, 2007. Our net cash flows used in operating
      activities increased during 2008 due to the following factors:





·
            Deposits
                on contracts and other current assets decreased by $2,480,834 due
                to
                completion of the contracts.





·
            Trade
                accounts receivable increased by $1,290,662, due to the increase
                level of
                sales during the year.





37


·
            We
                increased inventory at September 30, 2008 by $251,318, due to better
                management of the production
                process.




·
            Accounts
                payable and accrued expenses increased by $1,867,980 at September
                30,
                2008, as compared to 2007, due to increases in production of products
                and
                expenses.





38


**Net
      Cash Used In Investing Activities.** For
      the
      nine months ended September 30, 2008, we used $10,188,918 in investing
      activities, compared with $689,983 used in investing activities for the nine
      months ended September 30, 2007. Our increase in net cash flows used in
      investing activities during 2008 was due to our purchase of land use rights
      for
      a new production facility in the amount of $1,280,574, our purchase of fixed
      assets of $6,165,211 and construction in process of $2,743,133.




**Net
      Cash Provided By (Used In) Financing Activities.** For
      the
      nine months ended September 30, 2008, $1,959,082 was provided by financing
      activities, compared with approximately $2,266,667 provided by financing
      activities for the nine months ended September 30, 2007. We raised $2,250,000
      with the sale of 8% promissory notes payable due on December 31, 2008 and
      warrants in September 2008. We also paid off notes payable of $290,918 in the
      nine months ended September 30, 2008.





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





Cash
      and
      cash equivalents at September 30, 2008 decreased by 42.9%, to $3,748,746, from
      $6,560,931 at December 31, 2007. Based upon our short term liabilities, we
      believe our cash and cash equivalents are adequate to satisfy our working
      capital needs and sustain our ongoing operations for the next twelve months.
      We
      are expecting the cash flows to fluctuate in the future as we try to raise
      funds
      from the capital markets to implement our growth strategy.





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 facility that will have annual
      production capacity of 9,000 tons of milk powder, which is expected to commence
      production in the second quarter of 2009. This project is expected to cost
      an
      aggregate of approximately $20.0 million, including land use rights,
      construction expenses and equipment costs. Management will need to raise $10.0
      million to $15.0 million to fund the construction of the new production
      facility **.**





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





39


In
      connection with the October Offerings, we received aggregate net proceeds of
      $4,395,104. The net proceeds from the October Offerings were used to 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
      net proceeds of $2,003,742. In addition, on November 10, 2008, we closed the
      November Note Offering, pursuant to which we received aggregate net proceeds
      of
      $260,000. We plan to use the net proceeds from the June Note Offering and
      November Note Offering offerings primarily for the construction and equipping
      of
      our new production facility in Hailun City, Heilonjiang Province, PRC. The
      June
      Note Offering and November Note Offering are further described in “- Recent
      Developments - Sale of Notes and Warrants” above.





One
      additional way we expect to raise funds in the short term, is through the Offer
      we have made to our Warrantholders, as further described in “Recent Developments
      - Warrant Tender Offer” above. As of the date hereof, a limited number of
      Warrantholders have elected to tender their warrants. However, since any
      Warrantholder may change its election and withdraw from the Offer, the funds
      related to such transactions are being held in escrow, and will not be released
      to us until November 21, 2008, the expiration date of the Offer, unless we
      sooner extend or terminate the period of time during which the Offer is open.
      If
      all of the Warrantholders exercise their warrants in connection with the Offer,
      we will raise an aggregate of $16,929,805.





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





In
      addition to constructing our new production facility, we have purchased an
      office building located in Heilonjiang Province, PRC, for approximately $1.8
      million, which will serve as our corporate headquarters. The balance of
      approximately $0.7 million was paid in the third quarter out of our retained
      earnings.





Currently,
      we spend about 8% - 12% of total revenues on advertising and promotional plans
      through out the year. We spent approximately $3.0 million, $1.9 million and
      $0.8
      million on advertising and promotion in fiscal 2007, 2006 and 2005,
      respectively. We plan to increase spending on advertising and promotion to
      an
      aggregate of between $4.0 million and $5.0 million in fiscal 2008. This will
      still fall within our standard budget for advertising and promotion of 8% -
      12%
      of total revenues. The funds for advertising and promotion will generally come
      out of our earnings.





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





***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.





40


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





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





As
      of
      September 30, 2008, there were accrued liquidated damages of $1,116,498. We
      have
      not yet paid out any of the accrued liquidated damages, which are payable in
      cash or shares of our common stock, or a combination thereof, at our sole
      discretion. Additionally, we will accrue $4,500 per day in liquidated damages
      until such time as the requirements described above have been
      satisfied.





***Share
      Repurchase and Put/Call Agreements***





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





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





·
            Either
                (i) a registration statement (“Registration Statement”) covering the
                resale of the Put/Call Shares has been declared effective by the
                Commission, and has been kept continuously effective by us, or (ii)
                all of
                the Put/Call Shares are freely tradable without registration pursuant
                to
                Rule 144; and




41


·
            The
                closing price of a share of our Common Stock as traded on the
                Over-the-Counter Bulletin Board (or such other exchange or stock
                market on
                which the Common Stock may then be listed or quoted) equals or exceeds
                $4.08 (appropriately adjusted for any stock split, reverse stock
                split,
                stock dividend or other reclassification or combination of the Common
                Stock occurring after the date hereof) for at least ten (10) consecutive
                trading days immediately preceding the date that the Call Option
                Exercise
                Notice is given by us.




We
      may
      only exercise our Call Option by delivering a written notice (a “Call Option
      Exercise Notice”) to the Put/Call Shareholders within thirty (30) days of such
      time as all of the Call Option Conditions have been met. The Call Option may
      be
      exercised for all, but not less than all, of the Put/Call Shares. The repurchase
      shall be consummated within ninety (90) days following the date of the Call
      Option Exercise Notice.




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





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




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




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




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





The
      Put/Call Shareholders shall exercise their Put Right by giving written notice
      (“Put Exercise Notice”) of their exercise of the Put Right to us within thirty
      (30) days of a Put Right Trigger. The Put/Call Shareholders may only exercise
      their Put Right as to all, but not less than all, of the Put/Call Shares. Upon
      exercise of the Put Right by the Put/Call Shareholders, our repurchase of the
      Put/Call Shares shall be consummated within ninety (90) days following the
      date
      of the Put Exercise Notice.





42


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





***Warrants***





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





Warrant
      W-1 represents the right to purchase 266,667 shares of our Common Stock, at
      an
      exercise price of $0.94 per share. Warrant No. W-1 will expire on October 9,
      2010. Warrant W-1 is exercisable for cash only, provided a registration
      statement covering the shares of Common Stock underlying Warrant W-1 is
      effective. The number of shares of our Common Stock to be deliverable upon
      exercise of Warrant W-1 will be subject to adjustment for, among other things,
      subdivision or consolidation of shares, rights or warrants issues, dividend
      distributions, stock dividends, bonus issues, asset distributions, and other
      standard dilutive events. Warrants to purchase an aggregate of 106,667 shares
      of
      our Common Stock issued to a finder, have terms and conditions identical to
      the
      those of Warrant W-1.





Warrant
      W-2 represents the right to purchase 1,333,333 shares of our Common Stock,
      at an
      exercise price of $1.50 per share. Warrant W-2 will expire on October 9, 2009.
      Warrant W-2 is exercisable for cash only, provided a registration statement
      covering the shares of Common Stock underlying the Warrant W-2 is effective.
      The
      number of shares of our Common Stock to be deliverable upon exercise of Warrant
      W-2 will be subject to adjustment for, among other things, subdivision or
      consolidation of shares, rights or warrants issues, dividend distributions,
      stock dividends, bonus issues, asset distributions, and other standard dilutive
      events. At anytime one year following the date a registration statement covering
      the shares of Common Stock underlying the Warrant W-2 is declared effective,
      we
      will have the ability to call the Warrant W-2 at a price of $0.01 per warrant,
      upon thirty (30) days prior written notice to the holders of the warrants,
      if
      the closing price of the Common Stock exceeded $1.88 for each of the ten (10)
      consecutive trading days immediately preceding the date that the call notice
      is
      given by us.





Our
      Class
      A Warrants represent the right to purchase an aggregate of 981,591 shares of
      our
      Common Stock, at an exercise price of $2.04 per share. The Class A Warrants
      will
      expire on the three-year anniversary of their date of issuance. The Class A
      Warrants will be exercisable for cash only, provided a registration statement
      covering the shares of Common Stock underlying the Class A Warrants is
      effective. The number of shares of Common Stock to be deliverable upon exercise
      of the Class A Warrants will be subject to adjustment for, among other things,
      subdivision or consolidation of shares, rights or warrants issues, dividend
      distributions, stock dividends, bonus issues, asset distributions, and other
      standard dilutive events. Warrants to purchase 392,639 shares of our Common
      Stock issued to finders and placement agents, have terms and conditions
      identical to the those of the Class A Warrants.





The
      Class
      B Warrants represent the right to purchase an aggregate of 4,907,973 shares
      of
      our Common Stock, at an exercise price of $3.26 per share. The Class B Warrants
      will expire on the two-year anniversary of their date of issuance. The Class
      B
      Warrants will be exercisable for cash only, provided a registration statement
      covering the shares of Common Stock underlying the Class B Warrants is
      effective. The number of shares of Common Stock to be deliverable upon exercise
      of the Class B Warrants will be subject to adjustment for, among other things,
      subdivision or consolidation of shares, rights or warrants issues, dividend
      distributions, stock dividends, bonus issues, asset distributions, and other
      standard dilutive events. At anytime one year following the date a registration
      statement covering the shares of Common Stock underlying the Class B Warrants
      is
      declared effective, we will have the ability to call the Class B Warrants at
      a
      price of $0.01 per Class B Warrant, upon thirty (30) days prior written notice
      to the holders of the Class B Warrants, if the closing price of the Common
      Stock
      exceeded $4.08 for each of the ten (10) consecutive trading days immediately
      preceding the date that the call notice is given by us.





43


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





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





In
      June
      2008 we closed the June Note Offering, pursuant to which we granted the June
      Warrants. In November 2008 we closed the November Note Offering, pursuant to
      which we granted the November Warrants. The June Note Offering and November
      Note
      Offering are further described in “Recent Developments - Sale of Notes and
      Warrants” above. The June Warrants and November Warrants (collectively, the New
      Warrants”) represent the right to purchase an aggregate of 275,000 shares of our
      Common Stock, at an exercise price of $2.61 per share. The New Warrants will
      expire three years after the date of issuance. The New Warrants may be exercised
      for cash only. The number of shares of our Common Stock deliverable upon
      exercise of the New Warrants will be subject to adjustment for, among other
      things, subdivision or consolidation of shares, and certain other standard
      dilutive events. A holder of the New Warrants will not be entitled to exercise
      a
      number of New Warrants in excess of the number of New Warrants upon exercise
      of
      which would result in beneficial ownership by such holder and his, her or its
      affiliates of more than 9.9% of the outstanding shares of our Common Stock,
      unless this provision is waived by written agreement between us and the holder
      not less than ninety-one (61) days from the date of such waiver. Warrants to
      purchase an aggregate of 70,000 shares of our Common Stock issued to a placement
      agent in connection with the June Note Offering and November Note Offering,
      have
      terms and conditions identical to the those of the New Warrants.





44


***Promissory
      Notes***





In
      the
      June Note Offering, further described in “- Recent Developments - Sale of Notes
      and Warrants” above, we also issued the 8% Notes. The 8% Notes will bear
      interest at a rate of 8% until they become due and payable on December 31,
      2008.
      Any amount of principal or interest which is not paid when due will bear
      interest at a rate of 12%. We may prepay the entire amount due under the 8%
      Notes at any time without penalty, upon 15 days prior written notice. Each
      holder of the 8% Notes has the right to be prepaid any amounts due under his,
      her or its 8% 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 8% Notes, there are limitations on our ability to: (a)
      pay
      dividends or make other distributions on its capital stock; (b) redeem,
      repurchase or otherwise acquire any of its securities; (c) create, incur or
      assume any liability for borrowed money; (d) sell, lease or otherwise dispose
      of
      any significant portion of its assets; (e) lend money, give credit or make
      advances; or (f) assume, guarantee, endorse, contingently agree to purchase
      or
      otherwise become liable upon the obligation of any other person or entity.
      It
      shall be deemed an “Event of Default” under each 8% Note if: (a) we fail to pay
      principal or interest when due on the 8% Note; (b) we breach any material
      covenant or other material term or condition contained in the 8% 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 8% 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 ninety (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 an 8% Note, unless such Event of Default shall have been waived
      in writing by the holder, the holder may consider the 8% 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 8% 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 10% Note. The 10% Note will bear
      interest at a rate of 10% until they become 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 10%
      Note at any time without penalty, upon 15 days prior written notice. The holder
      of the 10% Note has the right to be prepaid any amounts due under his 10% 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
      10%
      Note, there are limitations on our ability to: (a) pay dividends or make other
      distributions on its capital stock; (b) redeem, repurchase or otherwise acquire
      any of its securities; (c) 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 10% Note if: (a) we fail to pay principal or
      interest when due on the 10% Note; (b) we breach any material covenant or other
      material term or condition contained in the 10% 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 10% 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 ninety (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 10% Note, unless such Event of Default shall have been
      waived in writing by the holder, the holder may consider the 10% 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.





45


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





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





**Transactions
      with Related Parties**





***Purchase
      of Assets from Chief Executive Officer***





On
      May
      28, 2006, American International Dairy Holding Co., Inc. (“AIDH”), our
      wholly-owned subsidiary, purchased and obtained legal titles to machinery,
      facilities, housing and 100 cows from Yang Yong Shan, our President, Chief
      Executive Officer and director, in exchange for a promissory note in the amount
      of $209,305. The note does not bear interest and is due on demand. We believe
      this was an arms-length transaction, since the price paid for this property
      and
      equipment was approximately the same as the seller’s cost in these assets, and
      was approximately the same amount we would have had to pay to purchase similar
      assets from a third party.





**Dividends**





We
      have
      not paid any dividends. In all likelihood, we will use our earnings to develop
      our business and do not intend to declare dividends for the foreseeable future.
      Any decision to pay dividends on our Common Stock in the future will be made
      by
      our board of directors on the basis of earnings, financial requirements and
      other such conditions that may exist at that time. In addition, the 8% Notes
      we
      issued in the June Note Offering, further described in “- Recent Developments -
      Sale of Notes and Warrants” above, contain restrictive covenants on our payment
      of dividends, as further described in “- Liquidity and Capital Resources -
      Promissory Notes” above.





46


**Contractual
      Obligations and Commercial Commitments**





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





**Payments
                Due By Period****Contractual
                obligations**
            
            **Total**
            
            **Less than**
              **1 year**
            
            **1-3 years**
            
            **After**
              **3-5 years**
            
            **More than**
              **5 years**Equipment
                purchase
            
            $
            1,585,311
            
            $
            1,585,311Operating
                leases
            
            $
            29,052
            
            $
            29,052
            
            
            —
            
            
            —
            
            
            —**Total:**
            
            $
            1,614,363
            
            $
            1,614,363
            
            
            —
            
            
            —
            
            
            —





**Critical
      Accounting Policies and Estimates**





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





***Use
      of estimates***





The
      preparation of these consolidated financial statements in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make estimates and assumptions that affected the reported
      amounts of assets and liabilities and disclosure of contingent assets and
      liabilities at the dates of the consolidated financial statements and the
      reported amounts of net sales and expenses during the reported periods.





Significant
      estimates and assumptions by management including, among others, values and
      lives assigned to acquired intangible assets, reserves for customer returns
      and
      allowances, uncollectible accounts receivable, slow moving, obsolete and/or
      damaged inventory and stock warrant valuation. Actual results may differ from
      these estimates





***Cash
      and cash equivalents***





We
      consider all highly liquid debt instruments purchased with maturity period
      of
      three months or less to be cash equivalents. Substantially all of our cash
      is
      held in bank accounts in The Peoples Republic of China and is not protected
      by
      FDIC insurance or any other similar insurance. Accounts held at United States
      financial institutions are insured by the Federal Deposit Insurance Corporation
      up to $250,000. As of September 30, 2008, no U.S. balances are in excess of
      insured amounts.





47


***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.





***Foreign
      Currency***





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




Assets
      and liabilities denominated in foreign currencies at the balance sheet date
      are
      translated at the exchange rates prevailing at the balance sheet date. The
      registered equity capital denominated in the functional currency is translated
      at the historical rate of exchange at the time of capital contribution. All
      translation adjustments resulting from the translation of the financial
      statements into the reporting currency (“US Dollars”) are dealt with as a
      separate component within stockholders’ equity. Translation adjustments net of
      tax totaled $171,146 and $1,078,852, for the three and nine months ended
      September 30, 2008, respectively. Translation adjustments totaled $109,072
      and
      $212,472 for the three and nine months ended September 30, 2007,
      respectively.





As
      of
      September 30, 2008 and 2007, the exchange rate was 6.8485 Yuan and 7.3 Yuan
      per
      U.S. Dollar, respectively.





***Revenue
      recognition***





Revenue
      is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue
      Recognition, which states that revenue should be recognized when the following
      criteria are met: (1) persuasive evidence of an arrangement exists; (2) the
      service has been rendered; (3) the selling price is fixed or determinable;
      and
      (4) collection of the resulting receivable is reasonably assured.





Interest
      income is recognized when earned, taking into account the average principal
      amounts outstanding and the interest rates applicable.





As
      of
      September 30, 2008, we had no sales or contracts that included multiple
      deliverables that would fall under the scope of EITF 00-21, “Revenue
      Arrangements with Multiple Deliverables.”





***Shipping
      and handling costs***





Shipping
      and handling costs are billed to the customer in sales transactions and are
      reported in sales. Costs incurred by us for shipping and handling are included
      in costs of goods sold.





***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.





48


***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 our subsidiary has been receiving expires. 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 Enterprises at a rate of 15%
      of
      their taxable income. Preferential tax treatment may, however, be granted
      pursuant to any law or regulations from time to time promulgated by the State
      Council. XAL enjoyed a 100% exemption from enterprise income taxes starting
      on
      January 10, 2006 due to its classification as a “Wholly Foreign Owned
      Enterprise.” On March 16, 2007, The People’s Republic of China enacted a new
      Enterprise Income Tax Law for the purpose of unifying the tax treatment of
      domestic and foreign enterprises. This new law eliminates the preferential
      tax
      treatment for new Wholly Foreign Owned Enterprises but allows previously granted
      exemptions to stay in place through 2012, with the exception that the statutory
      tax rate will increase by 2% per year from 15% in 2006 to 25% by 2012. This
      exemption ended on January 10, 2008, at which time XAL will qualify under the
      current tax structure for a 50% reduction in the statutory enterprise income
      tax
      rates for an additional three years.





***Freestanding
      Financial Instruments with Characteristics of Both Liabilities and
      Equity***





In
      accordance with SFAS 150, “ *Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and
      Equity* ,”
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.





49


***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. Under SFAS No. 123R, we must
      determine the appropriate fair value model to be used for valuing share-based
      payments, the amortization method for compensation cost and the transition
      method to be used at date of adoption. The transition methods include
      prospective and retroactive adoption options. Under the retroactive option,
      prior periods may be restated either as of the beginning of the year of adoption
      or for all periods presented. The prospective method requires that compensation
      expense be recorded for all unvested stock options and restricted stock at
      the
      beginning of the first quarter of adoption of SFAS No. 123R, while the
      retroactive methods would record compensation expense for all unvested stock
      options and restricted stock beginning with the first period restated. We have
      adopted the requirements of SFAS No. 123R for the fiscal year beginning on
      January 1, 2006.





***Fair
      value of financial instruments***





The
      carrying amounts of certain financial instruments, including cash, accounts
      receivable, other receivables, accounts payable, commercial notes payable,
      and
      accrued expenses approximate their fair values as of September 30, 2008 and
      December 31, 2007 because of the relatively short-term maturity of these
      instruments.




**Recently
      Issued Accounting Pronouncements**





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





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





50


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





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




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




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. The guidance in SFAS 161 is effective for financial statements
      issued for fiscal years and interim periods beginning after November 15, 2008,
      with early application encouraged. This Statement encourages, but does not
      require, comparative disclosures for earlier periods at initial adoption. We
      are
      currently assessing the impact of SFAS 161.





In
      May
      2008, the FASB issued SFAS 162, *The
      Hierarchy of Generally Accepted Accounting Principles* (SFAS
      162). SFAS 162 is intended to improve financial reporting by identifying a
      consistent framework, or hierarchy, for selecting accounting principles to
      be
      used in the preparation of financial statements of nongovernmental entities
      that
      are presented in conformity with U.S. generally accepted accounting principles
      (GAAP). SFAS 162 directs the GAAP hierarchy to the entity, not the independent
      auditors, as the entity is responsible for selecting accounting principles
      for
      financial statements that are presented in conformity with GAAP. SFAS 162 is
      effective 60 days following the Securities and Exchange Commission's approval
      of
      the Public Company Accounting Oversight Board amendments to remove the GAAP
      hierarchy from the auditing standards. We do not expect SFAS 162 to have a
      material impact on its future consolidated results of operations or its
      financial position.




In
      June
      2008, the Emerging Issues Task Force (EITF) reached a final consensus on EITF
      Issue 08-4, *Transition
      Guidance for Conforming Changes to Issue No. 98-5* .
      Certain
      conclusions reached in EITF Issue No. 98-5, “Accounting for Convertible
      Securities with Beneficial Conversion Features or Contingently Adjustable
      Conversion Ratios,” were nullified in EITF Issue No. 00-27, “Application of
      Issue No. 98-5 to Certain Convertible Instruments.” Moreover, some of the
      conclusions in Issue No. 98-5 and Issue No. 00-27 were superseded by SFAS No.
      150 , *Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and
      Equity* .
      While
      the conclusions reached in Issue No. 98-5 were subsequently updated to reflect
      the issuance of Issue No. 00-27 and SFAS No. 150, the transition guidance in
      Issue No. 98-5 was not revised. The EITF reached a consensus on Issue No. 08-4,
      which provides such guidance and requires that (1) conforming changes made
      to
      Issue No. 98-5 resulting from Issue No. 00-27 and SFAS No. 150 be effective
      for
      financial statements of fiscal years ending after December 15, 2008, with early
      application allowed, and (2) the effect of applying the conforming changes
      be
      presented retrospectively (with the cumulative effect of the change reported
      in
      retained earnings as of the beginning of the first period presented). We are
      currently assessing the impact of EITF Issue 08-4.





51


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. EITF 07-5 is effective
      for
      financial statements issued for fiscal years beginning after December 15, 2008,
      and interim periods within those fiscal years. We are currently assessing the
      impact of EITF 07-5.





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). FSP
      No.
      EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008
      (and
      for interim periods within such years). We are currently assessing the impact
      of
      FSP No. FAS 157-3.





In
      October 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-3 , *Determining
      the Fair Value of a Financial Asset in a Market That Is Not
      Active* .
      The FSP
      amends Statement of Financial Accounting Standards (SFAS) No. 157 , Fair Value
      Measurements, by clarifying the application of SFAS No. 157 when the market
      for
      a financial asset is inactive. Specifically, the FSP clarifies how (1)
      management's internal assumptions should be considered in measuring fair value
      when observable data are not present, (2) observable market information from
      an
      inactive market should be taken into account, and (3) the use of broker quotes
      or pricing services should be considered in assessing the relevance of
      observable and unobservable data to measure fair value. The guidance in FSP
      No.
      FAS 157-3 is effective immediately and applies as well to prior periods for
      which financial statements have not been issued. We are currently assessing
      the
      impact of FSP No. FAS 157-3.





**Off-Balance
      Sheet Arrangements**





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





52


**Item
      3. Quantitative and Qualitative Disclosures about Market
      Risk**





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





**Item
      4T. Controls and Procedures.**





**Disclosure
      Controls and Procedures**





We
      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 SEC's rules and forms, and
      that such information is accumulated and communicated to our management,
      including our president (also our principal executive officer) and our chief
      financial officer (also our principal financial and accounting officer) to
      allow
      for timely decisions regarding required disclosure.





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





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




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




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




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




As
      a
      result of the transactions, there was a change in control of the filing company,
      as the stockholders of AIDH became the majority stockholders the filing company.
      For accounting purposes, the transaction was accounted for as a reverse
      acquisition under the purchase method. Accordingly, AIDH and its subsidiary
      are
      treated as the continuing entity for accounting purposes.





Therefore,
      we have only recently become subject to the laws related to reporting companies,
      including the Sarbanes-Oxley Act of 2002, as amended. Our management is
      currently carrying out an evaluation, 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), of
      the
      effectiveness of the design and operation of our disclosure controls and
      procedures, in order to conclude if our disclosure controls and procedures
      are
      effective.





53


**Management’s
      Report on Internal Control over Financial Reporting**





Section
      404(a) of the Sarbanes-Oxley Act of 2002 required that management document
      and
      test our internal control over financial reporting and include in our annual
      report on Form 10-KSB, for the fiscal year ended December 31, 2007, a report
      on
      management’s assessment of the effectiveness of our internal control over
      financial reporting.





Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting (as defined in Rule 13a-15(f) under the
      Securities Exchange Act, as amended). In fulfilling this responsibility,
      estimates and judgments by management are required to assess the expected
      benefits and related costs of control procedures. The objectives of internal
      control include providing management with reasonable, but not absolute,
      assurance that assets are safeguarded against loss from unauthorized use or
      disposition, and that transactions are executed in accordance with management’s
      authorization and recorded properly to permit the preparation of consolidated
      financial statements in conformity with accounting principles generally accepted
      in the USA. For the reasons described in “Management’s Report on Disclosure
      Controls and Procedures” above, our management is still in the process of
      assessing the effectiveness of our internal control over financial reporting.
      In
      making this assessment, our management is using the criteria set forth by the
      Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in
      Internal Control-Integrated Framework. Our management will shortly conclude
      whether our internal control over financial reporting is effective in providing
      reasonable assurance regarding the reliability of financial reporting and the
      preparation of financial statements for external purposes in accordance with
      US
      generally accepted accounting principles. Upon such conclusion, our management
      will review the results of their assessment with our Board of
      Directors.





In
      connection with the audit of the fiscal year ended December 31, 2007, Windes
      & McClaughry Accountancy Corporation (“Windes”), our independent registered
      public accounting firm, noted matters involving our internal controls that
      it
      considered to be significant deficiencies, and taken together constitute a
      material weakness, under the standards of the Public Company Accounting
      Oversight Board, or PCAOB. Under the PCAOB standards, a material weakness is
      a
      significant deficiency, or combination of significant deficiencies, that, in
      Windes’s judgment, results in more than a remote likelihood that a material
      misstatement of the annual or interim financial statements will not be prevented
      or detected. The material weaknesses identified by Windes were as
      follows:





·
            Improper
                treatment of the effects of exchange rate changes on cash balances
                held in
                foreign currencies in the 2006 statement 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 remediation efforts to ensure that the significant
      deficiencies do not reoccur, including:





·
            Hiring
                of outside consultants to assist with the preparation of our financial
                statements; and




·
            Implementation
                of review and analysis processes for all significant contractual
                and other
                liabilities.




In
      addition, we are in the process of implementing a new revenue accounting system,
      which we recently purchased, that we believe will enable us to record and report
      revenue as required to support our preparation of timely and accurate financial
      statements.





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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. In particular, we
      will incur significant expenses in implementing a new revenue accounting system,
      including software license fees as well as fees of third-party consultants
      and
      employment-related expenses attributable to additional internal staffing. We
      are
      currently unable to estimate with reasonable certainty the anticipated costs
      associated with our remediation efforts.





Our
      failure to remediate the material weakness identified as of December 31, 2007,
      or the identification in the future of other material weaknesses in our internal
      control over financial reporting may adversely affect our ability to report
      financial information, including the filing of our quarterly or annual reports
      with the SEC, on a timely and accurate basis and, in particular, may impair
      our
      ability to comply with Section 404 of the Sarbanes-Oxley Act. If we are unable
      to comply with Section 404 or otherwise to produce accurate and timely financial
      statements, our stock price may be adversely affected and we may be unable
      to
      maintain compliance with SEC requirements.





Except
      as
      described above, there were no changes in our internal **** control
      over financial reporting in connection with our evaluation that
      occurred **** during
      our last fiscal year that materially affected, or is reasonable likely
      to **** materially
      affect, our internal control over financial reporting.




55


**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 September 30, 2008, and subsequent period through
      the
      date hereof, we did not consummate any unregistered sales of equity securities,
      except as follows:





**Sales
      of Notes and Warrants**





On
      November 10, 2008, we sold to one “accredited investor” (the “Purchaser”) for
      a
      purchase price of $500,000, a
      10%
      promissory note (the “10% 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 10% Note are further described in “Part I. Item
      2. Management’s Discussion and Analysis of Financial Condition and Results of
      Operations - Liquidity and Capital Resources - Promissory Notes” above. The
      rights and obligations under the November Warrants are further described in
      “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and
      Results of Operations - Liquidity and Capital Resources - Warrants”
above.





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





We
      have
      granted the Purchaser and Placement Agent “piggyback” registration rights with
      respect to the shares of Common Stock underlying the warrants they received
      in
      connection with the November Note Offering.





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





**Item
      3. Defaults Upon Senior Securities.**





In
      the
      three-month period ended September 30, 2008, and subsequent period through
      the
      date hereof, we did not default upon any senior securities.





56


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





In
      the
      three-month period ended September 30, 2008, and subsequent period through
      the
      date hereof, the we did not submit any matters to a vote of our security
      holders, except as follows:





**Written
      Consent to Borrowing**





Our
      outstanding 8% promissory notes (the “8% Notes”), in the aggregate principal
      amount of $2,250,000, contain a restrictive covenant requiring that, so long
      as
      we have any obligation under the 8% Notes, we need to obtain written consent
      of
      the holders (the “8% Note Holders”) to, among other things, incur any additional
      liability for borrowed money, with certain exceptions. Therefore, as of November
      10, 2008, we obtained the written consent of both of the 8% Note Holders to
      sell
      and issue a 10% promissory note to one purchaser, in the principal amount of
      $500,000.





Reference
      is made to the disclosure set forth under “Part II, Item 2. Unregistered Sales
      of Equity Securities and Use of Proceeds - Sales of Notes and Warrants” above,
      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 September 30, 2008, or subsequent period through the
      date hereof, which was not so reported, except as follows:





**Sale
      of Notes and Warrants**





On
      November 10, 2008, we sold to one “accredited investor” (the “Purchaser”) for
      a
      purchase price of $500,000, a
      10%
      promissory note (the “10% 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 10% Note are further described in “Part I. Item
      2. Management’s Discussion and Analysis of Financial Condition and Results of
      Operations - Liquidity and Capital Resources - Promissory Notes” above. The
      rights and obligations under the November Warrants are further described in
      “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and
      Results of Operations - Liquidity and Capital Resources - Warrants”
above.





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





We
      have
      granted the Purchaser and Placement Agent “piggyback” registration rights with
      respect to the shares of Common Stock underlying the warrants they received
      in
      connection with the November Note Offering.





57


**Item
      6.**  **Exhibits**





**Exhibit No.**
            
            **Description
                of Exhibit**4.1
            
            Form
                of 10% Promissory Note — filed herewith4.2
            
            Form
                of Warrant — filed herewith10.1
            
            Form
                of Securities Purchase Agreement — filed herewith31.1
            
            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




58


**SIGNATURES**




Pursuant
      to the requirements of Section 13 or 15(d) 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:
                November 14, 2008
            By:
            /s/
                Yang Yong ShanYang
                Yong Shan
              Chairman,
                Chief Executive Officer andPresident


**COMPANY
              NAME CORPORATION**Dated:
                November 14, 2008
            By:
            /s/
                Shu KanekoShu
                Kaneko
              Chief
                Financial Officer and Secretary




59