UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM 10-Q





(Mark
One)





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





For
      the quarterly period ended
            September 30,
  2010





or





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





For the
transition period from __________________________________ to
_________________________________





Commission
      File Number:
            000-52174




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





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





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





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




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


xYes      ̈No





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


 ̈Yes      ̈No





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





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





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


 ̈Yes     x No





The
registrant had 34,032,131 shares of common stock issued and outstanding as of
November 1, 2010 (not including an additional 1,944,444 shares of common stock
of the registrant currently being held in treasury).









QUARTERLY
REPORT ON FORM 10-Q
 OF
EMERALD DAIRY INC. AND SUBSIDIARIES
 FOR
THE PERIOD ENDED SEPTEMBER 30, 2010
 
 TABLE
OF CONTENTS
 
 PAGEPART I
                                          -
                                          FINANCIAL
      INFORMATIONItem
      1.
                                          
                                          Financial
      Statements
                                          
                                          1Condensed
      Consolidated Balance Sheets as of September 30, 2010 (unaudited) and
      December 31, 2009
                                          
                                          1Condensed
      Consolidated Statements of Income for the Three and Nine Months Ended
      September 30, 2010 and 2009 (unaudited)
                                          
                                          2Condensed
      Consolidated Statements of Cash Flows for the Nine Months Ended September
      30, 2010 and 2009 (unaudited)
                                          
                                          3Notes
      to Condensed Consolidated Financial Statements (unaudited)
                                          
                                          4Item
      2.
                                          
                                          Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                          
                                          23Item
      3.
                                          
                                          Quantitative
      and Qualitative Disclosures About Market Risk
                                          
                                          43Item
      4.
                                          
                                          Controls
      and Procedures
                                          
                                          43PART II
                                          -
                                          OTHER
      INFORMATIONItem
      1.
                                          
                                          Legal
      Proceedings
                                          
                                          45Item
      1A.
                                          
                                          Risk
      Factors
                                          
                                          45Item
      2.
                                          
                                          Unregistered
      Sales of Equity Securities and Use of Proceeds
                                          
                                          45Item
      3.
                                          
                                          Defaults
      Upon Senior Securities
                                          
                                          45Item
      4.
                                          
                                          (Removed
      and Reserved)
                                          
                                          45Item
      5.
                                          
                                          Other
      Information
                                          
                                          45Item
      6.
                                          
                                          Exhibits
                                          
                                          46Signatures
                                          
                                          47
  i
  PART
I. FINANCIAL INFORMATION
 
 Item
      1.
              Financial
      Statements.
 
 Emerald
Dairy Inc. and Subsidiaries
 Condensed
Consolidated Balance Sheets
 September
30, 2010 and December 31, 2009
 
 September
      30,
                                        
                                        
                                        December
      31,2010
                                        
                                        
                                        2009(Unaudited)ASSETSCurrent
      AssetsCash
      and cash equivalents
                                        
                                        $
                                        14,559,414
                                        
                                        
                                        $
                                        13,486,429Trade
      accounts receivable,net
                                        
                                        
                                        6,567,168
                                        
                                        
                                        
                                        7,223,016Inventory,
      net
                                        
                                        
                                        1,624,509
                                        
                                        
                                        
                                        1,298,488Advances
      to equipment supplier
                                        
                                        
                                        10,033,849
                                        
                                        
                                        
                                        3,710,707Other
      current assets
                                        
                                        
                                        2,914,909
                                        
                                        
                                        
                                        1,292,749Total
      current assets
                                        
                                        
                                        35,699,849
                                        
                                        
                                        
                                        27,011,389Property,
      plant and equipmentProperty,
      plant and equipment, net
                                        
                                        
                                        5,759,821
                                        
                                        
                                        
                                        5,946,330Contruction
      in progress
                                        
                                        
                                        14,900,348
                                        
                                        
                                        
                                        8,772,93120,660,169
                                        
                                        
                                        
                                        14,719,261Intangible
      assets, net
                                        
                                        
                                        1,339,817
                                        
                                        
                                        
                                        1,341,534$
                                        57,699,835
                                        
                                        
                                        $
                                        43,072,184LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
                                        
                                        $
                                        3,750,273
                                        
                                        
                                        $
                                        2,917,798Notes
      payable, net of debt discount of $171,755 and $729,830 atSeptember
      30, 2010 and December 31, 2009, respectively
                                        
                                        
                                        5,844,656
                                        
                                        
                                        
                                        5,843,472Other
      current liabilities
                                        
                                        
                                        391,337
                                        
                                        
                                        
                                        704,056Current
      portion of long-term lease
                                        
                                        
                                        1,080,770
                                        
                                        
                                        
                                        -Loan
      from shareholder
                                        
                                        
                                        214,397
                                        
                                        
                                        
                                        210,142Total
      current liabilities
                                        
                                        
                                        11,281,433
                                        
                                        
                                        
                                        9,675,468Long-term
      lease payable
                                        
                                        
                                        2,754,828
                                        
                                        
                                        
                                        -Commitments
      and Contingencies (Note 19)Stockholders'
      EquityPreferred
      stock ($0.001 par value, 10,000,000 shares authorized, noneissued
      and outstanding at September 30, 2010 and December 31,
      2009)
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Common
      stock ($0.001 par value, 100,000,000 shares authorized,35,976,575
      and 34,890,267 issued and outstanding at September 30, 2010December 31,
      2009, respectively)
                                        
                                        
                                        35,977
                                        
                                        
                                        
                                        34,890Treasury
      Stock (1,944,444 shares at September 30, 2010 andDecember 31,
      2009, respectively)
                                        
                                        
                                        (1,944
                                        )
                                        
                                        
                                        (1,944
                                        )Additional
      paid-in capital
                                        
                                        
                                        25,862,219
                                        
                                        
                                        
                                        17,003,093Retained
      earnings (of which $3,191,614 and $1,834,742 are restricted atSeptember 30, 2010 and December 31, 2009, respectively, for
      commonwelfare reserves)
                                        
                                        
                                        14,777,814
                                        
                                        
                                        
                                        14,318,425Accumulated
      other comprehensive income
                                        
                                        
                                        2,989,508
                                        
                                        
                                        
                                        2,042,252Total
      stockholders' equity
                                        
                                        
                                        43,663,574
                                        
                                        
                                        
                                        33,396,716$
                                        57,699,835
                                        
                                        
                                        $
                                        43,072,184
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  1
 
 Emerald
Dairy Inc. and Subsidiaries
 Condensed
Consolidated Statements of Income
 For
the Three and Nine Months Ended September 30, 2010 and 2009
 
 Three months ended
                          
                          
                          Nine months endedSeptember 30,
                          
                          
                          September 30,
                          
                          
                          September 30,
                          
                          
                          September 30,2010
                          
                          
                          2009
                          
                          
                          2010
                          
                          
                          2009Sales
                          
                          $
                          12,897,019
                          
                          
                          $
                          10,158,004
                          
                          
                          $
                          40,459,377
                          
                          
                          $
                          31,261,491Cost
      of Goods Sold
                          
                          
                          6,408,452
                          
                          
                          
                          5,569,598
                          
                          
                          
                          20,356,931
                          
                          
                          
                          17,057,583Gross
      Profit
                          
                          
                          6,488,567
                          
                          
                          
                          4,588,406
                          
                          
                          
                          20,102,446
                          
                          
                          
                          14,203,908Operating
      ExpensesSelling
      expenses and administrative expenses
                          
                          
                          3,999,971
                          
                          
                          
                          3,348,522
                          
                          
                          
                          11,906,641
                          
                          
                          
                          9,448,920Liquidated
      damages
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          5,021,669
                          
                          
                          
                          -Depreciation
      and amortization
                          
                          
                          51,404
                          
                          
                          
                          43,595
                          
                          
                          
                          154,356
                          
                          
                          
                          130,107Total
      operating expenses
                          
                          
                          4,051,375
                          
                          
                          
                          3,392,117
                          
                          
                          
                          17,082,666
                          
                          
                          
                          9,579,027Other
      Income (Expense)Interest
      income
                          
                          
                          1,418
                          
                          
                          
                          1,277
                          
                          
                          
                          3,553
                          
                          
                          
                          4,421Interest
      expense
                          
                          
                          (555,257
                          )
                          
                          
                          (67,887
                          )
                          
                          
                          (1,339,936
                          )
                          
                          
                          (67,887
                          )Total
      other income (expense)
                          
                          
                          (553,839
                          )
                          
                          
                          (66,610
                          )
                          
                          
                          (1,336,383
                          )
                          
                          
                          (63,466
                          )Net
      Income Before Provision for Income Tax
                          
                          
                          1,883,353
                          
                          
                          
                          1,129,679
                          
                          
                          
                          1,683,397
                          
                          
                          
                          4,561,415Provision
      for Income TaxesCurrent
                          
                          
                          411,266
                          
                          
                          
                          245,054
                          
                          
                          
                          1,224,008
                          
                          
                          
                          860,948411,266
                          
                          
                          
                          245,054
                          
                          
                          
                          1,224,008
                          
                          
                          
                          860,948Net
      Income
                          
                          $
                          1,472,087
                          
                          
                          $
                          884,625
                          
                          
                          $
                          459,389
                          
                          
                          $
                          3,700,467Basic
      Earnings Per Share
                          
                          $
                          0.04
                          
                          
                          $
                          0.03
                          
                          
                          $
                          0.01
                          
                          
                          $
                          0.12Basic
      Weighted  Average Shares Outstanding
                          
                          
                          34,020,324
                          
                          
                          
                          30,844,547
                          
                          
                          
                          33,643,729
                          
                          
                          
                          29,979,356Diluted
      Earnings Per Share
                          
                          $
                          0.04
                          
                          
                          $
                          0.03
                          
                          
                          $
                          0.01
                          
                          
                          $
                          0.12Diluted
      Weighted  Average Shares Outstanding
                          
                          
                          34,464,712
                          
                          
                          
                          31,631,381
                          
                          
                          
                          34,132,311
                          
                          
                          
                          30,429,024The
      Components of Other Comprehensive Income (Loss)Net
      Income
                          
                          $
                          1,472,087
                          
                          
                          $
                          884,625
                          
                          
                          $
                          459,389
                          
                          
                          $
                          3,700,467Foreign
      currency translation adjustment
                          
                          
                          977,589
                          
                          
                          
                          24,487
                          
                          
                          
                          1,431,900
                          
                          
                          
                          (14,933
                          )Income
      tax related to other comprehensive income
                          
                          
                          (332,380
                          )
                          
                          
                          (8,326
                          )
                          
                          
                          (486,846
                          )
                          
                          
                          5,077Comprehensive
      Income
                          
                          $
                          2,117,296
                          
                          
                          $
                          900,786
                          
                          
                          $
                          1,404,443
                          
                          
                          $
                          3,690,611
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  2
  Emerald
Dairy Inc. and Subsidiaries
 Condensed
Consolidated Statements of Cash Flows
 For
the Nine Months Ended September 30, 2010 and 2009
  2010
                            
                            
                            2009Cash
      flows from operating activitiesNet
      Income
                            
                            $
                            459,389
                            
                            
                            $
                            3,700,467Adjustments
      to reconcile net cash provided byoperating
      activitiesDepreciation
      and amortization
                            
                            
                            415,021
                            
                            
                            
                            400,227Amortization
      of loan discount
                            
                            
                            558,075
                            
                            
                            
                            65,916Capitalized
      interest
                            
                            
                            (763,495
                            )
                            
                            
                            (351,071
                            )Stock
      issued for services
                            
                            
                            34,657
                            
                            
                            
                            33,475Warrants
      modified for liquidated damages
                            
                            
                            5,021,669
                            
                            
                            
                            -Warrants
      modified for services
                            
                            
                            -
                            
                            
                            
                            3,975Warrants
      issued for services
                            
                            
                            915,097
                            
                            
                            
                            -Warrants
      issued for loan costs
                            
                            
                            79,991
                            
                            
                            
                            117,155Incentive
      stock options
                            
                            
                            385,891
                            
                            
                            
                            125,452Net
      change in assets and liabilitiesTrade
      accounts receivable
                            
                            
                            799,208
                            
                            
                            
                            (559,266
                            )Inventory
                            
                            
                            (300,249
                            )
                            
                            
                            (837,027
                            )Other
      current assets
                            
                            
                            (1,112,306
                            )
                            
                            
                            140,875Accounts
      payable and accrued expenses
                            
                            
                            1,024,764
                            
                            
                            
                            (424,925
                            )Other
      current liabilities
                            
                            
                            (326,693
                            )
                            
                            
                            (313,945
                            )Net
      cash provided by operating activities
                            
                            
                            7,191,019
                            
                            
                            
                            2,101,308Cash
      flows from investing activitiesDeposit
      on equipment and construction
                            
                            
                            (6,733,689
                            )
                            
                            
                            -Construction
      in progress
                            
                            
                            (5,189,800
                            )
                            
                            
                            -Purchases
      of fixed assets and intangibles
                            
                            
                            (82,097
                            )
                            
                            
                            (4,194,717
                            )Net
      cash used in investing activities
                            
                            
                            (12,005,586
                            )
                            
                            
                            (4,194,717
                            )Cash
      flows from financing activitiesAdvances
      on notes payable
                            
                            
                            800,000
                            
                            
                            
                            -Repayments
      of notes payable
                            
                            
                            (477,464
                            )
                            
                            
                            -Advances
      on sale-leaseback
                            
                            
                            5,090,026
                            
                            
                            
                            -Repayments
      of sale-leaseback
                            
                            
                            (257,555
                            )
                            
                            
                            -Exercise
      of warrants
                            
                            
                            296,408
                            
                            
                            
                            4,433,590Net
      cash provided by financing activities
                            
                            
                            5,451,415
                            
                            
                            
                            4,433,590Effect
      of exchange rate
                            
                            
                            436,137
                            
                            
                            
                            (2,762
                            )Net
      increase in cash
                            
                            
                            1,072,985
                            
                            
                            
                            2,337,419Cash
      and cash equivalents at beginning of period
                            
                            
                            13,486,429
                            
                            
                            
                            7,343,588Cash
      and cash equivalents at end of period
                            
                            $
                            14,559,414
                            
                            
                            $
                            9,681,007
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  3
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 
 1.
              Description of
      Business
 
 Emerald
Dairy, Inc. (“Company”), a Nevada corporation, is a producer of milk powder,
rice powder and soybean milk powder in the People’s Republic of China (“PRC”),
through its wholly owned subsidiaries. Through the Company’s network of over
1,100 salespeople, the Company’s products are distributed throughout 20
provinces in the PRC, and sold in over 6,000 retail outlets.
 
 The
Company’s subsidiary, American International Dairy Holdings, Inc. (“AIDH”), a
Nevada corporation, was formed in 2005 for the purpose of acquiring the stock in
Heilongjiang Xing An Ling Dairy, Co. (“XAL”), a corporation formed on September
8, 2003 in Heilongjiang Providence, pursuant to the laws of the PRC. XAL is a
dairy company engaged in manufacturing of milk powder, soybean powder and rice
powder. On May 30, 2005, AIDH acquired  XAL, pursuant to a Share
Transfer Agreement. This transaction was treated as a recapitalization of XAL
for financial reporting purposes. The effect of this recapitalization was rolled
back to the inception of XAL for financial reporting purposes.
  Prior to
September 23, 2006, XAL owned 57.69% of Heilongjiang Be’ian Nongken Changxing
LvBao Dairy Limited Liability Company (“LvBao”), with the remaining balance
being held by the Company’s sole shareholder. On September 23, 2006, the
remaining 42.31% ownership in LvBao was transferred to XAL and was treated as an
additional capital contribution. The effect of this contribution by the sole
shareholder was rolled back to September 8, 2003 for financial reporting
purposes. LvBao was formed on January 20, 2000 and is engaged in manufacturing
and sales of dairy products.
 
 On May
22, 2008, the Company formed a new wholly-owned subsidiary,
Hailun Xinganling Dairy Co., Ltd. (“HXD”), pursuant to the laws of the
PRC. In July 2008, HXD commenced construction of a production facility in
Hailun City, Heilongjiang Province, PRC. It is expected that the
construction and equipping of this new facility will be completed in the fourth
fiscal quarter of 2010. Upon completion, it is anticipated that HXD will engage
in the manufacture of the Company's milk powder, soybean powder and rice powder
products at this new facility.
 
 2.
              Basis of Preparation of Financial
      Statements
 
 XAL,
LvBao and HXD maintain their books and accounting records in Renminbi
(“RMB”).
 
 The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles 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, 2009 which are included in the Company’s Form 10-K/A for the year
ended December 31, 2009, filed with the Securities and Exchange Commission
(“SEC”) on April 1, 2010.
 
 In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (which include only normal
recurring adjustments) necessary to present fairly the consolidated balance
sheets of Emerald Dairy Inc. and subsidiaries as of September 30, 2010, and the
results of their operations for the three and nine months ended September 30,
2010 and 2009, and cash flows for the nine months ended September 30, 2010 and
2009. The results of operations for the three and nine months ended September
30, 2010 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” in Note 3).
  The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries, XAL, LvBao and HXD. All inter-company transactions
and balances have been eliminated in consolidation.
 4
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 3.
              Summary of Significant Accounting
      Policies
 
 Use of estimates - The
preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of net sales and expenses during the reported
periods.
 
 Significant
estimates and assumptions by management include, among others, values and lives
assigned to acquired intangible assets, reserves for customer returns and
allowances, uncollectible accounts receivable, slow moving, obsolete and/or
damaged inventory, deferred tax assets, property, plant and equipment, reserve
for employee benefit obligations, stock warrant valuation, income tax
uncertainties and other uncertainties. Actual results may differ from these
estimates.  The current economic environment has increased the degree
of uncertainty inherent in these estimates and assumptions.
 
 Cash and cash equivalents -Cash and cash equivalents represent cash on hand, demand deposits and all
highly liquid investments placed with banks or other financial institutions with
original maturities of three months or less. Substantially all of the Company’s
cash is held in bank accounts in the PRC and is not protected by 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, 2010, no U.S. balances are in excess of insured
amounts. Given the current economic environment and risks in the banking
industry, there is a risk that the deposits may not be readily available or
covered by such insurance.
 
 Trade accounts receivable -Trade accounts receivable are recorded at the invoiced amount and do not
bear interest. Amounts collected on trade accounts receivable are included in
net cash provided by operating activities in the consolidated statements of cash
flows. The Company maintains an allowance for doubtful accounts for estimated
losses inherent in its accounts receivable portfolio. In establishing the
required allowance, management considers historical losses, current receivables
aging, and existing industry and PRC economic data. The Company reviews its
allowance for doubtful accounts monthly. Past due balances over 90 days and over
a specified amount are reviewed individually for collectibility. Account
balances are charged off against the allowance after all means of collection
have been exhausted and the potential for recovery is considered remote. At
September 30, 2010 and December 31, 2009, there were no allowances for doubtful
accounts based on the review of the above factors. There were no write-off’s for
the three and nine months ended September 30, 2010 and 2009. The Company does
not have any off-balance sheet credit exposure related to its
customers.
 
 Construction-in-Progress -
Plant and production lines currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditure, professional fees and
the interest expenses capitalized during the course of construction for the
purpose of financing the project. Upon completion and readiness for use of the
project, the cost of construction-in-progress is to be transferred to fixed
assets, at which time depreciation will commence. As of September 30, 2010, the
Company has incurred and capitalized into construction-in-progress $13,494,302
of construction costs and $1,406,046 of capitalized interest for a balance of
$14,900,348.  As of December 31, 2009, the Company had incurred and
capitalized into construction-in-progress $8,130,380 of construction costs and
$642,551 of capitalized interest.  The estimated cost to be incurred
in 2010 to complete the project is approximately $500,000.
 
 
 5
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
  Capitalized Interest– The Company’s policy is to capitalize interest costs
on debt during the construction of major projects exceeding one
year.  A reconciliation of total interest cost to interest expense as
reported in the consolidated statements of income for three and nine months
ended September 30, 2010 and 2009 is as follows:
 Three Months
                  Ended September 30,
                
                
                Nine months
                  Ended September 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Interest
      cost capitalized
                
                $
                304,624
                
                
                $
                130,343
                
                
                $
                763,495
                
                
                $
                351,070Interest
      cost charged to income
                
                
                555,257
                
                
                
                67,877
                
                
                
                1,339,936
                
                
                
                67,877$
                859,881
                
                
                $
                198,220
                
                
                $
                2,103,431
                
                
                $
                418,947
  Foreign Currency- The
Company’s principal country of operations is the PRC. The financial position and
results of operations of the Company are determined using the local currency,
RMB, as the functional currency. The results of operations denominated in
foreign currency are translated at the average rate of exchange during the
reporting period.
  Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the exchange rates prevailing at the balance sheet date. The
registered equity capital denominated in the functional currency is translated
at the historical rate of exchange at the time of capital contribution. All
translation adjustments resulting from the translation of the financial
statements into the reporting currency (“U.S. Dollars”) are dealt with as a
separate component within stockholders’ equity. Translation adjustments net of
tax totaled $645,209 and $16,161, for the three months ended September 30, 2010
and 2009, respectively and $945,054 and $(9,856) for the nine months ended
September 30, 2010 and 2009, respectively.
 
 As of
September 30, 2010 and 2009, the exchange rate was 6.6915 RMB and 6.8263 RMB per
U.S. Dollar, respectively.
 
 Revenue recognition - Revenue
is recognized when the following criteria are met: (1) persuasive evidence
of an arrangement exists; (2) the service has been rendered; (3) the
selling price is fixed or determinable; and (4) collection of the resulting
receivable is reasonably assured.
 
 Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.
 
 As of
September 30, 2010, the Company has no sales or contracts that included multiple
deliverables that would fall under the accounting guidance.
 
 Earnings per share -Basic net
earnings per common share is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common shares outstanding
during the period. Diluted net earnings per common share is determined using the
weighted-average number of common share shares outstanding during the period,
adjusted for the dilutive effect of common stock equivalents, using the treasury
stock method, consisting of shares that might be issued upon exercise of common
stock warrants. In periods where losses are reported, the weighted-average
number of common shares outstanding excludes common stock equivalents, because
their inclusion would be anti-dilutive.
 
 Taxation - Taxation on
profits earned in the PRC has been calculated on the estimated assessable
profits for the year at the rates of taxation prevailing in the PRC in which the
Company operates after taking into effect the benefits from any special tax
credits or “tax holidays” allowed in the country of operations.
 
 The
Company accounts for income tax under accounting guidance that requires
recognition of deferred tax assets and liabilities for the expected future tax
consequences of the events that have been included in the financial statements
or tax returns. Deferred income taxes are recognized for all significant
temporary differences between tax and financial statements bases of assets and
liabilities. Valuation allowances are established against net deferred tax
assets when it is more likely than not that some portion or all of the deferred
tax asset will not be realized.
 
 6
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 The
Company does not have any long-term deferred tax assets or liabilities in the
PRC that will exist once the tax holiday (See Note 10) expires. The Company
does not have any significant deferred tax asset or liabilities that relate to
tax jurisdictions not covered by the tax holiday.
 
 The
Company does not accrue United States income tax on unremitted earnings from
foreign operations, as it is the Company’s intention to invest these earnings in
the foreign operations indefinitely.
 
 Enterprise income
tax
 
 Under the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the State Council which came into effect on
January 1, 1994, income tax is payable by a Wholly Foreign Owned Enterprises at
a rate of 15% of their taxable income. Preferential tax treatment may, however,
be granted pursuant to any law or regulations from time to time promulgated by
the State Council. XAL enjoyed a 100% exemption from enterprise income taxes
starting on January 10, 2006 due to its classification as a “Wholly Foreign
Owned Enterprise.” On March 16, 2007, the PRC enacted a new Enterprise Income
Tax Law for the purpose of unifying the tax treatment of domestic and foreign
enterprises. This new law eliminates the preferential tax treatment for new
Wholly Foreign Owned Enterprises but allows previously granted exemptions to
stay in place through 2012, with the exception that the statutory tax rate will
increase by 2% per year from 15% in 2006 to 25% by 2012. This exemption ended on
January 10, 2008, at which time XAL qualified under the current tax structure
for a 50% reduction in the statutory enterprise income tax rates for an
additional three years expiring in January 2011.
 
 Freestanding Financial Instruments
with Characteristics of Both Liabilities and Equity -The Company
accounts for financial instruments as a liability if it embodies an obligation
to repurchase the issuer’s equity shares, or is indexed to such an obligation,
and that requires or may require the issuer to settle the obligation by
transferring assets. Freestanding financial instruments are financial
instruments that are entered into separately and apart from any of the entity's
other financial instruments or equity transactions, or that is entered into in
conjunction with some other transaction and is legally detachable and separately
exercisable. The liability recorded is the per share price to be paid and is
offset to equity.
 
 Stock Based Compensation –The
Company has adopted accounting guidance which requires all share-based payments
to employees, including grants of employee stock options, to be recognized in
the financial statements based on the grant date fair value of the
award.
 
 Fair value of financial instruments -The Company applies the provisions accounting guidance that requires all
entities to disclose the fair value of financial instruments, both assets and
liabilities recognized and not recognized on the balance sheet, for which it is
practicable to estimate fair value.  The accounting guidance defines
fair value of a financial instrument as the amount at which the instrument could
be exchanged in a current transaction between willing parties.  As of
September 30, 2010 and December 31, 2009, the fair value of cash, trade accounts
receivable, other receivables, accounts payable, commercial notes payable, and
accrued expenses approximated carrying value due to the short maturity of the
instruments, quoted market prices, or interest rates, which fluctuate with
market rates.
 
 Fair Value Measurements– On
January 1, 2008, the Company adopted accounting guidance that establishes a
framework for measuring fair value in generally accepted accounting principles,
clarifies the definition of fair value within that framework, and expands
disclosures about the use of fair value measurements. The accounting guidance
applies to fair value measurements required by existing accounting guidance and
does not require any new fair value measurements.
 
 On
January 1, 2009, the Company adopted accounting guidance for non-financial
assets and non-financial liabilities that are recognized or disclosed at fair
value in the consolidated financial statements on a nonrecurring basis as
permitted by, which provided a deferral of such provisions until 2009. The
adoption of this guidance did not have a material impact on the Company’s
financial position, results of operations, or cash flows.
 
 7
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 The
carrying value of financial assets and liabilities recorded at fair value is
measured on a recurring or nonrecurring basis. Financial assets and liabilities
measured on a non-recurring basis are those that are adjusted to fair value when
a significant event occurs. The Company had no financial assets or liabilities
carried and measured on a nonrecurring basis during the reporting periods.
Financial assets and liabilities measured on a recurring basis are those that
are adjusted to fair value each time a financial statement is prepared. The
Company’s had no financial assets and/or liabilities carried at fair value on a
recurring basis at September 30, 2010.
 
 The
availability of inputs observable in the market varies from instrument to
instrument and depends on a variety of factors including the type of instrument,
whether the instrument is actively traded, and other characteristics particular
to the transaction. For many financial instruments, pricing inputs are readily
observable in the market, the valuation methodology used is widely accepted by
market participants, and the valuation does not require significant management
discretion. For other financial instruments, pricing inputs are less observable
in the market and may require management judgment.
 
 Recent accounting
pronouncements
 
 In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (Topic 605): “Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task
Force.”  This update provides application guidance on whether
multiple deliverables exist, how the deliverables should be separated and how
the consideration should be allocated to one or more units of accounting. This
update establishes a selling price hierarchy for determining the selling price
of a deliverable. The selling price used for each deliverable will be based on
vendor-specific objective evidence, if available, third-party evidence if
vendor-specific objective evidence is not available, or estimated selling price
if neither vendor-specific or third-party evidence is available. On January 1,
2010 the Company adopted this amended accounting guidance, the adoption of this
guidance did not have a material impact on the Company’s financial condition,
results of operations or cash flows.
 
 In June
2009, the FASB issued guidance related to accounting for transfers of financial
assets. This guidance improves the information that a reporting entity provides
in its financial reports about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance and cash flows; and a
continuing interest in transferred financial assets. In addition, this guidance
amends various ASC concepts with respect to accounting for transfers and
servicing of financial assets and extinguishments of liabilities, including
removing the concept of qualified special purpose entities. This guidance must be
applied to transfers occurring on or after the effective date. On January 1,
2010, the Company adopted this amended accounting guidance, the adoption of this
guidance did not have a material impact on the Company’s financial condition,
results of operations or cash flows.
 
 In June
2009, the FASB issued guidance which amends certain ASC concepts related to
consolidation of variable interest entities. Among other accounting and
disclosure requirements, this guidance replaces the quantitative-based risks and
rewards calculation for determining which enterprise has a controlling financial
interest in a variable interest entity with an approach focused on identifying
which enterprise has the power to direct the activities of a variable interest
entity and the obligation to absorb losses of the entity or the right to receive
benefits from the entity. On January 1, 2010, the Company adopted this amended
accounting guidance, the adoption of this guidance did not have a material
impact on the Company’s financial condition, results of operations or cash
flows.
 
 4.
              Concentrations of Business and
      Credit Risk
 
 The
Company conducts all of its primary business in the PRC.  There can be
no assurance that the Company will be able to successfully conduct its business,
and failure to do so would have a material adverse effect on the Company’s
financial position, results of operations and cash flows. Also, the success of
the Company’s operations is subject to numerous contingencies, some of which are
beyond management’s control. These contingencies include general economic
conditions, price of raw material, competition, governmental and political
conditions, and changes in regulations. Because the Company conducts all of its
business and operations in the PRC, the Company is subject to various additional
political, economic and other uncertainties. Among other risks, the Company’s
operations will be subject to risk of restrictions on transfer of funds,
domestic and international customs, changing taxation policies, foreign exchange
restrictions, and political and governmental regulations.
 
 Substantially
all of the Company’s bank accounts are in banks located in the PRC and are not
covered by any type of protection similar to that provided by the FDIC on funds
held in U.S. banks. Accounts held at U.S. financial institutions are insured by
the Federal Deposit Insurance Corporation up to $250,000. As of September 30,
2010 none of the U.S. cash balances are in excess of insured
amounts.
 
 8
 Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 Milk
powder has historically represented 75% to 95% of the Company’s total sales.
Dairy product consumption in China has historically been lower than in many
other countries in the world.  Growing interest in milk products in
China is a relatively recent phenomenon which makes the market for the Company’s
products less predictable.  Consumers may lose interest in the
products.  As a result, achieving and maintaining market acceptance
for the Company’s products will require substantial marketing efforts and the
expenditure of significant funds to encourage dairy consumption in general, and
the purchase of the Company’s products in particular.  There is
substantial risk that the market may not accept or be receptive to the Company’s
products.  Market acceptance of the Company’s current and proposed
products will depend, in large part, upon our ability to inform potential
customers that the distinctive characteristics of the Company’s products make
them superior to competitive products and justify their pricing.  The
Company’s current and proposed products may not be accepted by consumers or able
to compete effectively against other premium or non-premium dairy
products.  Lack of market acceptance would limit the Company’s
revenues and profitability.
 
 The
Company operates in the PRC, which may give rise to significant foreign currency
risks from fluctuations and the degree of volatility of foreign exchange rates
between US dollars and the Chinese currency RMB.
 
 Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash and trade accounts receivable, the balances of which
are stated on the balance sheet. Concentration of credit risk with respect to
trade accounts receivable is limited due to the Company's large number of
diverse customers in different locations in the PRC. The Company does not
require collateral or other security to support financial instruments subject to
credit risk.
 
 For the
three and nine months ended September 30, 2010 and 2009, no single customer
accounted for 10% or more of sales.
 
 Payments
of dividends may be subject to some restrictions due to the fact that the
operating activities are conducted in subsidiaries residing in the
PRC.
 
 The
operations of the Company are located in the PRC. Accordingly, the Company’s
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
 
 5.
              Inventory
 
 As of
September 30, 2010 and December 31, 2009 inventory consists of the
following:
 
 2010
                    
                    
                    2009Raw
      materials
                    
                    $
                    1,157,836
                    
                    
                    $
                    689,984Work-in-process
                    
                    
                    387,877
                    
                    
                    
                    579,806Finished
      goods
                    
                    
                    69,855
                    
                    
                    
                    20,365Repair
      parts
                    
                    
                    8,941
                    
                    
                    
                    8,333$
                    1,624,509
                    
                    
                    $
                    1,298,488
  6.
              Other Current
      Assets
 
 As of
September 30, 2010 and December 31, 2009, other current assets consist of the
following:
 
 2010
                    
                    
                    
                    2009Advances
      to milk suppliers
                    
                    $
                    345,032
                    
                    
                    $
                    368,566Advances
      to construction contractor
                    
                    
                    484,196
                    
                    
                    
                    -Deposit
      on lease
                    
                    
                    1,046,103
                    
                    
                    
                    -Advances
      to staff
                    
                    
                    33,282
                    
                    
                    
                    15,496Deposit
      on contract
                    
                    
                    198,580
                    
                    
                    
                    71,598Prepaid
      loan costs
                    
                    
                    162,327
                    
                    
                    
                    828,725Prepaid
      expenses
                    
                    
                    645,389
                    
                    
                    
                    8,364$
                    2,914,909
                    
                    
                    $
                    1,292,749
  9
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 7.
              Property, Plant, and
      Equipment
 
 As of
September 30, 2010 and December 31, 2009, Property, Plant, and Equipment consist
of the following:
 
 2010
                    
                    
                    2009Building
                    
                    $
                    3,844,284
                    
                    
                    $
                    3,767,984Plant
      and Machinery
                    
                    
                    3,329,627
                    
                    
                    
                    3,227,110Motor
      vehicles
                    
                    
                    578,918
                    
                    
                    
                    526,597Dairy
      cows
                    
                    
                    262,385
                    
                    
                    
                    253,439Office
      equipment
                    
                    
                    81,814
                    
                    
                    
                    76,6168,097,028
                    
                    
                    
                    7,851,746Less:
      Accumulated depreciation
                    
                    
                    (2,337,207
                    )
                    
                    
                    (1,905,416
                    )$
                    5,759,821
                    
                    
                    $
                    5,946,330
 
 Depreciation
expenses totaled $121,977 and $386,627 for the three and nine months ended
September 30, 2010, respectively, and $124,421 and $371,939 for the three and
nine months ended September 30, 2009, respectively. $80,090 and $260,665 were
included as a component of cost of goods sold for the three and nine months
ended September 30, 2010, respectively, and $90,258 and 270,120 for the three
and nine months ended September 30, 2009, respectively.
 
 8.
              Construction-in-progress
 
 September 30,
                      2010
                    
                    
                    December 31,
                      2009Construction
      in progress
                    
                    $
                    14,900,348
                    
                    
                    $
                    8,772,931
 
 Construction-in-progress
represents construction and installations of the new plant and machinery for the
production facility in Hailun City.
 
 9.
              Intangible
      Assets
 
 September 30,
                      2010
                    
                    
                    December 31,
                      2009Land
      use rights
                    
                    $
                    1,383,039
                    
                    
                    $
                    1,355,589Patents
                    
                    
                    54,248
                    
                    
                    
                    53,1711,437,287
                    
                    
                    
                    1,408,760Less:
      Accumulated amortization
                    
                    
                    (97,470
                    )
                    
                    
                    (67,226
                    )$
                    1,339,817
                    
                    
                    $
                    1,341,534
 
 Amortization
expenses totaled $9,518 and $28,394 for the three and nine months ended
September 30, 2010, respectively and $9,432 and 28,288 for the three and nine
months ended September 30, 2009,respectively.
 
 Amortization
expense is estimated to be $37,744 for each of the next five years.
 
 10
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 10.
              Income
    Taxes
 
 On May
30, 2005, AIDH executed a Share Transfer Agreement with XAL. XAL applied to be
treated as a foreign invested company right after the share transfer, and its
business license was approved as a foreign invested company on January 10, 2006.
According to Chinese taxation policy, a foreign invested company, Advanced
Technology Company or Software Development Company, receives a 100% income tax
exemption for the first 2 years and a 50% tax exemption for the next 3 years,.
XAL is considered an Advanced Technology Company. Therefore the Company received
the benefit of this income tax exemption from January 10, 2006, the date XAL was
approved 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 from such date expiring in January 2011.
 
 LvBao is
currently subject to the Enterprise income tax of 25%.
 
 HXD is
currently subject to the Enterprise income tax of 25% while the local government
will refund the local portion (25% of the total tax payment) to HXD for five
years.  The local government refund will expire on December 31,
2015.
 
 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 30,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009U.S.
      Operations
                      
                      $
                      (1,106,000
                      )
                      
                      $
                      (713,000
                      )
                      
                      $
                      (8,171,000
                      )
                      
                      $
                      (1,543,000
                      )Chinese
      Operations
                      
                      
                      2,989,000
                      
                      
                      
                      1,843,000
                      
                      
                      
                      9,854,000
                      
                      
                      
                      6,105,000$
                      1,883,000
                      
                      
                      $
                      1,130,000
                      
                      
                      $
                      1,683,000
                      
                      
                      $
                      4,562,000
 
 The
components of the provision for income taxes are approximately as
follows:
  Three Months
                        Ended September 30,
                      
                      
                      Nine months
                        Ended September 30,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Federal,
      State and Local
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -Peoples
      Republic of China -Federal and Local
                      
                      
                      411,300
                      
                      
                      
                      245,000
                      
                      
                      
                      1,223,900
                      
                      
                      
                      861,000$
                      411,300
                      
                      
                      $
                      245,000
                      
                      
                      $
                      1,223,900
                      
                      
                      $
                      861,000
 
 The table
below approximately summarizes the reconciliation of the Company’s income tax
provision (benefit) computed at the statutory U.S. Federal rate and the actual
tax provision:
 
 Three Months
                      Ended September 30,
                    
                    
                    Nine months
                      Ended September 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Income
      tax provision at Federal statutory rate
                    
                    $
                    640,400
                    
                    
                    $
                    384,100
                    
                    
                    $
                    572,200
                    
                    
                    $
                    1,550,900State
      income taxes, net of Federal benefit
                    
                    
                    -0-
                    
                    
                    
                    -0-
                    
                    
                    
                    -0-
                    
                    
                    
                    -0-U.S.
      tax rate in excess of foreign tax rate
                    
                    
                    (269,100
                    )
                    
                    
                    (165,900
                    )
                    
                    
                    (886,900
                    )
                    
                    
                    (549,400
                    )Abatement
      of foreign income taxes
                    
                    
                    (336,100
                    )
                    
                    
                    (215,800
                    )
                    
                    
                    (1,239,600
                    )
                    
                    
                    (665,200
                    )Increase
      in valuation allowance
                    
                    
                    376,100
                    
                    
                    
                    242,600
                    
                    
                    
                    2,778,200
                    
                    
                    
                    524,700Tax
      provision
                    
                    $
                    411,300
                    
                    
                    $
                    245,000
                    
                    
                    $
                    1,223,900
                    
                    
                    $
                    861,000
 
 11
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 The
Company has a U.S. net operating loss carryforward of approximately $14,455,000
as of September 30, 2010 which expires in 2030. The deferred tax asset
associated with these net operating loss carryforwards was fully reserved as of
September 30, 2010.
 
 The
change in the valuation allowance as of September 30, 2010 and 2009 was
$2,778,200 and $524,700, respectively.
 
 The
effects of the tax exemption per share were as follows:
 
 Three Months
                      Ended September 30,
                    
                    
                    Nine months
                      Ended September 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Tax
      Saving
                    
                    $
                    336,100
                    
                    
                    $
                    215,800
                    
                    
                    $
                    1,239,600
                    
                    
                    $
                    665,200Benefit
      per share:Basic
                    
                    $
                    0.01
                    
                    
                    $
                    0.01
                    
                    
                    $
                    0.04
                    
                    
                    $
                    0.02Diluted
                    
                    $
                    0.01
                    
                    
                    $
                    0.01
                    
                    
                    $
                    0.04
                    
                    
                    $
                    0.02
 
 Had the
tax exemption not been in place for the three and nine months ended September
30, 2010 and 2009, the Company estimates the following proforma financial
statement impact:
 
 Three Months
                      Ended September 30,
                    
                    
                    Nine months
                      Ended September 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Net
      income before tax provision, as reported
                    
                    $
                    1,883,000
                    
                    
                    $
                    1,130,000
                    
                    
                    $
                    1,683,000
                    
                    
                    $
                    4,562,000Less
      Tax provision not exempted
                    
                    
                    411,300
                    
                    
                    
                    245,000
                    
                    
                    
                    1,223,900
                    
                    
                    
                    861,000Less
      Tax provision exempted
                    
                    
                    336,100
                    
                    
                    
                    215,800
                    
                    
                    
                    1,239,600
                    
                    
                    
                    665,200$
                    1,135,600
                    
                    
                    $
                    669,200
                    
                    
                    $
                    (780,500
                    )
                    
                    $
                    3,035,800
 
 11.
              Employee Retirement Benefits and
      Post Retirement Benefits
 
 According
to the Heilongjiang Provincial regulations on state pension program, both
employees and employers have to contribute toward pensions. The pension
contributions range from 2% to 8% that was contributed by individuals
(employees), and the Company is required to make contributions to the state
retirement plan based on 20% of the employees’ monthly basic salaries. Employees
in the PRC are entitled to retirement benefits calculated with reference to
their basic salaries on retirement and their length of service in accordance
with a government managed benefits plan. The PRC government is responsible for
the benefit liability to these retired employees. During the three and nine
months ended September 30, 2010, respectively, the Company contributed $28,732
and $88,753 in pension contributions. During the three and nine months ended
September 30, 2009, respectively, the Company contributed $59,264 and $204,448
in pension contributions.
 
 12
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 12.
              Accounts Payable and accrued
      Expenses
 
 At
September 30, 2010 and December 31, 2009 accounts payable and accrued expenses
consisted of:
 
 September 30,
                      2010
                    
                    
                    December 31,
                      2009Accounts
      payable
                    
                    $
                    3,175,268
                    
                    
                    $
                    2,308,866Accrued
      payroll
                    
                    
                    58,865
                    
                    
                    
                    306,011Accrued
      interest
                    
                    
                    421,938
                    
                    
                    
                    71,570Economic
      development advance
                    
                    
                    44,833
                    
                    
                    
                    43,943Accrued
      insurance
                    
                    
                    49,369
                    
                    
                    
                    187,408$
                    3,750,273
                    
                    
                    $
                    2,917,798
 
 13.
              Notes
    payable
 
 At
September 30, 2010 and December 31, 2009 notes payable consisted of the
following:
 
 September 30,
                        2010
                      
                      
                      December 31,
                        2009Notes
      dated June, 2008, due December 31, 2010 with a interest rate of
      10%,
                      
                      $
                      1,716,411
                      
                      
                      $
                      2,573,301Notes
      dated November, 2008 due May 10, 2010 with a interest rate of
      10%
                      
                      
                      -
                      
                      
                      
                      500,000Note
      dated November, 2009 due November 30, 2010 with a interest rate of
      10%
                      
                      
                      1,750,000
                      
                      
                      
                      1,750,000Notes
      dated December, 2009 due December 24, 2010 with a interest rate of 10%,
      net of debt discount of $171,755  and $729,830 at September 30,
      2010 and December 31, 2009, respectively
                      
                      
                      1,578,245
                      
                      
                      
                      1,020,171Note
      dated June, 2010 due June 23, 2011 with a interest rate of
    10%
                      
                      
                      800,000
                      
                      
                      
                      -$
                      5,844,656
                      
                      
                      $
                      5,843,472
 
 14.
              Lease
      payable
 
 On June
23, 2010, HXD entered into a sale and leaseback agreement pursuant to which, the
lessor purchased certain equipment from HXD located in HXD’s new milk powder
production facility, for a purchase price of $5,161,176, (RMB 35,000,000); the
lessor leased the equipment back to HXD for 36 monthly payments of $164,124,
(RMB 1,112,991), a commission fee of $154,835 (RMB 1,050,000), a refundable
deposit of $774,176 (RMB 5,250,000); and the Company issued to the lessor
three-year warrants to purchase 934,600 shares of the Company’s common stock at
an exercise price of $1.65 per share with a fair value of $996,873 (RMB
6,760,197). See note 15 regarding calculation of the fair value of the
warrants.
 
 HXD
retained the benefits and risks incident to the ownership of the equipment, and
title to the equipment will transfer back to HXD at the completion of the lease.
Therefore the lease was treated as a financing with no recognition of gain or
loss on the sale.  Per accounting guidance the lease was recorded as a
capital lease at the present value of the minimum lease payments, including the
commission fee and the fair value of the warrants issued.
 
 13
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 The
balances on the lease are as follows:
 
 September 30,
                        2010
                      
                      
                      December 31,
                        2009Remaining
      lease payments
                      
                      $
                      5,488,859
                      
                      
                      $
                      -Imputed
      interest
                      
                      
                      (1,653,261
                      )
                      
                      
                      -Lease
      balance
                      
                      
                      3,835,598
                      
                      
                      
                      -Less
      current portion
                      
                      
                      (1,080,770
                      )
                      
                      
                      -Long-term
      lease payable
                      
                      $
                      2,754,828
                      
                      
                      $
                      -
 
 Future
principal payments over the next four years are as follows:
 2010
                      
                      $
                      243,5782011
                      
                      
                      1,155,9482012
                      
                      
                      1,512,7252013
                      
                      
                      923,347
 
 15.
              Equity
 
 Warrants
 
 Information
with respect to stock warrants outstanding as of September 30, 2010 are as
follows:
 
 Exercisable:
  Exercise Price
                      
                      Outstanding
                        December
                        31, 2009
                      
                      
                      Granted
                        Modified
                      
                      
                      Modified,
                        Expired or
                        Exercised
                      
                      
                      Outstanding
                        September
                        30, 2010
                      
                      Expiration
                        Date$0.75
                      
                      
                      -0-
                      
                      
                      
                      373,334
                      
                      
                      
                      (373,334
                      )
                      
                      
                      -0-
                      
                      4/6/2010$0.94
                      
                      
                      373,334
                      
                      
                      
                      -0-
                      
                      
                      
                      (373,334
                      )
                      
                      
                      -0-
                      
                      10/09/2010$1.20
                      
                      
                      -0-
                      
                      
                      
                      499,522
                      
                      
                      
                      (499,522
                      )
                      
                      
                      -0-
                      
                      4/6/2010$1.50*
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      833,811
                      
                      
                      
                      833,811
                      
                      8/02/2011$2.04*
                      
                      
                      578,884
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      578,884
                      
                      8/01/2012$2.04*
                      
                      
                      327,306
                      
                      
                      
                      -0-
                      
                      
                      
                      (30,675
                      )
                      
                      
                      296,631
                      
                      8/11/2012$1.63*
                      
                      
                      235,583
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      235,583
                      
                      8/11/2012$1.63*
                      
                      
                      195,000
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      195,000
                      
                      6/12/2013$1.63*
                      
                      
                      75,000
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      75,000
                      
                      6/20/2013$1.63
                      
                      
                      97,500
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      97,500
                      
                      12/31/2011$1.63
                      
                      
                      100,000
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      100,000
                      
                      11/10/2012$1.63
                      
                      
                      120,000
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      120,000
                      
                      11/30/2012$1.63
                      
                      
                      536,809
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      536,809
                      
                      12/24/2012$1.63
                      
                      
                      789,536
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      789,536
                      
                      12/31/2012$1.63
                      
                      
                      -0-
                      
                      
                      
                      184,049
                      
                      
                      
                      (184,049
                      )
                      
                      
                      -0-
                      
                      4/6/2010$1.63
                      
                      
                      -0-
                      
                      
                      
                      44,643
                      
                      
                      
                      -0-
                      
                      
                      
                      44,643
                      
                      9/2/2014$1.63
                      
                      
                      -0-
                      
                      
                      
                      40,000
                      
                      
                      
                      -0-
                      
                      
                      
                      40,000
                      
                      6/25/2013$1.65
                      
                      
                      -0-
                      
                      
                      
                      623,000
                      
                      
                      
                      -0-
                      
                      
                      
                      623,000
                      
                      7/22/2013$1.65
                      
                      
                      -0-
                      
                      
                      
                      80,000
                      
                      
                      
                      -0-
                      
                      
                      
                      80,000
                      
                      3/31/2014$1.65
                      
                      
                      -0-
                      
                      
                      
                      934,600
                      
                      
                      
                      -0-
                      
                      
                      
                      934,600
                      
                      6/24/2013$3.26*
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      981,747
                      
                      
                      
                      981,747
                      
                      8/02/2011$3.26*
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      1,423,372
                      
                      
                      
                      1,423,372
                      
                      8/11/2011$2.61
                      
                      
                      75,000
                      
                      
                      
                      -0-
                      
                      
                      
                      -0-
                      
                      
                      
                      75,000
                      
                      11/10/2011
 
 Not-exercisable:
 
 Exercise Price
                  
                  Outstanding
                    December
                    31, 2009
                  
                  
                  Granted
                  
                  
                  Modified,
                    Expired or
                    Exercised
                  
                  
                  Outstanding
                    September
                    30, 2010
                  
                  Expiration
                    Date$1.65
                  
                  
                  -0-
                  
                  
                  
                  80,000
                  
                  
                  
                  -0-
                  
                  
                  
                  80,000
                  
                  3/31/2014
 
 *  On
      January 28, 2010 the Company’s registration statement became effective
      which extended the expiration date of these
  warrants.
 
 14
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 Extension
of Warrants
 
 Pursuant
to the provisions of Section 10 of the respective common stock purchase warrants
(the “Warrants”) previously issued by the Company to the investors and certain
finders and placement agents in connection with private offerings the Company
consummated in October 2007, the original expiration dates of the Warrants were
to be extended beyond their initial stated termination dates for certain
specified periods until the Company satisfied certain registration rights
provisions relating to the shares of the Company’s common stock underlying the
Warrants. As a result of the Company’s satisfaction on January 28, 2010 of
certain registration rights provisions relating to the warrants, the expiration
dates of the Warrants were adjusted to provide as follows:
 
 ·
              373,334 Warrants exercisable at
      $0.94 per share that would otherwise have expired on October 9, 2010 now
      expire on  August 1,
2012;
 
 ·
              1,333,333 Warrants exercisable at
      $1.50 per share that would otherwise have expired on October 9, 2009 now
      expire on August 2, 2011;
 
 ·
              190,245 Warrants exercisable at
      $2.04 per share that would otherwise have expired on October 9, 2010 now
      expire on August 1, 2012;
 
 ·
              981,747 Warrants exercisable
      at  $3.26 per share that would otherwise have expired on October
      9, 2009 now expire on August 2,
2011;
 
 ·
              235,583 Warrants exercisable at
      $1.63 per share that would otherwise have expired on October 19, 2010 now
      expire on August 11, 2012;
 
 ·
              715,945 Warrants exercisable
      at  $2.04 per share that would otherwise have expired on October
      19, 2010 now expire on August 11, 2012;
  and
 
 ·
              1,544,461 Warrants exercisable at
      $3.26 per share that would otherwise have expired on October 19, 2009 now
      expire on August 12, 2011.
  The fair
value of the warrants as of January 28, 2010, before modification of the terms,
was calculated to be $759,035. The fair value of the warrants as of January 28,
2010, after modification of the terms, was calculated to be
$5,780,704.  The incremental change in the value of the warrants is
$5,021,669, which was recorded to liquidated damages in the nine months ended
September 30, 2010.
 
 Warrant
Tender Offers
 
 On
February 10, 2010, the Company commenced an offer (the “Third Offer”) to the
holders of 5,374,648 outstanding warrants to purchase shares of the Company’s
common stock originally issued in connection with the private offerings the
Company consummated in October 2007, having exercise prices of either $0.94,
$1.50, $1.63, $2.04 or $3.26 per share (the “Original Warrants”), to voluntarily
exchange any or all of the Original Warrants for amended warrants exercisable at
reduced exercise prices (“Amended Warrants”).  The reduced exercise
prices of the Amended Warrants will depend on the current exercise prices
applicable to the Original Warrants. As of February 10, 2010, the Original
Warrants included:
 
 ·
              373,334 Original Warrants to
      purchase shares of Common Stock at an exercise price of $0.94 per share,
      which may be exchanged for Amended Warrants exercisable at a reduced price
      of $0.75 per share,
 
 ·
              1,333,333 Original Warrants to
      purchase shares of Common Stock at an exercise price of $1.50 per share,
      which may be exchanged for Amended Warrants exercisable at a reduced price
      of $1.20 per share,
 
 15
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 ·
              235,583 Original Warrants to
      purchase shares of Common Stock at an exercise price of $1.63 per share,
      which may be exchanged for Amended Warrants exercisable at a reduced price
      of $1.30 per share,
 
 ·
              906,190 Original Warrants to
      purchase shares of Common Stock at an exercise price of $2.04 per share,
      which may be exchanged for Amended Warrants exercisable at a reduced price
      of $1.63 per share, and
 
 ·
              2,526,208 Original Warrants to
      purchase shares of Common Stock at an exercise price of $3.26 per share,
      which may be exchanged for Amended Warrants exercisable at a reduced price
      of $1.63 per share.
 
 On March
17, 2010 the Company closed the Third Offer with the following warrants
exchanged:
 
 ·
              a total of 373,334 Original
      Warrants with exercise prices of $0.94 per share were exchanged for
      Amended Warrants with reduced exercise prices of $0.75 per
      share;
 
 ·
              a total of 499,522 Original
      Warrants with exercise prices of $1.50 per share were exchanged for
      Amended Warrants with reduced exercise prices of $1.20 per
      share;
 
 ·
              no Original Warrants with
      exercise prices of $1.63 per share were exchanged for Amended Warrants
      with reduced exercise prices of $1.30 per
  share;
 
 ·
              a total of 30,675 Original
      Warrants with exercise prices of $2.04 per share were exchanged for
      Amended Warrants with reduced exercise prices of $1.63 per share;
      and
 
 ·
              a total of 153,374 Original
      Warrants with exercise prices of $3.26 per share were exchanged for
      Amended Warrants with reduced exercise prices of $1.63 per
      share.
 
 On April
6, 2010, the holder of the Company’s 10% promissory notes in the principal
amount of $856,890, due on December 31, 2010 (the “Note”), requested that the
Company apply the $879,427 balance due to him under the Note (which balance
included $19,537 of accrued and unpaid interest) to the holder’s exercise of (a)
373,334 of his Amended Warrants, at an exercise price of $0.75 per share, and
(b) 499,522 of his Amended Warrants, at an exercise price of $1.20 per
share.  The Company’s Board approved the request and, accordingly, on
April 6, 2010 the holder exercised the Amended Warrants, the Company issued
872,856 shares of its common stock to the holder, and the Note was
cancelled.
 
 On April
6, 2010 one holder of Amended Warrants exercised all 184,049 of his Amended
Warrants, at an exercise price of $1.63 per share, resulting in gross proceeds
to the Company of approximately $300,000.
 
 Warrants
Issued for Loan Costs
 
 In April
2010, the Company’s board of directors approved a November 23, 2009 amendment to
a financial consulting agreement with an advisor.  Pursuant to the
amended agreement, in connection with the Company’s December 2009 private
placement of priomissory notes, the Company issued to the advisor 44,643
warrants to purchase shares of the Company’s common stock, at an exercise price
of $1.63 per share, which expire on September 2, 2014.
 
 The fair
value of the warrants as of November 23, 2009, the date of the amended
agreement, was calculated to be $79,991 and recorded as prepaid loan costs to be
amortized over the life of the notes.  The following assumptions were
used to calculate the fair value of the warrants:
 
 Dividend
      yield
                  
                  
                  0
                  %Expected
      volatility
                  
                  
                  177.42
                  %Risk-free
      interest rate
                  
                  
                  2.21
                  %Expected
      life
                  
                  4.75
      yearsStock
      price
                  
                  $
                  1.88Exercise
      price
                  
                  $
                  1.63
 
 16
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 Warrants
Issued for Services
 
 In April
2010 the Company issued 4 year warrants to purchase 160,000 shares of common
stock for $1.65 per share.  The warrants vest 25% per quarter over the
one year life of the contract.  Pursuant to accounting guidance the
fair value of the warrants will be measured and recorded when
vested.  During the quarter ended June 30, 2010 the fair value of the
40,000 warrants vested was calculated to be $46,097 and was expensed to selling,
general and administrative expense.  The following assumptions were
used to calculate the fair value of the warrants:
 
 Dividend
      yield
                  
                  
                  0
                  %Expected
      volatility
                  
                  
                  146.93
                  %Risk-free
      interest rate
                  
                  
                  1.37
                  %Expected
      life
                  
                  3.75
      yearsStock
      price
                  
                  $
                  1.38Exercise
      price
                  
                  $
                  1.65
 
 During
the quarter ended September 30, 2010 the fair value of the 40,000 warrants
vested was calculated to be $31,676 and was expensed to selling, general and
administrative expense.  The following assumptions were used to
calculate the fair value of the warrants:
 
 Dividend
      yield
                  
                  
                  0
                  %Expected
      volatility
                  
                  
                  139.06
                  %Risk-free
      interest rate
                  
                  
                  .68
                  %Expected
      life
                  
                  3.5
      yearsStock
      price
                  
                  $
                  1.04Exercise
      price
                  
                  $
                  1.65
 
 In June
2010, the Company entered into a consulting services contract pursuant to which
the Company issued 3 year warrants to purchase 40,000 shares of common stock for
$1.63 per share.  The fair value of the warrants was calculated to be
$44,039 and was recorded as prepaid expense to be amortized over the life of the
contract.  The following assumptions were used to calculate the fair
value of the warrants:
 
 Dividend
      yield
                  
                  
                  0
                  %Expected
      volatility
                  
                  
                  147.62
                  %Risk-free
      interest rate
                  
                  
                  1.01
                  %Expected
      life
                  
                  3.00
      yearsStock
      price
                  
                  $
                  1.40Exercise
      price
                  
                  $
                  1.63
 
 In July
2010, the Company entered into a consulting services contract pursuant to which
the Company issued 3 year warrants to purchase 623,000 shares of common stock
for $1.65 per share.  The fair value of the warrants was calculated to
be $648,250 and was recorded as prepaid expense to be amortized over the life of
the contract.  The following assumptions were used to calculate the
fair value of the warrants:
 
 Dividend
      yield
                  
                  
                  0
                  %Expected
      volatility
                  
                  
                  144.50
                  %Risk-free
      interest rate
                  
                  
                  1.00
                  %Expected
      life
                  
                  3.00
      yearsStock
      price
                  
                  $
                  1.35Exercise
      price
                  
                  $
                  1.65
  17
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 Shares
Issued For Services
 
 On March
18, 2010, the Company issued 180,000 shares of the Company’s common stock with a
fair value of $250,200 to an employee for services rendered in
2009.  The $250,200 was accrued as compensation expense for the year
ended December 31, 2009, and was included in accrued payroll at December 31,
2009.
 
 Return
of Shares
 
 On March
18, 2010, Yang Yong Shan, the Company’s Chairman, Chief Executive Officer and
President, returned 180,000 shares of the Company’s common stock to the Company
as a capital contribution.  The 180,000 shares have been returned to
the Company’s number of authorized but unissued shares of common stock. The $180
par value of the shares was transferred from common stock to additional paid-in
capital as of March 18, 2010.
 
 Shares
Issued For Loan Extension
 
 On May
10, 2010 the Company entered into an amendment of the note originally issued in
connection with a private placement consummated in November 2008 (the “November
2008 Note”), whereby the Company agreed:
 
 (a) 
to pay the note holder $75,000 on May 11, 2010, which represented the full
amount of accrued and unpaid interest on the November 2008 Note as of May 10,
2010;
 
 (b) 
that within thirty (30) days of May 10, 2010, the Company would repay to the
note holder the full $500,000 principal amount due under the November 2008 Note,
plus additional interest, at a rate of 15%, accrued from May 10, 2010 through
the date of repayment; and
 
 (c) 
that, as additional consideration, the Company would issue to the note holder a
total of
 
 (i) 
5,000 restricted shares of the Company’s common stock, if the full amount due
under the November 2008 Note was repaid to the note holder on or before May 25,
2010; or
 
 (ii) 
10,000 restricted shares of the Company’s common stock, if the full amount due
under the November 2008 Note was repaid to the note holder after May 25, 2010,
but on or before June 9, 2010.
 
 On June
9, 2010, the Company entered into another letter agreement pursuant to which the
Company agreed that:
 
 (a) 
within fifteen (15) days of June 9, 2010, the Company would
repay the note holder the full $500,000 principal amount of the
November 2008 Note, plus interest, at a rate of 15% per annum, accrued from May
11, 2010, through the date of repayment; and
  (b) 
as additional consideration, the Company would issue to the note
holder a total of 5,000 restricted shares of the Company's common
stock.
  The
Company repaid all remaining amounts of principal and interest
due to the note holder under his promissory note ) as of June 24,
2010.  The 15,000 shares of the Company’s common stock due the noteholder
under these agreements was valued at the closing price as of the date the stock
became due under the agreements as follows:
 
 Date
                            
                            Number of Shares
                            
                            
                            Closing Price
                            
                            
                            Value5/10/10
                            
                            
                            5,000
                            
                            
                            $
                            1.20
                            
                            
                            $
                            6,000.005/26/10
                            
                            
                            5,000
                            
                            
                            $
                            1.25
                            
                            
                            $
                            6,250.006/9/10
                            
                            
                            5,000
                            
                            
                            $
                            1.27
                            
                            
                            $
                            6,350.00
 
 The total
value of $18,600 was recorded as loan costs and charged to interest expense in
the nine months ended September 30, 2010.
 
 The
Company entered into an Investor Relations Consulting Agreement (the “IR
Agreement”) with an consultant, as of January 1, 2009.  Pursuant to
the IR Agreement, in consideration for investor relations services to be
provided to the Company by the consultant, the Company agreed to pay a monthly
retainer of $9,000, consisting of (i) $4,500 in cash, and (ii) such number of
shares of restricted stock of the Corporation to be determined by dividing
$4,500 by 85% of the average closing trading price of the Company’s common stock
for the first ten trading days of the applicable month, capped at 10,588 shares
per month.
  On June
15, 2010 the Company issued 14,403 shares of common stock with a fair value of
$15,807 pursuant to the agreement.  The fair value of the stock was
determined by the closing price of the stock on the 10th day of
each month, which is the day the number of shares to be issued is
determined.
 18
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 16.
              Common Welfare
      Reserves
 
 The
Company is required to transfer 10% of its net income, as determined in
accordance with PRC accounting rules and regulations, to the general reserve.
The balance of these reserves at September 30, 2010 and December 31, 2009, was
$3,191,614 and $1,834,742, respectively. These amounts are restricted and are
included in retained earnings.
 
 This fund
can only be utilized on capital items for the collective benefit of the
Company’s employees, such as construction of dormitories, cafeteria facilities,
and other staff welfare facilities. The fund is non-distributable other than
upon liquidation.
 
 17.
              Earnings Per
      Share
 
 Accounting
guidance requires a reconciliation of the numerator and denominator of the basic
and diluted earnings per share (EPS) computations.
 
 For the
three and nine months ended September 30, 2010 dilutive shares include stock
options of 444,388 and 488,582, respectively. Stock options of 760,000 and
warrants to purchase 8,060,936 shares of common stock were not included in
dilutive shares as the effect would have been anti-dilutive.
 
 For the
three months ended September 30, 2009, dilutive shares include stock options of
180,742, outstanding warrants to purchase 373,334 shares of common stock at an
exercise price of $0.94 and outstanding warrants to purchase 1,333,333 shares of
common stock at an exercise price of $1.50. Warrants to purchase 4,105,481 share
of common stock were not included in dilutive shares as the effect would have
been anti-dilutive.
 
 For the
nine months ended September 30, 2009, dilutive shares include stock options of
341,554 and outstanding warrants to purchase 373,334 shares of common stock at
an exercise price of $0.94. Warrants to purchase 5,438,814 share of common stock
were not included in dilutive shares as the effect would have been
anti-dilutive.
 
 The
following reconciles the components of the EPS computation:
 
 Income
                  
                  
                  Shares
                  
                  
                  Per Share(Numerator)
                  
                  
                  (Denominator)
                  
                  
                  AmountFor
      the three months ended September 30, 2010:Net
      income
                  
                  $
                  1,472,087Basic
      EPS income available to common shareholders
                  
                  $
                  1,472,087
                  
                  
                  
                  34,020,324
                  
                  
                  $
                  0.04Effect
      of dilutive securities:Warrants
                  
                  
                  
                  
                  
                  
                  —Stock
      options
                  
                  
                  —
                  
                  
                  
                  444,388Diluted
      EPS income available to common shareholders
                  
                  $
                  1,472,087
                  
                  
                  
                  34,464,712
                  
                  
                  $
                  0.04For
      the three months ended September 30, 2009:Net
      income
                  
                  $
                  884,625Basic
      EPS income available to common shareholders
                  
                  $
                  884,625
                  
                  
                  
                  30,844,547
                  
                  
                  $
                  0.03Effect
      of dilutive securities:Warrants
                  
                  
                  
                  
                  
                  
                  264,376Stock
      options
                  
                  
                  —
                  
                  
                  
                  522,458Diluted
      EPS income available to common shareholders
                  
                  $
                  884,625
                  
                  
                  
                  31,631,381
                  
                  
                  $
                  0.03
 
 19
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 Income
                  
                  
                  Shares
                  
                  
                  Per Share(Numerator)
                  
                  
                  (Denominator)
                  
                  
                  AmountFor
      the nine months ended September 30, 2010:Net
      income
                  
                  $
                  459,389Basic
      EPS income available to common shareholders
                  
                  $
                  459,389
                  
                  
                  
                  33,643,729
                  
                  
                  $
                  0.01Effect
      of dilutive securities:Warrants
                  
                  
                  
                  
                  
                  
                  —Stock
      options
                  
                  
                  —
                  
                  
                  
                  488,582Diluted
      EPS loss available to common shareholders
                  
                  $
                  459,389
                  
                  
                  
                  34,132,311
                  
                  
                  $
                  0.01For
      the nine months ended September 30, 2009:Net
      income
                  
                  $
                  3,700,467Basic
      EPS income available to common shareholders
                  
                  $
                  3,700,467
                  
                  
                  
                  29,979,356
                  
                  
                  $
                  0.12Effect
      of dilutive securities:Warrants
                  
                  
                  
                  
                  
                  
                  88,022Stock
      Options
                  
                  
                  —
                  
                  
                  
                  361,646Diluted
      EPS income available to common shareholders
                  
                  $
                  3,700,467
                  
                  
                  
                  30,429,024
                  
                  
                  $
                  0.12
 
 18.
              Equity Incentive
      Plan
 
 On March
2, 2009, the Company’s board of directors and majority stockholders adopted the
Emerald Dairy Inc. 2009 Equity Incentive Plan (the “Plan”) to attract and retain
the best available personnel, provide additional incentives to employees,
directors and consultants and promote the success of the Company’s business.
1,500,000 shares of the Company’s common stock have been reserved for issuance
under the Plan.
 
 Eligibility
 
 The
Company may grant awards to its employees, directors and consultants, including
those of the Company’s subsidiaries. However, the Company may grant options that
are intended to qualify as incentive stock options (“ISOs”) only to its
employees and employees of its subsidiaries.
 
 Acceleration of Awards upon
Corporate Transactions.
 
 The
outstanding awards will terminate and/or accelerate upon occurrence of certain
significant corporate transactions, including amalgamations, consolidations,
liquidations or dissolutions, sales of substantially all or all of the Company’s
assets, reverse takeovers or acquisitions resulting in a change of
control.
 
 Exercise Price and Term of
Awards.
 
 In
general, the plan administrator will determine the exercise price of an option
in the award agreement. The exercise price may be a fixed price, or it may be a
variable price related to the fair market value of the Company’s ordinary
shares. If the Company grants an ISO to an employee, the exercise price may not
be less than 100% of the fair market value of its common stock on the date of
the grant, except that if the grantee, at the time of that grant, owns shares
representing more than 10% of the voting power of all classes of the Company’s
shares of common stock, the exercise price may not be less than 110% of the fair
market value of its common stock on the date of that grant. If the Company
grants a non-qualified share option to a grantee, the exercise price may not be
less than 100% of the fair market value of its common stock on the date of
grant.
 
 20
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 The term
of each award under the Plan will be specified in the award agreement, but may
not exceed ten years from the earlier of the adoption or the approval of the
plan, unless sooner terminated.
 
 Total
share-based compensation costs included in the Condensed Consolidated Statements
of Income were $172,530 and $385,891 during the three and nine months ended
September 30, 2010, respectively, and $57,180 and $75,688 during the three and
nine months ended September 30, 2009, respectively. All share-based compensation
costs are included in selling expenses and administrative expenses.
  The
Company estimates the fair value of stock options using a Black-Scholes option
pricing valuation model, consistent with accounting guidance. Key inputs and
assumptions used to estimate the fair value of stock options include the grant
price of the award, the expected option term, volatility of the Company’s stock,
the risk-free rate and the Company’s dividend yield. Estimates of fair value are
not intended to predict actual future events or the value ultimately realized by
grantees, and subsequent events are not indicative of the reasonableness of the
original estimates of fair value made by the Company.
  No
options were granted during the three and nine months ended September 30,
2010.
 
 Share
Options
 
 A summary
of the Company’s outstanding share option award grants as of September 30, 2010
and changes during the three months then ended are presented below:
 
 Shares
                                  
                                  
                                  Weighted-Average
                                    Exercise Price
                                  
                                  
                                  Weighted-Average Remaining
                                    Contractual Term
                                  
                                  
                                  Aggregate
                                    Intrinsic Value(in years)
                                  
                                  
                                  (in millions)Outstanding
      at December 31, 2009
                                  
                                  
                                  1,463,200
                                  
                                  
                                  $
                                  1.14Granted
                                  
                                  
                                  -0-
                                  
                                  
                                  
                                  —Exercised
                                  
                                  
                                  -0-
                                  
                                  
                                  
                                  —Expired
                                  
                                  
                                  -0-
                                  
                                  
                                  
                                  —Forfeited
                                  
                                  
                                  (15,200
                                  )
                                  
                                  
                                  0.42Outstanding
      at September 30, 2010
                                  
                                  
                                  1,448,000
                                  
                                  
                                  $
                                  1.14
                                  
                                  
                                  
                                  8.78
                                  
                                  
                                  $
                                  435,984Vested
      and expected to vest at September 30, 2010
                                  
                                  
                                  1,448,000
                                  
                                  
                                  $
                                  1.14
                                  
                                  
                                  
                                  8.78
                                  
                                  
                                  $
                                  435,984Exercisable
      at September 30, 2010
                                  
                                  
                                  717,400
                                  
                                  
                                  $
                                  0.79
                                  
                                  
                                  
                                  8.61
                                  
                                  
                                  $
                                  326,988
 
 As of
September 30, 2010, there was $289,282 of total unrecognized compensation
costs related to non-vested Company share options granted under Company share
option plans. The cost is expected to be recognized over a weighted-average
period of 0.82 years.
 
 19.
              Commitments and
      Contingencies
 
 The
Company has various purchase commitments for materials, supplies and services
incident to the ordinary conduct of business, generally for quantities required
for the Company’s business and at prevailing market prices. No material annual
loss is expected from these commitments.
 
 The
Company has contracted to purchase equipment from a supplier for the second
processing facility for $13,135,171 of which $10,460,360 has been
paid.  The remaining $2,674,811 will be paid on delivery and
completion of installation of the equipment in 2010.
 
 The
Company has advances to milk suppliers of $345,032 which will be offset against
future milk purchases from those suppliers (see Note 6).
 
 21
  Emerald
Dairy Inc. and Subsidiaries
 Footnotes
to Condensed Consolidated Financial Statements
 September
30, 2010 and 2009
 In order
for the Company to conduct its current operations, an Infant & Baby Formula
Milk Powder Production Permit is required from the State General Administration
of Quality Supervision and Inspection and Quarantine of the People’s Republic of
China (the “Administration”). The Company’s current license will expire on April
25, 2013.  Other than the foregoing, no government approvals are
required to conduct the Company’s principal operations, and the Company is not
aware of any probable governmental regulation of our business sectors in the
near future. Although management believes that the Company is in material
compliance with the statutes, laws, rules and regulations of every
jurisdiction in which it operates, no assurance can be given that the Company’s
compliance with the applicable statutes, laws, rules and regulations will
not be challenged by governing authorities or private parties, or that such
challenges will not lead to a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
 
 The
Company is not involved in any legal matters arising in the normal course of
business. While incapable of estimation, in the opinion of the management, the
individual regulatory and legal matters in which it might involve in the future
are not expected to have a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
 
 19.
              Operating
      Leases
 
 The
Company leases various distribution facilities. All leases are on an annual
basis and commence on January 1, of each year. The Company also leases office
space which expires September 2010.  For the three and nine months
ended September 30, 2010, the Company incurred rental expense of $80,199 and
$118,263, respectively, and $39,518 and $117,927 for the three and nine months
ended September 30, 2009, respectively. As of September 30, 2010, the Company
had outstanding lease commitments totaling $161,270, $130,936 is due within the
one year and $30,334 in the second year.
 
 20.
              Subsequent
      events
 
 Management
has evaluated subsequent events from October 1, 2010 to November 15, 2010, the
date which the Company’s financial statements have been issued and were
available to be issued, and has concluded the following events should be
reported during this period.  Subsequent events that may occur after
November 15, 2010 have not been evaluated in the financial statements as of
September 30, 2010.
 
 21.
              Segment
      reporting
 
 The
Company operates in one operating segment in accordance with the provisions
accounting guidance regarding segment reporting. Although the Company has key
product lines of milk, soybean milk, and rice powder, the Company’s chief
operating decision maker reviews and evaluates one set of combined financial
information deciding how to allocate resources and in assessing
performance.
 
 For the
three and nine months ended September 30, 2010 and 2009, the Company’s sales
revenues from various products are as follows:
 
 Three Months
                      Ended September 30,
                    
                    
                    Nine months
                      Ended September 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Milk
      powder
                    
                    $
                    11,111,272
                    
                    
                    $
                    8,922,796
                    
                    
                    $
                    35,053,092
                    
                    
                    $
                    27,318,421Soybean
      milk powder
                    
                    
                    388,002
                    
                    
                    
                    267,138
                    
                    
                    
                    1,077,993
                    
                    
                    
                    822,026Rice
      powder
                    
                    
                    338,810
                    
                    
                    
                    319,942
                    
                    
                    
                    1,241,042
                    
                    
                    
                    954,482Sub-contract
      processing
                    
                    
                    1,058,935
                    
                    
                    
                    648,128
                    
                    
                    
                    3,087,250
                    
                    
                    
                    2,166,562$
                    12,897,019
                    
                    
                    $
                    10,158,004
                    
                    
                    $
                    40,459,377
                    
                    
                    $
                    31,261,491
  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 94.2%, 3.1% and 2.7%of our sales,
respectively. Through our network of over 1,100 salespeople, our products are
distributed throughout 20 provinces in the People’s Republic of China (“PRC”),
and sold in over 6,000 retail outlets.
 
 Our
products are marketed under two brand names:
 
 ·
              “Xing
      An Ling,” which is designed for high-end customers;
  and
  ·
              “Yi
      Bai,” which is designed for middle and low-end
  customers.
  The
Chinese government has initiated programs to promote milk consumption and is
providing incentives to increase dairy production. The dairy market is one of
the fastest growing markets in the PRC. It has been growing at a rate of 16% per
year over the past six years, according to the National Bureau of Statistics of
China, and is expected to grow at a rate of 15% per year for the foreseeable
future. We focus on the infant formula segment of the market, which, according
to the Dairy Association of China, has grown even faster in recent years, at a
rate of 20%-30% per year. Currently, it is estimated that demand for infant
formula in the PRC outstrips supply by at least 2-to-1.
 
 We have
received an Infant & Baby Formula Milk Powder Production Permit from the
State General Administration of Quality Supervision and Inspection and
Quarantine of the PRC. Only current license holders are permitted to produce
formula milk powder in the PRC.
  23
 
 Because
of our close proximity to our sources of fresh milk, we are able to complete the
production process in approximately 30-35 hours, which is faster than
competitors of ours that are not similarly situated. We produced approximately
7,000 tons of milk powder at our facility in Be’ian City, Heilongjiang Province,
PRC in fiscal 2007, up from approximately 5,000 tons in fiscal 2006. By adding a
third shift to the existing two shifts working schedule, we produced
approximately 9,000 tons of milk powder in each of fiscal 2008 and 2009. During
the first nine months of 2010 we produced an aggregate of approximately 7,000
tons of milk powder. Due to the commencement of production at our new production
facility (as further described below), we expect to have produced a total of
between 10,000 and 11,000 tons of milk powder by the end of fiscal
2010.
 
 All of
our business is conducted through our wholly-owned Chinese
subsidiaries:
 
 ·
              Heilongjiang
      Xing An Ling Dairy, Co., a PRC company (“XAL”), which handles our
      promotion, sales and administrative
functions;
  ·
              Heilongjiang
      Be’ian Nongken Changxing Lvbao Dairy Limited Liability Company, a PRC
      company (“Lvbao”), which handles production of our products at our
      production facility in Be’ian City, Heilongjiang Province, PRC;
      and
  ·
              Hailun
      Xinganling Dairy Co., Ltd., a PRC company (“HXD”), which handles
      production of our products at our new production facility in Hailun City,
      Heilongjiang Province, PRC.
  We have
experienced tremendous growth well above the industry average during recent
years. Sales increased from approximately $7.9 million in 2005 to approximately
$44.7 million in 2009, a 466% increase over four years. Net income increased
from approximately $0.7 million in 2005 to approximately $4.2 million in 2009, a
500% increase over four years.
 
 Recent
Developments
  Commencement
of Production at Hailun City Production Facility
  In
November 2010, we commenced production at our new production facility in Hailun
City, Heilongjiang Province, PRC. Currently,this new facility has one production
line, with the capacity to produce over 9,000 tons of milk power annually. This
first phase of this project has cost us an aggregate of approximately $22.0
million, including land use rights, construction expenses and equipment
costs.
  A second
production line can be added at this new facility, which, when completed, would
enable us to produce in excess of an additional 9,000 tons of milk powder per
year. Although there can be no assurance that we will add a second production
line to our new facility, we currently intend to do so. If we were to add a
second production line at this new facility it would enable us to produce over
9,000 additional tons of milk powder per year, giving us a total annual
production capacity of approximately 29,000 tons of milk powder. We expect the
cost to add a second production line at our Hailun City production facility to
be approximately $15.0 million. We plan to fund the second production line with
a combination of retained earnings and, to the extent necessary, funds raised
from the capital market through private or public equity offerings, private or
public debt offerings and/or equipment lease transactions. There can be no
assurance that that any additional financing will become available to us, and if
available, on terms acceptable to us.
  24
  Trends
and Uncertainties
 
 Economic
Downturn
 
 The
worldwide economic downturn and market instability, which began in 2008, have
made the business climate more volatile and more costly. Although all of our
business operations are currently conducted in the PRC, our general business
strategy, as well as our results of operations and financial condition, may be
adversely affected by unpredictable and unstable market conditions. If the
current equity and credit markets deteriorate, or do not improve from current
levels, it may make it difficult, if not impossible, for us to obtain debt or
equity financing on acceptable terms at a time when we wish to do so. Failure to
secure any necessary financing in a timely manner and on favorable terms could
have a material adverse effect on our growth strategy, financial performance and
stock price and could require us to delay or abandon our expansion plans. We do
not expect this economic downturn to have a significant effect on our business
or operations in the near future.However, we cannot predict
the timing or duration of any economic slowdown or recession or the timing or
strength of a subsequent recovery, worldwide, or in the specific markets we
serve. If the markets for our products significantly deteriorate due to these
economic effects, our business, financial condition and results of operations
may be materially and adversely affected.
 
 Narrowing
of Gap in Milk Consumption
 
 The
Chinese government has initiated programs to promote milk consumption and is
providing incentives to increase dairy production. In addition to improving the
overall health of its populous, the government views increased dairy production
as a means of improving employment in rural areas thus improving social
stability. The programs are designed to narrow the significant gap between the
PRC’s per capita milk consumption of 15 kg per person and the global average of
100 kg per person. We believe this initiative will continue to provide us with
growth opportunities.
 
 Industry
Growth
 
 The dairy
market is one of the fastest growing markets in the PRC. It has been growing at
a rate of 16% per year over the past six years, according to the National Bureau
of Statistics of China, and is expected to grow at a rate of 15% per year for
the foreseeable future. On its website, the Dairy Association of China estimates
that the infant formula market segment, which is the market segment we target,
has grown even faster in recent years, at a rate of 20%-30% per year. We believe
the following three factors are the main drivers of the infant formula
market:
 
 ·
              Increased
      household income made infant formula more affordable in the
      PRC;
 
 ·
              Increased
      number of working mothers or busy mothers created more demands for infant
      formula products; and
 
 ·
              Increased
      popularity and acceptance of infant formula
  products.
 
 Based on
these factors, we expect to see significant growth in our business and
operations when we commence production at our new production facility in Hailun
City. However, a slowdown in overall economic growth, an economic downturn or
recession or other adverse economic developments in the PRC may materially
reduce the demand for our products and materially and adversely affect our
business.
 
 Supply
of Infant Formula
 
 It is
estimated that the demand for infant formula in the PRC outstrips supply by at
least 2-to-1.  In recent years, our production capabilities have not
been able to keep up with demand for our products. In November 2010, the first
production line at our new facility in Hailun City became operational, which
will enable us to increase our annual production capacity of milk powder by over
9,000 tons. 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.
  25
 
 Product
Pricing and Raw Material Supply
 
 Historically
we have been able to obtain sufficient raw milk and other raw materials to meet
our production needs. The price of raw milk is affected by regional market in
Heilongjiang Province, PRC, while other raw materials are affected by global
markets. We expect that the raw materials we require to produce our products
will continue to be readily available to us for the foreseeable future. In
fiscal 2009, the price of certain raw materials we use declined. We believe the
prices of the raw materials we use to produce our products will stay relatively
stable for the foreseeable future.
 
 Brand
Name and Product Quality
 
 There are
more than 30 brand names of infant formula products sold in the PRC. Most of our
international and larger competitors have been concentrating in the first tier
cities, or well-known urban centers such as Beijing and Shanghai. The rest of
the Chinese domestic companies in the industry, including us, have been focusing
on less developed second and third tier cities where competition is less severe
than the top tier cities. As consumers have many options for infant formula
products, infant formula producers with better quality and safety images have
the advantages to sell their product at higher price. Brand image and
recognition are increasingly important in gaining customer loyalty. We plan to
continue to focus on penetrating less-competitive second and third tier
cities.
 
 Organic
Label Milk Products
 
 Historically,
there have been 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 recently began commercializing an organic
label product line. Initially, we expect sales of organic milk powder to be
insignificant. However, over the long term, we believe that, similar to the
growth of the organic milk market in the U.S., organic milk products will become
increasingly popular in the PRC. Over time, we believe 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.
  26
  Contamination
of Milk Powder Products Produced in the PRC
 
 In
mid-2008, a number of milk powder products produced within the PRC were found to
contain unsafe levels of tripolycyanamide, also known as melamine, sickening
thousands of infants. This prompted the Chinese government to conduct a
nationwide investigation into how the milk powder was contaminated, and caused a
worldwide recall of certain milk powder products produced within the
PRC.  On September 16, 2008, China’s Administration of Quality
Supervision, Inspection and Quarantine (AQSIQ) revealed that it had tested
samples from 175 dairy manufacturers, and published a list of 22 companies whose
products contained melamine. We passed the emergency inspection and were not
included on AQSIQ’s list. The contraction in the Chinese milk powder industry
caused by this crisis has lead to increased demand for our products. However, we
can not be certain that the illnesses caused by contamination in the milk powder
industry, whether or not related to our products, will not lead to decreased
demand for milk powder products produced within the PRC, thereby having a
material adverse effect on our business.
 
 Results
of Operations
 
 Three-Month
Period Ended September 30, 2010 Compared to Three-Month Period Ended September
30, 2009
 
 The
following summarizes changes in our operations for the three months ended
September 30, 2010 and 2009.  Net income increased by $587,462, from
$884,625 in the three months ended September 30, 2009, to $1,472,087 for the
three months ended September 30, 2010. The increase in net income during the
three months ended September 30, 2010, as compared to the same time period in
the prior year, was due to an increase in our gross profit as well as other
factors further described below.
  Sales
and Cost of Goods Sold
 
 For the Three Months
                                      Ended September 30,2010
                                    
                                    2009Sales
                                    
                                    $
                                    12,897,019
                                    
                                    
                                    $
                                    10,158,004Cost
      of Goods Sold
                                    
                                    
                                    6,408,452
                                    
                                    
                                    
                                    5,569,598Gross
      Profit
                                    
                                    $
                                    6,488,567
                                    
                                    
                                    $
                                    4,588,406
 
 Sales. Sales volume increased
by 344 metric tons, or 17.6%, period on period, to 2,302 metric tons for the
three months ended September 30, 2010, from 1,958 metric tons for the three
months ended September 30, 2009. Sales revenues increased by $2,739,015, or
27.0%, from $10,158,004 in the three months ended September 30, 2009, to
$12,897,019 for the three months ended September 30, 2010. These increases were
primarily due to increased demand for our products as well as an increase in the
average selling price for all of our products of $415 per metric ton, as
compared to the three months ended September 30, 2009, resulting from increased
sales of our middle and lower end products and better average selling prices for
subcontracting.
  27
 
 Sales by product
line.A break-down of our sales by product line for the three
months ended September 30, 2010 and 2009 is as follows:
 
 Three Months Ended September 30,2010
                                
                                
                                2009
                                
                                
                                Period-on-periodProduct category
                                
                                Quantity
                                  (tons)
                                
                                
                                $ Amount
                                
                                
                                % of sales
                                
                                
                                Quantity
                                  (tons)
                                
                                
                                $ Amount
                                
                                
                                % of
                                  sales
                                
                                
                                Qty.
                                  VarianceMilk
      powder
                                
                                
                                1,724
                                
                                
                                
                                11,111,272
                                
                                
                                
                                86.2
                                
                                
                                
                                1,421
                                
                                
                                
                                8,922,796
                                
                                
                                
                                87.9
                                
                                
                                
                                303Rice
      powder
                                
                                
                                68
                                
                                
                                
                                388,002
                                
                                
                                
                                3.0
                                
                                
                                
                                56
                                
                                
                                
                                319,942
                                
                                
                                
                                3.1
                                
                                
                                
                                12Soybean
      powder
                                
                                
                                205
                                
                                
                                
                                338,810
                                
                                
                                
                                2.6
                                
                                
                                
                                163
                                
                                
                                
                                267,138
                                
                                
                                
                                2.6
                                
                                
                                
                                42Subcontracting
                                
                                
                                305
                                
                                
                                
                                1,058,935
                                
                                
                                
                                8.2
                                
                                
                                
                                318
                                
                                
                                
                                648,128
                                
                                
                                
                                6.4
                                
                                
                                
                                (13
                                )Total
                                
                                
                                2,302
                                
                                
                                
                                12,897,019
                                
                                
                                
                                100.0
                                
                                
                                
                                1,958
                                
                                
                                
                                10,158,004
                                
                                
                                
                                100.0
                                
                                
                                
                                344
 
 There
were various changes to the break-down of sales among our product lines over the
three months ended September 30, 2010, as we increased production in most all
lines. Milk powder accounted for 86.2% of third quarter 2010 sales mix, at
an average selling price of $6,445 per metric ton, as compared to 87.9% of our
third quarter 2009 sales mix, at an average selling price of $6,279 per metric
ton. Rice powder accounted for 3.0% of our sales mix for the three months ended
September 30, 2010, at an average selling price of $5,706 per metric ton, as
compared to 3.1% of our sales mix in the three months ended September 30, 2009,
at an average selling price of $5,713 per metric ton. Soybean powder accounted
for 2.6% of our sales mix for the three months ended September 30, 2010, at an
average selling price of $1,653 per metric ton, as compared to 2.6% of our sales
mix in the three months ended September 30, 2009, at an average selling price of
$1,639 per metric ton. We increased our subcontract production during the
three months ended September 30, 2010 to 8.2% of the sales mix, at an average
selling price of $3,472 per metric ton, as compared to 6.4% of the sales mix in
the three months ended September 30, 2009, at an average sales price of $2,038
per metric ton. The primary reason for the increase in our sales from
subcontracting was that we began extending relationships with other companies
for which we can subcontract to help absorb the extra production capacity we
have at our new production facility.
  A
breakdown of our average selling price by product line for the three months
ended September 30, 2010 and 2009 is as follows:
  Three Months Ended
                                    September 30,Average selling prices
                                  
                                  2010
                                  
                                  
                                  2009
                                  
                                  
                                  Variance$
                                  
                                  
                                  $
                                  
                                  
                                  $
                                  
                                  
                                  
                                  %Milk
      powder
                                  
                                  
                                  6,445
                                  
                                  
                                  
                                  6,279
                                  
                                  
                                  
                                  166
                                  
                                  
                                  
                                  2.6Rice
      powder
                                  
                                  
                                  5,706
                                  
                                  
                                  
                                  5,713
                                  
                                  
                                  
                                  (7
                                  )
                                  
                                  
                                  (0.1
                                  )Soybean
      powder
                                  
                                  
                                  1,653
                                  
                                  
                                  
                                  1,639
                                  
                                  
                                  
                                  14
                                  
                                  
                                  
                                  0.9Subcontracting
                                  
                                  
                                  3,472
                                  
                                  
                                  
                                  2,038
                                  
                                  
                                  
                                  1,434
                                  
                                  
                                  
                                  70.4Total
                                  
                                  
                                  5,603
                                  
                                  
                                  
                                  5,188
                                  
                                  
                                  
                                  415
                                  
                                  
                                  
                                  7.9
 
 Cost of Goods
Sold.  Cost of goods sold increased by $838,854, or 15.1%, from
$5,569,598 in the three months ended September 30, 2009, to $6,408,452 for the
three months ended September 30, 2010. This increase was directly related to our
increased production during the three months ended September 30, 2010. Overall
our cost per metric ton of goods sold decreased by $76, or 2.7%, to $2,769 per
metric ton in the three months ended September 30, 2010, as compared to $2,845
per metric ton in three months ended September 30, 2009, due to decreases in the
price of raw materials we use to produce our products. We expect the prices of
the raw materials we use to produce our products to stay relatively stable for
the foreseeable future.
  28
  A
breakdown of cost of sales by product line for the three months ended September
30, 2010 and 2009 is as follows:
  Three Months Ended September 30,2010
                                              
                                              
                                              2009
                                              
                                              
                                              Variance$
                                              
                                              
                                              $
                                              
                                              
                                              $
                                              
                                              
                                              
                                              %Cost
      of salesMilk
      powder
                                              
                                              
                                              5,151,197
                                              
                                              
                                              
                                              4,511,008
                                              
                                              
                                              
                                              640,189
                                              
                                              
                                              
                                              14.2Rice
      powder
                                              
                                              
                                              175,399
                                              
                                              
                                              
                                              125,467
                                              
                                              
                                              
                                              49,932
                                              
                                              
                                              
                                              39.8Soybean
      powder
                                              
                                              
                                              225,799
                                              
                                              
                                              
                                              185,513
                                              
                                              
                                              
                                              40,286
                                              
                                              
                                              
                                              21.7Subcontracting
                                              
                                              
                                              856,057
                                              
                                              
                                              
                                              747,610
                                              
                                              
                                              
                                              108,447
                                              
                                              
                                              
                                              14.5Total
                                              
                                              
                                              6,408,452
                                              
                                              
                                              
                                              5,569,598
                                              
                                              
                                              
                                              838,854
                                              
                                              
                                              
                                              15.1Cost
      per units sold (per ton)Milk
      powder
                                              
                                              
                                              2,998
                                              
                                              
                                              
                                              3,175
                                              
                                              
                                              
                                              (187
                                              )
                                              
                                              
                                              (5.9
                                              )Rice
      powder
                                              
                                              
                                              2,579
                                              
                                              
                                              
                                              2,240
                                              
                                              
                                              
                                              339
                                              
                                              
                                              
                                              (15.1
                                              )Soybean
      powder
                                              
                                              
                                              1,101
                                              
                                              
                                              
                                              1,138
                                              
                                              
                                              
                                              (37
                                              )
                                              
                                              
                                              3.3Subcontracting
                                              
                                              
                                              2,807
                                              
                                              
                                              
                                              2,351
                                              
                                              
                                              
                                              456
                                              
                                              
                                              
                                              19.4Average
      cost per unit sold
                                              
                                              
                                              2,784
                                              
                                              
                                              
                                              2,845
                                              
                                              
                                              
                                              (61
                                              )
                                              
                                              
                                              (2.1
                                              )
  Gross Profit. Gross profit was
$6,488,567, or 50.3% of our sales for the three months ended September 30, 2010,
as compared to gross profit of $4,588,406, or 45.2% of sales, for the three
months ended September 30, 2009. During the three months ended September 30,
2010, our gross margin on milk powder increased to 53.6%, from 49.4% in the same
period of the prior year, due to a 5.9% decrease in cost per metric ton of our
products as well as an increase in average selling price of 2.6%. The gross
margin for subcontracting increased 34.5% to 19.2% in the three months ended
September 30, 2010, as compared to (15.3)% in the three months ended September
30, 2009, due to a decrease in the average cost per ton of 2.1% in the three
months ended September 30, 2010 as compared to the same period in 2009, as well
as an increase in the average selling price of 70.4%.
 
 A
breakdown of gross margin by product line for the three months ended September
30, 2010 and 2009 is as follows:
  Three Months Ended September 30,2010
                                    
                                    
                                    2009
                                    
                                    
                                    Period-on-periodProduct category
                                    
                                    $ Amount
                                    
                                    
                                    Gross
                                      Margin %
                                    
                                    
                                    $ Amount
                                    
                                    
                                    Gross
                                      Margin %
                                    
                                    
                                    Margin
                                      VarianceMilk
      powder
                                    
                                    
                                    5,960,075
                                    
                                    
                                    
                                    53.6
                                    
                                    
                                    
                                    4,411,788
                                    
                                    
                                    
                                    49.4
                                    
                                    
                                    
                                    4.2Rice
      powder
                                    
                                    
                                    212,603
                                    
                                    
                                    
                                    54.8
                                    
                                    
                                    
                                    194,475
                                    
                                    
                                    
                                    60.8
                                    
                                    
                                    
                                    6.0Soybean
      powder
                                    
                                    
                                    113,011
                                    
                                    
                                    
                                    33.4
                                    
                                    
                                    
                                    81,625
                                    
                                    
                                    
                                    30.6
                                    
                                    
                                    
                                    2.8Subcontracting
                                    
                                    
                                    202,878
                                    
                                    
                                    
                                    19.2
                                    
                                    
                                    
                                    (99,482
                                    )
                                    
                                    
                                    (15.3
                                    )
                                    
                                    
                                    34.5Total
                                    
                                    
                                    6,488,567
                                    
                                    
                                    
                                    50.3
                                    
                                    
                                    
                                    4,588,406
                                    
                                    
                                    
                                    45.2
                                    
                                    
                                    
                                    5.1
  Operating
Expenses
 
 For the Three Months
                          Ended September 30,2010
                        
                        
                        2009Operating ExpensesSelling
      and administrative expenses
                        
                        $
                        3,999,971
                        
                        
                        $
                        3,348,522Depreciation
      and amortization
                        
                        
                        51,404
                        
                        
                        
                        43,595Total
      operating expenses
                        
                        $
                        4,051,375
                        
                        
                        $
                        3,392,117
  29
 
 Selling Expenses. Selling
expenses overall increased by $775,510, or 31.3%, from $2,478,002 in the three
months ended September 30, 2009, to $3,253,512 for the three months ended
September 30, 2010. The major factors in the increase in selling expenses are as
follows:
 
 ·
              Advertising
      increased by $200,282, or 81.4%, to $446,230 in 2010, from $245,948 in
      2009, due to an increased marketing campaign in
  2010.
 
 ·
              Promotion
      expenses increased by $316,120, or 64.6%, to $805,235 in 2010, from
      $489,115 in 2009, as we increased our marketing efforts as compared to
      2009.
 
 ·
              Outdoor
      promotion expenses increased by $27,923, or 12.0%, to $260,791 in 2010,
      from $232,868 in 2009, as a result of our increased marketing campaign in
      2010.
 
 ·
              Selling
      salary expenses increased by $82,932, or 15.5%, to $618,428 in 2010, from
      $535,496 in 2009, as a result of our increased marketing campaign in
      2010.
 
 Rather
than using a wholesaler, our sales people deal directly with the retail
outlets.  This business model has higher sales expenses compared to
the traditional business model, but creates better profit margins for
us.
 
 Administrative Expenses.
Administrative expenses decreased by $114,566, or 13.3%, from $861,023 in three
months ended September 30, 2009, to $746,457 for the three months ended
September 30, 2010. The major factors in the increase in administrative expenses
are as follows:
 
 ·
              Decrease
      in consulting expenses of $77,209, to $146,559 in 2010, from $223,768 in
      2009, as a result of decreasing use of consultants during
      2010.
 
 ·
              Decrease
      in legal and accounting expenses of $128,601, to $108,320 in 2010, from
      $236,921 in 2009, as a result of decreased use of professional services
      during 2010.
 
 These
increases were partially offset by an increase of $94,135 in stock option
expense as compared with 2009 and an increase in salaries of $14,529 as compared
with 2009.
  Provision
for Income Taxes
 
 For the Three Months
                        Ended September 30,2010
                      
                      
                      2009Provision
      for Income TaxesCurrent
                      
                      $
                      411,266
                      
                      
                      $
                      245,054Deferred
                      
                      
                      -
                      
                      
                      
                      -$
                      411,266
                      
                      
                      $
                      245,054
 
 Provision for Income Taxes.
Income taxes increased by $166,212, or 67.8%, from $245,054 for the three months
ended September 30, 2009, to $411,266 for the three months ended September 30,
2010. This increase was due to the increase in our taxable income in our
operating subsidiaries. XAL, our wholly owned subsidiary, has been enjoying a
50% tax holiday in the fiscal years ended December 31, 2009 and 2010. This tax
holiday will expire in January 2011, which we expect will increase our taxes and
therefore negatively affect our net income.
  30
  Nine-Month
Period Ended September 30, 2010 Compared to Nine-Month Period Ended September
30, 2009
 
 The
following summarizes changes in our operations for the nine months ended
September 30, 2010 and 2009.  Net income decreased by $3,241,078, from
$3,700,467 in the nine months ended September 30, 2009, to $459,389 for the nine
months ended September 30, 2010. The decrease in net income during the nine
months ended September 30, 2010, as compared to the same time period in the
prior year, was due to liquidated damages we incurred during the current year
period in connection with the extension of the expiration dates of certain of
our issued and outstanding warrants, which offset an increase in our gross
profit as further described below.
  Sales
and Cost of Goods Sold
 
 For the Nine Months
                          Ended September 30,2010
                        
                        2009Sales
                        
                        $
                        40,459,377
                        
                        
                        $
                        31,261,491Cost
      of Goods Sold
                        
                        
                        20,356,931
                        
                        
                        
                        17,057,583Gross
      Profit
                        
                        $
                        20,102,446
                        
                        
                        $
                        14,203,908
 
 Sales. Sales volume increased
by 1,367 metric tons, or 22.8%, period on period, to 7,354 metric tons for the
nine months ended September 30, 2010, from 5,987 metric tons for the nine months
ended September 30, 2009. Sales revenues increased by $9,197,886, or 29.4%,
from $31,261,491 in the nine months ended September 30, 2009, to $40,459,377 for
the nine months ended September 30, 2010. This increase was due to an increase
the quantity of products we sold by 1,367 metric tons, as well as an increase in
the average selling price for all of our products, by $280 per metric ton, as
compared to the nine months ended September 30, 2009, as a result producing more
of our high end product line in the first nine months of fiscal 2010 as a
whole.
 
 Sales by product
line.A break-down of our sales by product line for the nine
months ended September 30, 2010 and 2009 is as follows:
 
 Nine Months Ended September 30,2010
                                      
                                      
                                      2009
                                      
                                      
                                      Period-on-periodProduct category
                                      
                                      Quantity
                                        (tons)
                                      
                                      
                                      $ Amount
                                      
                                      
                                      % of sales
                                      
                                      
                                      Quantity
                                        (tons)
                                      
                                      
                                      $ Amount
                                      
                                      
                                      % of
                                        sales
                                      
                                      
                                      Qty.
                                        VarianceMilk
      powder
                                      
                                      
                                      5,504
                                      
                                      
                                      
                                      35,053,092
                                      
                                      
                                      
                                      86.6
                                      
                                      
                                      
                                      4,454
                                      
                                      
                                      
                                      27,318,421
                                      
                                      
                                      
                                      87.4
                                      
                                      
                                      
                                      1,050Rice
      powder
                                      
                                      
                                      218
                                      
                                      
                                      
                                      1,241,042
                                      
                                      
                                      
                                      3.1
                                      
                                      
                                      
                                      168
                                      
                                      
                                      
                                      954,482
                                      
                                      
                                      
                                      3.1
                                      
                                      
                                      
                                      50Soybean
      powder
                                      
                                      
                                      656
                                      
                                      
                                      
                                      1,077,993
                                      
                                      
                                      
                                      2.7
                                      
                                      
                                      
                                      472
                                      
                                      
                                      
                                      822,026
                                      
                                      
                                      
                                      2.6
                                      
                                      
                                      
                                      184Subcontracting
                                      
                                      
                                      976
                                      
                                      
                                      
                                      3,087,250
                                      
                                      
                                      
                                      7.6
                                      
                                      
                                      
                                      893
                                      
                                      
                                      
                                      2,166,562
                                      
                                      
                                      
                                      6.9
                                      
                                      
                                      
                                      83Total
                                      
                                      
                                      7,354
                                      
                                      
                                      
                                      40,459,377
                                      
                                      
                                      
                                      100.0
                                      
                                      
                                      
                                      5,987
                                      
                                      
                                      
                                      31,261,491
                                      
                                      
                                      
                                      100.0
                                      
                                      
                                      
                                      1,367
  31
  There
were various changes to the break-down of sales among our product lines over the
nine months ended September 30, 2010, as we increased production in all lines,
but attempted to adjust our sales mix to higher margin products. Milk
powder accounted for 86.6% of the 2010 sales mix, at an average selling price of
$6,369 per metric ton, as compared to 87.4% in 2009, at an average selling price
of $6,133 per metric ton. Rice powder accounted for 3.1% of our sales mix for
the nine months ended September 30, 2010, at an average selling price of $5,693
per metric ton, as compared to 3.1% of our sales mix in the nine months ended
September 30, 2009, at an average selling price of $5,681 per metric
ton. Soybean powder accounted for 2.7% of our sales mix for the nine months
ended September 30, 2010, at an average selling price of $1,643 per metric ton,
as compared to 2.6% of our sales mix in the nine months ended September 30,
2009, at an average selling price of $1,742 per metric ton.  We increased
our subcontract production during the nine months ended September 30, 2010 to
7.6% of the sales mix, at an average selling price of $3,163 per metric ton, as
compared to 6.9% of the sales mix in the nine months ended September 30, 2009,
at an average sales price of $2,426 per metric ton. The primary reason for the
increase in our sales from subcontracting was that we began extending
relationships with other companies for which we can subcontract to help absorb
the excess production capacity we have at our new facility.
  A
breakdown of our average selling price by product line for the nine months ended
September 30, 2010 and 2009 is as follows:
  Nine Months Ended
                                September 30,Average selling prices
                              
                              2010
                              
                              
                              2009
                              
                              
                              Variance$
                              
                              
                              $
                              
                              
                              $
                              
                              
                              
                              %Milk
      powder
                              
                              
                              6,369
                              
                              
                              
                              6,133
                              
                              
                              
                              236
                              
                              
                              
                              3.8Rice
      powder
                              
                              
                              5,693
                              
                              
                              
                              5,681
                              
                              
                              
                              12
                              
                              
                              
                              0.2Soybean
      powder
                              
                              
                              1,643
                              
                              
                              
                              1,742
                              
                              
                              
                              (99
                              )
                              
                              
                              (5.7
                              )Subcontracting
                              
                              
                              3,163
                              
                              
                              
                              2,426
                              
                              
                              
                              737
                              
                              
                              
                              30.4Total
                              
                              
                              5,502
                              
                              
                              
                              5,222
                              
                              
                              
                              280
                              
                              
                              
                              5.4
 
 Cost of Goods
Sold.  Cost of goods sold increased by $3,299,348, or 19.3%,
from $17,057,583 in the nine months ended September 30, 2009, to $20,356,931 for
the nine months ended September 30, 2010. This increase was directly related to
our increased production during the nine months ended September 30, 2010.
Overall our cost per metric ton decreased by $81, or 2.8%, to $2,768 per metric
ton in the nine months ended September 30, 2010, as compared to $2,849 per
metric ton in nine months ended September 30, 2009, due to decreases in the
price of raw materials we use to produce our products We expect the prices of
the raw materials we use to produce our products to stay relatively stable for
the foreseeable future.
 
 A
breakdown of cost of sales by product line for the years ended September 30,
2010 and 2009 is as follows:
  Nine Months Ended September 30,2010
                              
                              
                              2009
                              
                              
                              Variance$
                              
                              
                              $
                              
                              
                              $
                              
                              
                              
                              %Cost
      of salesMilk
      powder
                              
                              
                              16,444,332
                              
                              
                              
                              13,887,172
                              
                              
                              
                              2,557,160
                              
                              
                              
                              18.4Rice
      powder
                              
                              
                              486,683
                              
                              
                              
                              374,307
                              
                              
                              
                              112,376
                              
                              
                              
                              30.0Soybean
      powder
                              
                              
                              748,606
                              
                              
                              
                              616,126
                              
                              
                              
                              132,480
                              
                              
                              
                              21.5Subcontracting
                              
                              
                              2,677,310
                              
                              
                              
                              2,179,978
                              
                              
                              
                              497,332
                              
                              
                              
                              22.8Total
                              
                              
                              20,356,931
                              
                              
                              
                              17,057,583
                              
                              
                              
                              3,299,348
                              
                              
                              
                              19.3Cost
      per units sold(per ton)Milk
      powder
                              
                              
                              2,988
                              
                              
                              
                              3,118
                              
                              
                              
                              (130
                              )
                              
                              
                              (4.2
                              )Rice
      powder
                              
                              
                              2,232
                              
                              
                              
                              2,228
                              
                              
                              
                              4
                              
                              
                              
                              0.2Soybean
      powder
                              
                              
                              1,141
                              
                              
                              
                              1,305
                              
                              
                              
                              (164
                              )
                              
                              
                              (12.6
                              )Subcontracting
                              
                              
                              2,743
                              
                              
                              
                              2,441
                              
                              
                              
                              302
                              
                              
                              
                              12.4Average
      cost per unit sold
                              
                              
                              2,768
                              
                              
                              
                              2,849
                              
                              
                              
                              (81
                              )
                              
                              
                              (2.8
                              )
  32
 
 Gross Profit. Gross profit was
$20,102,446, or 49.7% of our sales for the nine months ended September 30, 2010,
as compared to gross profit of $14,203,908, or 45.4%, for the nine months ended
September 30, 2009. During the nine months ended September 30, 2010, our gross
margin on milk powder increased to 53.1%, from 49.2% in the same period of the
prior year, due to a decrease in the average sales price of 3.8%, while there
was a 4.2% decrease in the cost per metric ton from the nine months ended
September 30, 2009. The gross margin for soybean powder increased 5.6% to
30.6% in the nine months ended September 30, 2010, as compared to 25.0% in the
nine months ended September 30, 2009, due to a decrease in the average cost per
ton of 12.6% in the nine months ended September 30, 2010 as compared to the same
period in 2009.
 
 A
breakdown of gross margin by product line for the years September 30, 2010 and
2009 is as follows:
  Nine Months Ended September 30,2010
                                
                                
                                2009
                                
                                
                                Period-on-periodProduct category
                                
                                $ Amount
                                
                                
                                Gross
                                  Margin %
                                
                                
                                $ Amount
                                
                                
                                Gross
                                  Margin %
                                
                                
                                Margin
                                  VarianceMilk
      powder
                                
                                
                                18,608,760
                                
                                
                                
                                53.1
                                
                                
                                
                                13,431,249
                                
                                
                                
                                49.2
                                
                                
                                
                                3.9Rice
      powder
                                
                                
                                754,359
                                
                                
                                
                                60.8
                                
                                
                                
                                580,175
                                
                                
                                
                                60.8
                                
                                
                                
                                -Soybean
      powder
                                
                                
                                329,387
                                
                                
                                
                                30.6
                                
                                
                                
                                205,900
                                
                                
                                
                                25.0
                                
                                
                                
                                5.6Subcontracting
                                
                                
                                409,940
                                
                                
                                
                                13.3
                                
                                
                                
                                (13,416
                                )
                                
                                
                                (0.6
                                )
                                
                                
                                13.9Total
                                
                                
                                20,102,446
                                
                                
                                
                                49.7
                                
                                
                                
                                14,203,908
                                
                                
                                
                                45.4
                                
                                
                                
                                4.3
 
 Operating
Expenses
 
 For the Nine Months
                          Ended September 30,2010
                        
                        
                        2009Operating ExpensesSelling
      and administrative expenses
                        
                        $
                        11,906,641
                        
                        
                        $
                        9,448,920Liquidated
      damages
                        
                        
                        5,021,669
                        
                        
                        
                        -Depreciation
      and amortization
                        
                        
                        154,356
                        
                        
                        
                        130,107Total
      operating expenses
                        
                        $
                        17,082,666
                        
                        
                        $
                        9,579,027
 
 Selling Expenses. Selling
expenses overall increased by $2,227,207, or 30.5%, from $7,291,862 in the nine
months ended September 30, 2009, to $9,519,069 for the nine months ended
September 30, 2010. The major factors in the decrease in selling expenses are as
follows:
 
 ·
              Advertising
      increased by $506,119, or 68.6%, to $1,243,792 in 2010, from $737,673 in
      2009, due to an increased marketing campaign in
  2010.
 
 ·
              Promotion
      expenses increased by $913,276, or 74.3%, to $2,141,879 in 2010, from
      $1,228,603 in 2009, as we increased our marketing efforts as compared to
      2009.
 
 ·
              Outdoor
      promotion expenses increased by $168,895, or 27.1%, to $792,232 in 2010,
      from $623,337 in 2009, as a result of our increased marketing campaign in
      2010.
 
 ·
              Selling
      salary expenses increased by $292,455, or 18.1%, to $1,907,509 in 2010,
      from $1,615,054 in 2009, as a result of our increased marketing campaign
      in 2010.
  33
 
 These
increases were partially offset by a decrease in entertainment expenses of
$45,628, or 13.0%, to $304,528 in 2010, from $350,156 in 2009, as part of
readjusting our marketing campaign.
 
 Rather
than using a wholesaler, our sales people deal directly with the retail
outlets.  This business model has higher sales expenses compared to
the traditional business model, but creates better profit margins for
us.
 
 Administrative Expenses.
Administrative expenses increased by $230,513, or 10.7%, from $2,157,058 in nine
months ended September 30, 2009, to $2,387,571 for the nine months ended
September 30, 2010. The major factors in the increase in administrative expenses
are as follows:
 
 ·
              Increase
      of salary and stock option expenses of $419,574, to $810,064 in 2010, from
      $390,489 in 2009, as a result of additional stock options granted in late
      2009.
 
 ·
              Increase
      in travel expenses of $33,883, to $185,669 in 2010, from $151,786 in 2009,
      as a result of increase in cost of travel during
  2010.
 
 ·
              Increase
      in investor relation expenses of $102,805, to $199,431 in 2010, from
      $96,626 in 2009, as a result of increase in cost of investor relations
      services in 2010.
 
 These
increases were partially offset by a decrease of $162,320 in consultation
expense as compared with 2009 and a decrease in legal and accounting expenses of
$56,857 as compared with 2009. We required less time in preparation of our
regulatory filings in the current year and did not use the services of the
consultant that was used in the 2009.
 
 Liquidated Damages.We
recorded $5,021,669 in liquidated damages during the nine months ended September
30, 2010, as a result of the extension of warrants previously issued by us to
satisfy certain registration rights provisions. See Note 15 of the Notes to
Condensed Consolidated Financial Statements for additional
information.
  Provision
for Income Taxes
 
 For the Nine Months
                          Ended September 30,2010
                        
                        
                        2009Provision
      for Income TaxesCurrent
                        
                        $
                        1,224,008
                        
                        
                        $
                        860,948Deferred
                        
                        
                        -
                        
                        
                        
                        -$
                        1,224,008
                        
                        
                        $
                        860,948
 
 Provision for Income Taxes.
Income taxes increased by $363,060, or 42.2%, from $860,948 for the nine months
ended September 30, 2009, to $1,224,008 for the nine months ended September 30,
2010. This increase was due to the increase in our taxable income in our
operating subsidiaries. XAL, our wholly owned subsidiary, has been enjoying a
50% tax holiday in the fiscal years ended December 31, 2009 and 2010. This tax
holiday will expire in January 2011, which we expect will increase our taxes and
therefore negatively affect our net income.
  34
  Liquidity
and Capital Resources
 
 Uses
of Capital
 
 For the Nine
                            Months Ended
                            September 30,2010
                          
                          
                          2009Net
      cash provided by operating activities
                          
                          $
                          7,191,019
                          
                          
                          $
                          2,101,308Net
      cash used in investing activities
                          
                          $
                          (12,005,586
                          )
                          
                          $
                          (4,194,717
                          )Net
      cash provided by financing activities
                          
                          $
                          5,451,415
                          
                          
                          $
                          4,433,590
 
 Net Cash Provided By Operating
Activities.For the nine months ended September 30, 2010,
$7,191,019 was provided by operating activities, compared with $2,101,308
provided by operating activities for the nine months ended September 30, 2009.
Our net cash flows provided from operating activities during 2010 increased due
to the following factors:
 
 ·
              Operations
      provided $459,389 of net cash during the nine months ended September 30,
      2010.
 
 ·
              Trade
      accounts receivable increased by $799,208, due to the decreased
      collections during the period.
 
 ·
              Inventory
      increased by $300,249, due to adjustments from increased sales of our
      products during the current period.
 
 ·
              Other
      current assets increased by $1,112,306, due the increase in our level of
      production during 2010.
 
 ·
              Accounts
      payable and accrued expenses increased by $1,024,764 at September 30, 2010
      due to increases in production of products and
  expenses.
 
 Net Cash Used In Investing
Activities.For the nine months ended September 30, 2010, we
used $12,005,586 in investing activities, compared with $4,194,717 used in
investing activities for the nine months ended September 30, 2009. The
$12,005,586 was primarily for the construction and equipping of our new
production facility.
 
 Net Cash Provided By Financing
Activities.For the nine months ended September 30, 2010 there
was $5,451,415 provided by financing activities, compared with $4,433,590
provided by financing activities for the nine months ended September 30, 2009.
We raised $296,408 through the exercise of warrants during the nine months ended
September 30, 2010, in connection with the consummation of warrant tender
offers. We also completed the Sale and Leaseback Transaction (described below)
with regard to certain equipment which provided $5,090,026 during the nine
months ended September 30, 2010.
 
 General
 
 Cash and
cash equivalents at September 30, 2010 increased by approximately 8.0% to
$14,559,414, from $13,486,429 at December 31, 2009. Working capital increased
from approximately $17.3 million at December 31, 2009, to approximately $24.4
million at September 30, 2010, which includes cash generated from operations, as
well as funds raised from private offerings of promissory notes and warrants we
consummated in fiscal 2009. Based upon our short term liabilities, we believe
our cash and cash equivalents are adequate to satisfy our working capital needs
and sustain our ongoing operations for the next twelve months.
  35
 
 We
believe that a lack of adequate production capacity has been a significant
impediment to our ability to increase our revenue in recent years. Our growth
strategy for the next three years will be primarily focused on expanding
production capacity and strengthening sales efforts. Management plans to achieve
this strategy by increasing our production capacity through the opening of our
new production facility, and increasing both sales staff and advertising
expenditures.
 
 In
November 2010, we commenced production at our new production facility. The new
facility currently has one production line, which has the capacity to produce
over 9,000 tons of milk power annually. This first phase of this project has
cost us an aggregate of approximately $22.0 million, including land use rights,
construction expenses and equipment costs.
 
 The new
facility has the capacity to handle a second production line. Although there can
be no assurance will add a second production line to our new facility, we
currently intend to do so. If we were to add a second production line at this
new facility it would enable us to produce over 9,000 additional tons of milk
powder per year, giving us a total annual production capacity of approximately
29,000 tons of milk powder. We believe the cost to add a second production line
would be an additional $15.0 million. Although there can be no assurance will
add a second production line to our new facility, we plan to fund the second
production line with a combination of retained earnings and, to the extent
necessary, funds raised from the capital market through private or public equity
offerings, private or public debt offerings and/or equipment lease transactions.
We currently have no sources for the additional financing we would need to add a
second production line at our new processing facility. There can be no assurance
that that any additional financing will become available to us, and if
available, on terms acceptable to us.
 
 Historically
we relied primarily on investments by our Chief Executive Officer and
shareholders, and bank loans, to meet our cash and capital expenditures.
However, as the amount of our capital expenditures increases, we expect to
depend more on the capital markets to raise funds through private and public
offerings of equity and/or debt. There can be no assurance that any future
financing will be available to us when needed, and on commercially reasonable
terms.
 
 In fiscal
2009, we raised approximately $7.7 million through the sale of promissory notes
and exercise of warrants. We used theses funds for the construction
and equipping of our new production facility and for general working capital
purposes.
 
 In fiscal
2010, we:
 
 ·
              entered
      into a loan agreement with an unrelated third party, pursuant to which we
      borrowed $800,000, at an interest rate of 10% per annum (the “June 2010
      Term Loan”); and
 
 ·
              consummated
      a sale and leaseback transaction with Fenghui Leasing Co., Ltd.
      (“Fenghui”), pursuant to which, among other things Fenghui purchased
      certain equipment from HXD, for a purchase price of approximately
      $5,161,176, and Fenghui leased the equipment back to HXD for 36 monthly
      payments of approximately $164,124 (a total of approximately $5,908,464),
      a commission fee of $154,835, and a refundable deposit of $774,176 (the
      “Sale and Leaseback
Transaction”).
  36
 
 We are
applied the proceeds we received from the June 2010 Term Loan and Sale and
Leaseback Transaction to completing the first production line of our new
production facility and for general working capital purposes.
 
 Currently,
we spend approximately 8%-12% of total revenues on advertising and promotional
efforts through out the year. We spent approximately $4.5 million on advertising
and promotion in fiscal 2009. We currently expect to spend an aggregate of
approximately $6.0 million on advertising and promotion in fiscal 2010, of which
we have already spent approximately $4.2 million during the nine months ended
September 30, 2010.
 
 Registration
Rights and Liquidated Damages
 
 We
entered into Registration Rights Agreements with the investors (the “October
2007 Investors”) in the private placements we consummated in October 2007 (the
“October 2007 Private Placements”), pursuant to which we agreed that within
thirty (30) business days of the respective closing date (the “Filing Date”), we
would file a registration statement with the SEC (the “Registration Statement”)
covering the resale of (i) the shares of common stock purchased in the October
2007 Private Placements (the “Purchased Shares”), and (ii) the common stock
issuable upon exercise of the October 2007 Warrants (collectively (i) and (ii),
the “Registrable Securities”). Further, we agreed to use our best efforts to (i)
cause the Registration Statement to be declared effective within ninety (90)
calendar days from the Filing Date, or, if reviewed by the SEC, within one
hundred eighty (180) calendar days after the Filing Date, and (ii) keep the
Registration Statement continuously effective until all of the Registrable
Securities have been sold, or may be sold without volume restrictions pursuant
to Rule 144.
 
 Pursuant
to the Registration Rights Agreements, we were required to pay liquidated
damages to the holders of the Purchased Shares if (i) we failed to file the
Registration Statement on or before the Filing Date, (ii) the SEC did not
declare the Registration Statement effective within ninety (90) days of the
Filing Date (or one hundred eighty (180) days in the event of a review by the
SEC) (the “Effectiveness Date”), (iii) we failed to request acceleration of
effectiveness within five (5) business days of a notice of no further review
from the SEC, (iv) we failed to respond to the SEC within ten (10) business days
of receipt by us of any comments on the Registration Statement, or (v) after it
has been declared effective, the Registration Statement ceases to be effective
or available or if we suspend the use of the prospectus forming a part of the
Registration Statement (A) for more than thirty (30) days in any period of 365
consecutive days if we suspend in reliance on its ability to do so due to the
existence of a development that, in the good faith discretion of its board of
directors, makes it appropriate to so suspend or which renders us unable to
comply with SEC requirements, or (B) for more than ninety (60) days in any
period of 365 consecutive days for any reason. The liquidated damages accumulate
at the rate of one and one-half percent (1.5%) of the purchase price paid by the
October 2007 Investors for units of our securities purchase in the October 2007
Private Placements for each thirty (30) day period during which a registration
default is continuing; provided, however, that (i) we would not be liable for
liquidated damages with respect to any warrants or shares of common stock
underlying the warrants, and (ii) in no event would we be liable for liquidated
damages in excess of 1.5% of the aggregate purchase price of the securities
purchased in the October Offerings in any 30 day period, and (iii) the maximum
aggregate liquidated damages payable to any of the October 2007 Investors shall
be 20% of the aggregate purchase price paid by such purchaser. The Registration
Rights Agreements further required that if we failed to pay any partial
liquidated damages in full within seven days after the date payable, we will pay
interest thereon at a rate of 15% per annum, until such amounts, plus all such
interest thereon, are paid in full.
 
 We did
not satisfy these registration requirements and, as a result, accrued a total of
$1,201,998 in liquidated damages and $172,900 in interest. As of October 5,
2009, we issued an aggregate of 775,833 shares in full payment of the liquidated
damages and interest.
  37
 
 On
January 28, 2010, a Registration Statement we filed to register the Registrable
Securities for resale was declared effective by the SEC. Pursuant to Section
10(a)(3) of the Securities Act of 1933, as amended (the “Securities Act”), we
must now file a post-effective amendment to the Registration Statement
(“Post-Effective Amendment”) to update the financial statements and other
information included in the Registration Statement, and to eliminate or modify
information regarding the selling stockholders listed in the Registration
Statement. We plan to file the Post-Effective Amendment as soon as
practicable.
 
 Changes
in foreign exchange regulations in the PRC and ability to pay dividends in
foreign currency or conduct other foreign exchange business
 
 The
Renminbi is currently not a freely convertible currency, and the restrictions on
currency exchange may limit our ability to use revenues generated in RMB to fund
our business activities outside the PRC, or to make dividends or other payments
in United States dollars. The PRC government strictly regulates conversion of
RMB into foreign currencies. Over the years, foreign exchange regulations in the
PRC have significantly reduced the government’s control over routine foreign
exchange transactions under current accounts. In the PRC, SAFE, regulates the
conversion of the RMB into foreign currencies. Pursuant to applicable PRC laws
and regulations, foreign invested enterprises incorporated in the PRC are
required to apply for “Foreign Exchange Registration Certificates.” Currently,
conversion within the scope of the “current account” (e.g. remittance of foreign
currencies for payment of dividends, etc.) can be effected without requiring the
approval of SAFE. However, conversion of currency in the “capital account” (e.g.
for capital items such as direct investments, loans, securities, etc.) still
requires the approval of SAFE.  See the discussion in Risk Factors
commencing on page 14 of Amendment No. 1 to our Annual Report on Form 10-K for
the fiscal year ended December 31, 2009 (the “Form 10-K/A”) for more
information.
 
 Warrants
 
 As of the
date hereof, we have outstanding exercisable warrants to purchase an aggregate
of 8,028,651 shares of our common stock, of which:
  ·
              833,811
      are exercisable at a price of $1.50 per
share;
  ·
              2,233,891
      are exercisable at a price of $1.63 per
share;
  ·
              1,637,600
      are exercisable at a price of $1.65 per share (and an additional 80,000 to
      be exercisable at a price of $1.65 per share, which vestas to one third of
      the underlying shares on each of December 31, 2010 and March 31,
      2011);
  ·
              875,515
      are exercisable at a price of $2.04 per
share;
  ·
              75,000
      are exercisable at a price of $2.61 per share;
  and
  ·
              2,372,834
      are exercisable at a price of $3.26 per
share.
  If all of
the vested warrants are exercised, we will receive gross proceeds of
approximately $17,311,000, although there can be no assurance that any of these
warrants will be exercised.
  38
  Promissory
Notes
 
 Sale and Leaseback
Transaction
 
 In
connection with the Sale and Leaseback Transaction (described above), our
wholly-owned subsidiary, HXD, entered into a Sale and Leaseback Agreement (the
“Sale and Leaseback Agreement”) with Fenghui, pursuant to which, among other
things:
 
 ·
              Fenghui
      purchased certain milk powder processing equipment located at our new milk
      powder processing facility (the “Equipment”) from HXD, for a purchase
      price of approximately $5,161,176;
 
 ·
              Fenghui
      leased the Equipment back to HXD for 36 months in return for monthly
      payments of approximately $164,124 (a total of approximately $5,908,464),
      a commission fee of $154,835, and a refundable deposit of $774,176;
      and
 
 ·
              We
      issued to Fenghui three-year warrants to purchase 934,600 shares of the
      Company’s common stock, at an exercise price of $1.65 per share (the
      “Fenghui Warrants”).
 
 See Note
14 of the Notes to our consolidated financial statements for additional
information concerning the Sale and Leaseback Transaction.
 
 The June 2010 Term Loan
Note
 
 A
promissory note we issued in connection with the June 2010 Term Loan (the “June
2010 Term Loan Note”) has a principal balance of $800,000. The interest rate on
the June 2010 Term Loan Note is 10% per annum and is payable on maturity. The
June 2010 Term Loan Note has a stated maturity date of June 24, 2011. Upon the
maturity of the June 2010 Term Loan Note, by acceleration or otherwise, interest
on unpaid amounts shall thereafter be payable at the rate of 12% per annum,
until the obligation is paid in full. Any regular interest or default interest
not paid when due under the June 2010 Term Loan Note shall be added to the
principal of the June 2010 Term Loan Note. We may from time-to-time prepay any
amount due under the June 2010 Term Loan Note, in whole or in part, without
penalty. The entire unpaid principal balance, together with accrued interest,
shall become due and payable, without presentment, demand, protest, notice of
protest or other notice of dishonor of any kind upon the occurrence of an “Event
of Default,” as defined in our Loan Agreement with the lender.
  39
 
 The Amended June 2008
Note
 
 A
promissory note we originally issued in connection with the private placement we
consummated in June 2008, as amended on December 31, 2008 and December 31, 2009
(the “Amended June 2008 Note”), which matures on December 31, 2010, has a
principal balance of $1,716,411 and bears interest at a rate of 10%, which is
also payable on December 31, 2010. Any amount of principal or interest which is
not paid when due will bear interest at a rate of 12%. We may prepay the entire
amount due under the Amended June 2008 Note at any time without penalty, upon 15
days prior written notice. The holder of the Amended June 2008 Note has the
right to be prepaid any amounts due under the Amended June 2008 Note from the
proceeds of any future offering we consummate resulting in gross proceeds of
$4,500,000 or more. So long as we have any obligation under the Amended June
2008 Note, there are limitations on our ability to: (a) pay dividends or make
other distributions on our capital stock; (b) redeem, repurchase or otherwise
acquire any of our securities; (c) create, incur or assume any liability for
borrowed money (except as is related to the completion of the construction of
our new production facility); (d) sell, lease or otherwise dispose of any
significant portion of its assets; (e) lend money, give credit or make advances;
or (f) assume, guarantee, endorse, contingently agree to purchase or otherwise
become liable upon the obligation of any other person or entity. It shall be
deemed an “Event of Default” under the Amended June 2008 Note if: (a) we fail to
pay principal or interest when due on the Amended June 2008 Note; (b) we breach
any material covenant or other material term or condition contained in the
Amended June 2008 Note or securities purchase agreement entered into in
connection with the June 2008 Offering, as amended (the “June Purchase
Agreement”), and such breach continues for a period of thirty (30) days after
written notice thereof; (c) any representation or warranty we made under the
Amended June 2008 Note or the June Purchase Agreement shall be false or
misleading in any material respect; (d) we, or any subsidiary of ours, shall
make an assignment for the benefit of creditors, or apply for or consent to the
appointment of a receiver or trustee, or such a receiver or trustee shall
otherwise be appointed; (e) a money judgment shall be entered against us, or any
subsidiary of ours, for more than $250,000, that remains in effect for a period
of twenty (20) days; (f) bankruptcy, insolvency, reorganization or liquidation
proceedings or other similar proceedings shall be instituted by or against us,
or any subsidiary of ours, which are not dismissed within sixty (60) days; or
(g) we fail to maintain the listing of our common stock on at least one of the
OTCBB, the Nasdaq National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the NYSE Amex Equities. Upon the occurrence of any Event of
Default under the Amended June 2008 Note, unless such Event of Default shall
have been waived in writing by the holder, the holder may consider the Amended
June 2008 Note immediately due and payable, without presentment, demand, protest
or notice of any kind, and the holder may immediately enforce any and all of its
rights and remedies provided in the Amended June 2008 Note or any other right or
remedy afforded by law. Our repayment of amounts due under the Amended June 2008
Note is secured by a pledge of an aggregate of 2,104,950 shares of our common
stock beneficially owned by Yang Yong Shan, our Chairman, Chief Executive
Officer and President.
 
 The November 2009 Term Loan
Note
 
 The
promissory note we issued in connection with a loan transaction we consummated
in November 2009 (the “November 2009 Term Loan Note”), which matures on November
30, 2010, has a principal balance of $1,750,000 and bears interest at a rate of
10% per annum, which is also payable on maturity. The November 2009 Term Loan
Note has a stated maturity date of November 30, 2010. Upon the maturity of the
November 2009 Term Loan Note, by acceleration or otherwise, interest on unpaid
amounts shall thereafter be payable at the rate of 12% per annum default
interest, until the obligation is paid in full. Any regular interest or default
interest not paid when due under the November 2009 Term Loan Note shall be added
to the principal of the November 2009 Term Loan Note. We may from time-to-time
prepay any amount due under the November 2009 Term Loan Note, in whole or in
part, without penalty. The entire unpaid principal balance, together with
accrued interest, shall become due and payable, without presentment, demand,
protest, notice of protest or other notice of dishonor of any kind upon the
occurrence of an “Event of Default,” as defined in our Loan Agreement with the
lender.
 
 The December 2009
Notes
 
 The
promissory notes we originally issued in connection with the private placement
we consummated in December 2009 (the “December 2009 Notes”), which mature on
December 24, 2010, have an aggregate principal balance of $1,750,000 and bear
interest at a rate of 10%, which is also payable on December 24, 2010. Any
amount of principal or interest which is not paid when due will bear interest at
a rate of 15% per annum. We may prepay the entire amount due under the December
2009 Notes at any time without penalty, upon 15 days prior written notice;
provided, however, in such event the noteholders (the “December 2009
Noteholders”) will be entitled to retain an amount of prepaid interest equal to
the greater of (i) the amount accrued as of the prepayment date, and (ii) an
aggregate of $105,000. The December 2009 Noteholders have the right to be
prepaid any amounts due under the December 2009 Notes should we consummate
certain additional offerings of equity or debt securities. So long as we have
any obligation under the December 2009 Notes, there are limitations on our
ability to: (a) pay dividends or make other distributions on our capital stock;
(b) redeem, repurchase or otherwise acquire any of our securities; (c) create,
incur or assume any liability for borrowed money; (d) sell, lease or otherwise
dispose of any significant portion of our assets; (e) lend money, give credit or
make advances; or (f) assume, guarantee, endorse, contingently agree to purchase
or otherwise become liable upon the obligation of any other person or entity.
The entire unpaid principal balance, together with accrued interest, shall
become due and payable, without presentment, demand, protest, notice of protest
or other notice of dishonor of any kind upon the occurrence of an “Event of
Default,” as defined in the December 2009 Notes. Our repayment of amounts due
under the December 2009 Notes is secured by a pledge of an aggregate of
5,883,329 shares of our common stock beneficially owned by Yang Yong Shan, our
Chairman, Chief Executive Officer and President.
  40
 
 Dividends
 
 We have
not paid any dividends. In all likelihood, we will use any 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, certain of our
outstanding promissory notes contain restrictive covenants on our payment of
dividends, as further described in “— Promissory Notes” above.
 
 Contractual
Obligations and Commercial Commitments
 
 Our
contractual obligations, as of September 30, 2010, were as follows:
  Payments Due By PeriodContractual obligations
                              
                              Total
                              
                              
                              Less than
                                1 year
                              
                              
                              1-3 years
                              
                              
                              After
                                3-5 years
                              
                              
                              More than
                                5 yearsEquipment
      purchase
                              
                              $
                              2,674,811
                              
                              
                              $
                              2,674,811
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Construction
      contract
                              
                              
                              506,613
                              
                              
                              
                              506,613
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Debt
      Obligations
                              
                              
                              6,569,732
                              
                              
                              
                              6,569,732
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Capital
      leases
                              
                              
                              5,488,859
                              
                              
                              
                              1,995,948
                              
                              
                              
                              3,492,911
                              
                              
                              
                              -
                              
                              
                              
                              -Operating
      leases
                              
                              
                              161,270
                              
                              
                              
                              130,936
                              
                              
                              
                              30,334
                              
                              
                              
                              -
                              
                              
                              
                              -Advertising
      contract
                              
                              
                              805,867
                              
                              
                              
                              805,867
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Total:
                              
                              $
                              16,207,152
                              
                              
                              $
                              12,683,907
                              
                              
                              
                              3,523,245
                              
                              
                              
                              -
                              
                              
                              
                              -
 
 Critical
Accounting Policies and Estimates
 
 Our
consolidated financial statements are prepared in accordance with U.S. generally
accepted accounting principles (“GAAP”). These accounting principles require us
to make certain estimates, judgments and assumptions. We believe that the
estimates, judgments and assumptions upon which we rely are reasonable based
upon information available to us at the time that these estimates, judgments and
assumptions are made. These estimates, judgments and assumptions can affect the
reported amounts of assets and liabilities as of the date of the financial
statements as well as the reported amounts of revenues and expenses during the
periods presented. To the extent there are material differences between these
estimates, judgments or assumptions and actual results, our financial statements
will be affected. The accounting policies that reflect our more significant
estimates, judgments and assumptions and which we believe are the most critical
to aid in fully understanding and evaluating our reported financial results
include the following:
   41
  ·
                Inventory
 ·
              Property
      and equipment
 
 ·
              Intangible
      Assets
 
 ·
              Revenue
      recognition
 
 ·
              Earnings
      per share
 
 ·
              Taxation
 
 ·
              Warrants
 
 ·
              Freestanding
      Financial Instruments with Characteristics of Both Liabilities and
      Equity
 
 ·
              Retirement
      benefit costs
 
 ·
              Stock
      Based Compensation
 
 ·
              Fair
      value of financial instruments
 
 ·
              Fair
      Value Measurements
 
 In many
cases, the accounting treatment of a particular transaction is specifically
dictated by GAAP and does not require management’s judgment in its application.
There are also areas in which management’s judgment in selecting among available
alternatives would not produce a materially different result. Our senior
management has reviewed these critical accounting policies and related
disclosures with the Board of Directors.
 
 During
the first nine months of fiscal 2010, there were no significant changes in our
critical accounting policies and estimates. You should refer to Management’s
Discussion and Analysis of Financial Condition and Results of Operations
contained in Part II, Item 7 of our Form 10-K/A for the fiscal year ended
December 31, 2009 for a more complete discussion of our critical accounting
policies and estimates.
 
 Recently
Enacted Accounting Standards
 
 Refer to
Note 3 to the Financial Statements included in Part I, Item 1 of this Quarterly
Report on Form 10-Q, which discusses new accounting pronouncements we recently
adopted, as well as accounting pronouncements recently issued or proposed but
not yet required to be adopted.
 
 Off-Balance
Sheet Arrangements
 
 We are
not a party to any off-balance sheet arrangements.
  42
  Item
3. Quantitative and Qualitative Disclosures about Market Risk
 
 We are a
smaller reporting company as defined by Rule 12b-2 of the Securities Exchange
Act of 1934 (“Exchange Act”) and are not required to provide the information
under this item.
 
 Item
4.  Controls and Procedures.
 
 Disclosure
Controls and Procedures
 
 Our
management maintains disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide
reasonable assurance that the material information required to be disclosed by
us in our periodic reports filed or submitted under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in the SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is accumulated and communicated our management, including our Chief
Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure.
 
 As of
September 30, 2010, our management, under the supervision of and with the
participation of our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of our disclosure controls and procedures as
required by Rules 13a-15(b) and 15d-15(b) under the Exchange Act. Based upon
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were not effective as of
September 30, 2010 as a result of the material weaknesses identified in our
internal control over financial reporting. These material weaknesses are
discussed in “Management’s Report on Internal Control over Financial Reporting”
contained in our Form 10-K/A. Our management considers our internal control over
financial reporting to be an integral part of our disclosure controls and
procedures.
 
 Our
management has taken and is continuing to take the following actions to improve
our internal controls over financial reporting, including actions to remediate
the identified material weaknesses:
 
 ·
              As
      financial conditions permit, our management will recruit an independent
      financial expert to the Board of Directors to chair the Audit Committee
      and formalize roles and responsibilities over our internal controls over
      financial reporting for the Board and our management. Our management also
      intends to develop and implement a formal corporate internal audit
      capability, eventually reporting directly to an independent Audit
      Committee, to provide more effective oversight of our internal control
      over financial reporting.
 
 ·
              Our
      management will implement a Code of Conduct specifically designed for
      public company applicability across all corporate entities. Company
      directors, management and staff will be required to certify receipt of the
      Code by signature. Thereafter, our management will periodically require
      employees to acknowledge that they understand the contents of the Code,
      and disclose whether they are aware of anyone in the Company that might
      have violated some part of the
Code.
 
 ·
              Our
      management will formalize finance-related job descriptions for all staff
      levels that specifically identify required financial reporting roles,
      responsibilities, and competencies, and clarify responsibility for
      maintaining our internal controls over financial reporting.  Our
      management will implement these revised policies and procedures across all
      of its corporate entities with appropriate staff training to ensure that
      financial reporting competencies are
  strengthened.
  43
 
 ·
              Our
      management will hire additional, qualified accounting personnel at the
      Chinese operating unit level to enhance our financial reporting
      competencies. Our management will also continue to provide training to
      existing accounting personnel regarding our significant accounting
      policies and procedures.
 
 ·
              Our
      management will continue to engage the services of qualified consultants
      with China GAAP, U.S. GAAP and SEC reporting experience to assist with and
      support our financial reporting and SOX compliance requirements in 2010,
      including assistance with the
following:
 
 o
              Remediating
      identified material weaknesses;
 
 o
              Monitoring
      our internal controls over financial reporting on an ongoing
      basis;
 
 o
              Managing
      our period-end financial closing and reporting processes;
    and
 
 o
              Identifying
      and resolving non-routine or complex accounting
  matters.
 
 ·
              Our
      management will determine and hire the staff competencies required to
      ensure that essential IT general controls are maintained over our
      accounting system. In addition, our management will formalize its policies
      and procedures over core IT functions, including access, change, data, and
      security management, to ensure that all relevant financial information is
      secure, identified, captured, processed, and reported within the
      accounting system.
 
 Our
management will continue to monitor and evaluate the effectiveness of its
disclosure controls and procedures, as well as its internal controls over
financial reporting, on an ongoing basis, and is committed to taking further
action and implementing additional improvements, as necessary and as funds
allow. However, our management cannot guarantee that the measures taken or any
future measures will remediate the material weaknesses identified or that any
additional material weaknesses or significant deficiencies will not arise in the
future due to a failure to implement and maintain adequate internal controls
over financial reporting.
 
 Notwithstanding
the material weaknesses described above, our management believes that there are
no material inaccuracies or omissions of material fact and, to the best of its
knowledge, believes that the consolidated financial statements included in this
annual report present fairly, in all material respects, our financial position,
results of operations, and cash flows for the periods presented in conformity
with accounting principles generally accepted in the United States.
 
 Changes
in Internal Control Over Financial Reporting
 
 There
were no changes in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the
interim period ended September 30, 2010, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
  44
  PART
II - OTHER INFORMATION
 
 Item
      1.
              Legal
      Proceedings.
 
 We are
not a party to any pending legal proceedings.
 
 Item
      1A.
              Risk
      Factors.
 
 We are a smaller reporting company as
defined by Rule 12b-2 of the Exchange Act and are not required to provide the
information under this item.
 
 Item
      2.
              Unregistered
      Sales of Equity Securities and Use of
Proceeds.
 
 Issuance
of Warrants to a Consultant
 
 On July
22, 2010, we entered into an Engagement & Fee Agreement (the “Agreement”)
with a consultant. Pursuant to the Agreement, in consideration for certain
consulting services to be provided to us by the consultant, we issued to the
consultant three-year warrants to purchase 623,000 shares of our common stock,
exercisable at an exercise price of $1.65 per share, or on a cashless basis (the
“Warrants”).
 
 We
believe the issuance of the Warrants is exempt from registration under the
Securities Act, pursuant to Section 4(2) thereof, as a transaction by an issuer
not involving a public offering.
 
 Item
      3.
              Defaults
      Upon Senior Securities.
 
 Not
Applicable
 
 Item
      4.
              (Removed
      and Reserved).
 
 Item
      5.
              Other
      Information.
 
 None
  45
  Item
6.  Exhibits
 
 Exhibit No.
                    
                    Description of Exhibit31.1
                    
                    Certification
      of principal executive officer pursuant to Section
    13a-14(a)*31.2
                    
                    Certification
      of principal financial and accounting officer pursuant to Section
      13a-14(a)*32.1
                    
                    Certification
      of principal executive officer pursuant to Section
1350*32.2
                    
                    Certification
      of principal financial and accounting officer pursuant to Section
      1350*
 
 *Filed
herewith
  46
  SIGNATURES
  Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly
authorized.
  EMERALD
      DAIRY INC.Dated:
      November 15, 2010
                            By:
                            /s/ Yang Yong ShanYang
      Yong ShanChairman,
      Chief Executive Officer andPresidentDated:
      November 15, 2010
                            By:
                            /s/ Shu KanekoShu
      KanekoChief
      Financial Officer and
Secretary
  47