10-Q 1 v201521_10-q.htm FORM 10-Q Unassociated Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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 001-32473

FEIHE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)

Utah
 
90-0208758
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

Star City International Building, 10 Jiuxianqiao Road, C-16th Floor
Chaoyang District, Beijing, China, 100016
(Address of principal executive offices, including zip code)

+86 (10) 8457-4688
(Registrant’s telephone number, including area code)

American Dairy, Inc.
(Former name, former address and former fiscal year, if changed since last report)
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x     No  ¨

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 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. (Check one):

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares outstanding of the registrant’s common stock as of November 5, 2010 was 22,296,291.
 
 


 
FEIHE INTERNATIONAL, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2010

 TABLE OF CONTENTS
 
PART I — FINANCIAL INFORMATION
 
     
Item 1.
Condensed Consolidated Financial Statements
1
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
23
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
33
     
Item 4.
Controls and Procedures
33
     
PART II — OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
35
     
Item 1A.
Risk Factors
35
     
Item 6.
Exhibits
35
     
SIGNATURES
36
     
EXHIBIT INDEX
 

Unless the context otherwise requires, the terms “we,” “us,” “our,” “Feihe International,” and “the Company” refer to Feihe International, Inc., a Utah corporation, and its consolidated subsidiaries.  References to “dollars” and “$” are to United States dollars.
 
- i -

 
PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

FEIHE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

   
September 30,
2010
   
December 31,
2009
 
   
US$
   
US$
 
             
Assets
           
Current assets:
           
Cash and cash equivalents
   
22,247,303
     
48,165,354
 
Restricted cash
   
2,799,675
     
 784,170
 
Notes and loans receivable, net of allowance of $3,500,028 and $4,000,000, respectively
   
2,313,777
     
438,776
 
Trade receivables, net of allowance of $876,408 and $791,119, respectively
   
15,182,622
     
27,495,190
 
Due from related parties
   
1,835,030
     
2,188,243
 
Employee receivables
   
1,232,931
     
396,724
 
Advances to suppliers
   
30,537,290
     
24,417,968
 
Inventories, net of allowance of $268,559 and $518,561, respectively
   
73,582,711
     
59,044,665
 
Prepayments and other current assets
   
265,544
     
1,814,472
 
Income taxes receivable
   
4,897,518
     
4,834,754
 
Input value-added taxes
   
1,754,047
     
3,697,875
 
Other receivables
   
4,994,543
     
4,307,680
 
Investment in mutual funds – available for sale
   
127,418
     
136,466
 
Total current assets
   
161,770,409
     
177,722,337
 
                 
Investments:
               
Investment at cost
   
268,732
     
 263,264
 
                 
Property and equipment:
               
Property and equipment, net
   
156,989,603
     
154,572,409
 
Construction in progress
   
44,783,782
     
 23,170,909
 
     
201,773,385
     
177,743,318
 
Biological assets:
               
Immature biological assets
   
31,654,159
     
35,672,123
 
Mature biological assets, net
   
24,892,914
     
 13,232,124
 
     
56,547,073
     
48,904,247
 
                 
Other assets:
               
Deferred tax assets
   
3,632,815
     
3,632,815
 
Prepaid leases
   
29,082,787
     
29,016,486
 
Other intangible assets, net
   
625,773
     
821,331
 
Goodwill
   
1,844,345
     
1,784,331
 
Deferred debt issuance cost, net
   
     
369,608
 
Total assets
   
455,545,319
     
 440,257,737
 
                 
Liabilities
               
Current liabilities:
               
Notes payable
   
2,120,005
     
3,429,767
 
Short term bank loans
   
39,707,466
     
58,624,312
 
Accounts payable
   
55,539,780
     
37,956,046
 
Accrued expenses
   
8,203,175
     
8,365,245
 
Income tax payable
   
920,225
     
2,980,774
 
Advances from customers
   
20,990,303
     
6,893,947
 
Due to related parties
   
77,634
     
10,531,851
 
Advances from employees
   
1,050,392
     
483,647
 
Employee benefits payable
   
5,288,625
     
4,120,053
 
Other payables
   
45,097,338
     
24,012,460
 
Current maturities of long term bank loans
   
7,464,803
     
7,312,935
 
Current portion of capital lease obligation
   
167,087
     
 —
 
Total current liabilities
   
186,626,833
     
 164,711,037
 
                 
Long term bank loans, net of current portion
   
28,993,297
     
32,427,230
 
Capital lease obligation, net of current portion
   
613,121
     
 
Long term tax payable
   
5,212,596
     
4,747,083
 
Deferred income
   
9,036,245
     
10,538,313
 
Performance share obligation
   
     
11,382,000
 
Total liabilities
   
230,482,092
     
 223,805,663
 
                 
Commitments and contingencies (see Note 21)
               
                 
Redeemable common stock (US$0.001 par value, 2,625,000 and 2,100,000 shares issued and outstanding as of September 30, 2010 and December 31, 2009, respectively)
   
65,027,093
     
53,645,093
 
                 
Equity
               
Feihe International, Inc. shareholders' equity:
               
Common stock (US$0.001 par value, 50,000,000 shares authorized; 19,671,291 and 19,607,376 issued and outstanding as of September 30, 2010 and December 31, 2009, respectively)
   
19,671
     
19,607
 
Additional paid-in capital
   
58,373,962
     
54,482,098
 
Common stock warrants
   
1,774,151
     
1,774,151
 
Statutory reserves
   
6,861,224
     
6,861,224
 
Accumulated other comprehensive income
   
30,358,508
     
25,651,571
 
Retained earnings
   
62,209,147
     
 73,672,879
 
Total Feihe International, Inc. shareholders' equity
   
159,596,663
     
162,461,530
 
Noncontrolling interests
   
439,471
     
345,451
 
                 
Total equity
   
160,036,134
     
162,806,981
 
                 
Total liabilities, redeemable common stock, and equity
   
455,545,319
     
 440,257,737
 
 
 
The accompanying notes are an integral part of these financial statements.
 
- 1 -

 
FEIHE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
US$
   
US$
   
US$
   
US$
 
                         
Sales
    61,141,112       72,110,934       194,771,521       227,119,247  
                                 
Cost of goods sold
    (33,828,464 )     (35,129,532 )     (110,556,813 )     (93,427,854 )
                                 
Gross profit
    27,312,648       36,981,402       84,214,708       133,691,393  
                                 
Operating expenses:
                               
Sales and marketing expenses
    (18,731,289 )     (27,455,572 )     (76,585,036 )     (79,771,636 )
General and administrative expenses
    (6,130,344 )     (5,656,116 )     (18,704,859 )     (16,957,199 )
Loss on disposal of biological assets
    (467,867 )     (151,183 )     (9,041,300 )     (971,984 )
Total operating expenses
    (25,329,500 )     (33,262,871 )     (104,331,195 )     (97,700,819 )
                                 
Other operating income, net
    64,895       309,593       428,920       1,824,274  
Income (loss) from continuing operations
    2,048,043       4,028,124       (19,687,567 )     37,814,848  
                                 
Other income (expenses):
                               
Interest income
    62,132       62,248       269,318       273,333  
Interest and finance costs
    (429,864 )     (1,700,702 )     (1,988,826 )     (5,114,679 )
Amortization of deferred debt issuance cost
          (33,914 )     (376,057 )     (101,742 )
Loss on derivatives
          (790,000 )           (790,000 )
Government subsidy
    1,753,268       7,895,626       10,911,750       14,640,034  
                                 
Income (loss) before income tax
    3,433,579       9,461,382       (10,871,382 )     46,721,794  
                                 
Income tax benefit (expense)
    211,478       1,672,167       (732,143 )     (3,502,574 )
Income (loss) from continuing operations, net of tax
    3,645,057       11,133,549       (11,603,525 )     43,219,220  
                                 
Net income from discontinued operations, net of tax
                      3,289,908  
Net income (loss)
    3,645,057       11,133,549       (11,603,525 )     46,509,128  
Less: Net (income) loss attributable to noncontrolling interests
    (67,793 )     7,548       139,793       50,193  
Net income (loss) attributable to Feihe International, Inc.
    3,577,264       11,141,097       (11,463,732 )     46,559,321  
                                 
Earnings (loss) per share of common stock – Basic
                               
Income (loss) from continuing operations attributable to Feihe International, Inc.
    0.16       0.57       (0.52 )     2.39  
Income from discontinued operations attributable to Feihe International, Inc., net of tax
                      0.18  
Net income (loss) attributable to Feihe International, Inc.
    0.16       0.57       (0.52 )     2.57  
Earnings (loss) per share of common stock – Diluted
                               
Income (loss) from continuing operations attributable to Feihe International, Inc.
    0.16       0.52       (0.52 )     2.21  
Income from discontinued operations attributable to Feihe International, Inc., net of tax
                      0.17  
Net income (loss) attributable to Feihe International, Inc.
    0.16       0.52       (0.52 )     2.38  
                                 
Weighted average shares of common stock outstanding
                               
Basic
    22,288,569       19,659,657       22,103,588       18,093,104  
Diluted
    22,299,017       21,597,188       22,103,588       19,541,775  
 
 
The accompanying notes are an integral part of these financial statements.
 
- 2 -



FEIHE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY AND COMPREHENSIVE INCOME (LOSS)
(unaudited)
 
   
Feihe International, Inc. Shareholders
                   
   
Common Stock
                                                 
   
(US$0.001 par value)
                     
Accumulated
                         
   
Number
of
Shares
   
Par
Value
   
Additional
Capital
Stock
   
Common
Stock
Warrants
   
Statutory
Reserves
   
Other
Comprehensive
Income
   
Retained
Earnings
   
Noncontrolling
Interest
   
Total
Equity
   
Total
Comprehensive
Income (Loss)
 
         
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
 
                                                             
Balance as of January 1, 2010
    19,607,376       19,607       54,482,098       1,774,151       6,861,224       25,651,571       73,672,879       345,451       162,806,981        
Share-based compensation
    55,915       56       3,795,872                                     3,795,928        
Issuance of common stock in connection with exercise of options
    8,000       8       95,992                                     96,000        
Net income
                                        (11,463,732 )     (139,793 )     (11,603,525 )     (11,603,525 )
Currency translation adjustments
                                  4,715,985             14,441       4,730,426       4,730,426  
Change in fair value of available for sale investments, net of tax $(2,262)
                                  (9,048                   (9,048 )     (9,048  
Comprehensive income (loss)
                                                                            (6,882,147  
Investment  in a new subsidiary
                                              219,372       219,372          
                                                                                 
Balance as of September 30, 2010
    19,671,291       19,671       58,373,962       1,774,151       6,861,224       30,358,508       62,209,147       439,471       160,036,134          
 
 
   
Feihe International, Inc. Shareholders
                   
   
Common Stock
                                                 
   
(US$0.001 par value)
                     
Accumulated
                         
   
Number
of
Shares
   
Par
Value
   
Additional
Capital
Stock
   
Common
Stock
Warrants
   
Statutory
Reserves
   
Other
Comprehensive
Income
   
Retained
Earnings
   
Noncontrolling
Interests
   
Total
Equity
   
Total
Comprehensive
Income
 
         
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
 
                                                             
Balance as of January 1, 2009
    17,253,907       17,254       26,758,425       3,003,448       6,861,224       25,146,055       54,091,493       546,447       116,424,346        
Share-based compensation
                2,278,754                                     2,278,754        
Warrants  exercise
    768,701       769       2,497,842       (883,963 )                             1,614,648        
Shares issued for notes conversion
    1,160,884       1,161       16,831,543                                     16,832,704        
Net income (loss)
                                        46,559,321       (50,193 )     46,509,128       46,509,128  
Currency translation adjustments
                                  593,949                   593,949       593,949  
Change in fair value of available for sale investments, net of tax $ 10,233
                                  40,933                   40,933       40,933  
Comprehensive income
                                                                            47,144,010  
Sales of a subsidiary
                                              (82,726       (82,726          
Balance as of September 30, 2009
    19,183,492       19,184       48,366,564       2,119,485       6,861,224       25,780,937       100,650,814       413,528       184,211,736          
 
 
The accompanying notes are an integral part of these financial statements.
 
- 3 -

 
FEIHE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

   
Nine months ended September 30,
 
   
2010
   
2009
 
   
US$
   
US$
 
             
Cash flows from operating activities:
           
Net (loss) income
   
(11,603,525
)
   
46,509,128
 
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
               
Depreciation of property and equipment
   
5,966,112
     
3,962,032
 
Depreciation of biological assets
   
2,699,711
     
1,115,296
 
Amortization of prepaid leases
   
526,980
     
418,003
 
Amortization of capital lease obligation
   
29,363
     
 
Amortization of other intangible assets
   
208,925
     
 
Amortization of deferred income
   
(11,892
)
   
(10,328
)
Gain on sale of property and equipment
   
(3,632
)
   
 
Loss on sale of biological assets
   
9,041,300
     
971,984
 
Provision for bad debts
   
68,860
     
(311,555
)
Provision for inventory reserve
   
(256,245
)
   
(30,789
)
Compensation expense from option awards
   
2,906,553
     
2,278,754
 
Compensation expense from shares issued for services
   
889,375
     
 
Net income from discontinued operations, net of tax
   
     
(3,289,908
)
Interest expense from amortization of note discounts
   
     
4,475,045
 
Gain on waived interest expense
   
     
(550,000
)
Loss on derivatives
   
     
790,000
 
Amortization of deferred debt issuance cost
   
376,057
     
101,742
 
                 
Changes in assets and liabilities:
               
Decrease (increase) in trade receivables
   
12,243,708
     
(19,721,366
)
Decrease (increase) in due from related parties
   
353,213
     
(1,985,395
)
(Increase) decrease in employee receivable
   
(836,207
)
   
107,686
 
Increase in inventories
   
(14,281,801
)
   
(13,600,082
)
Increase in advances to suppliers
   
(9,614,054
)
   
(5,196,616
)
Decrease (increase) in prepayments and other current assets
   
1,548,928
     
(33,507
)
Increase in income taxes receivable
   
(62,764
)
   
(3,319,458
)
Decrease (increase) in input value-added taxes
   
1,943,828
     
(327,383
)
Increase in other receivables
   
(686,863
)
   
(1,454,913
)
(Increase) decrease in notes receivables
   
(2,027,311
)
   
1,493,245
 
Decrease in notes payable
   
(1,309,762
)
   
 
Increase in accounts payable
   
17,583,734
     
7,571,397
 
Decrease in accrued expenses
   
(162,070
)
   
(1,321,981
)
Decrease in income taxes payable
   
(2,060,549
)
   
(357,878
)
Increase (decrease) in advances from customers
   
14,096,356
     
(5,905,546
)
Decrease in due to related parties
   
(40,445
)
   
(423,342
)
Increase (decrease) in advances from employees
   
566,744
     
(546,442
)
Increase (decrease) in accrued employee benefits payable
   
1,168,572
     
(113,856
)
Decrease in other payables
   
(6,478,858
)
   
(110,663
)
Increase in long term tax payable
   
465,513
     
3,132,860
 
(Decrease) increase in deferred income
   
(1,590,848
)
   
3,579,449
 
Net cash provided by continuing operations
   
21,657,006
     
17,895,613
 
Discontinued operations
   
     
(2,108,429
)
Net cash provided by operating activities
   
21,657,006
     
15,787,184
 
                 
Cash flows from investing activities:
               
Purchase of property and equipment
   
(15,328,491
)
   
(46,998,833
)
Purchase of biological assets
   
(9,280,870
)
   
(12,932,023
)
Proceeds from disposal of property and equipment
   
32,182
     
 
Change in restricted cash
   
(2,015,505
)
   
464,366
 
Purchase of a dairy operation
   
     
(3,287,167
)
Proceeds from sale of a subsidiary
   
     
38,957,413
 
Proceeds from disposal of biological assets
   
1,445,553
     
81,785
 
Net cash used in continuing operations
   
(25,147,131
)
   
(23,714,459
)
Discontinued operations
   
     
 
Net cash used in investing activities
   
(25,147,131
)
   
(23,714,459
)
                 
Cash flows from financing activities:
               
Proceeds from short term bank loans
   
25,460,501
     
38,879,321
 
Proceeds from long term bank loans
   
3,266,638
     
10,748,531
 
Repayment of long term bank loans
   
(7,404,199
)
   
(408,311
)
Repayment of short term bank loans
   
(44,874,361
)
   
(76,268,710
)
Proceeds from issuance of redeemable common stock
   
     
63,000,010
 
Capital injection in a new subsidiary by noncontrolling interest
   
219,372
     
 
Proceeds from option exercise
   
96,000
     
 
Proceeds from warrant exercise
   
     
1,614,648
 
Net cash (used in) provided by continuing operations
   
(23,236,049
)
   
37,565,489
 
Discontinued operations
   
     
 
Net cash (used in) provided by financing activities
   
(23,236,049
)
   
37,565,489
 
                 
Effect of exchange rate changes on cash
   
808,123
     
424,118
 
Net decrease in cash from discontinued operations
   
     
2,108,429
 
                 
Net (decrease) increase in cash and cash equivalents
   
(25,918,051
)
   
32,170,761
 
Cash and cash equivalents, beginning of period
   
48,165,354
     
10,736,041
 
Cash and cash equivalents, end of period
   
22,247,303
     
42,906,802
 
                 
Supplemental disclosure of cash flow information:
               
Income tax paid
   
(1,528,754
)
   
(6,100,224
)
Tax refunds received
   
6,457,039
     
12,183,248
 
Interest paid
   
(3,509,532
)
   
(1,559,026
)
                 
Non-cash investing and financing activities:
               
Conversion of bridge loan to redeemable common stock
   
     
16,000,000
 
Conversion of convertible debt and accrued interest to common stock
   
     
16,832,704
 
Issuance of performance shares of common stock
   
11,382,000
     
 
Capital lease obligation for the purchase of property and equipment
   
735,179
     
 
 
 
The accompanying notes are an integral part of these financial statements.
 
- 4 -


FEIHE INTERNATIONAL, INC
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. 
ORGANIZATION AND NATURE OF OPERATION

The accompanying consolidated financial statements include the financial statements of Feihe International, Inc. (the “Company” or “Feihe International,” formerly known as “American Dairy, Inc.”) and its subsidiaries. The Company and its subsidiaries are collectively referred to as the “Group.” All of the Group's operations are conducted in the People's Republic of China.

The core activities of subsidiaries included in the condensed consolidated financial statements are as follows:

 
American Flying Crane Corporation – Investment holding
 
Langfang Flying Crane Dairy Products Co., Limited – Packaging and distributing dairy products
 
Gannan Flying Crane Dairy Products Co., Limited (“Gannan Feihe”) – Manufacturing dairy products
 
Heilongjiang Feihe Dairy Co., Limited (“Feihe Dairy”) – Manufacturing and distributing dairy products
 
Baiquan Feihe Dairy Co., Limited – Manufacturing dairy products
 
Beijing Feihe Biotechnology Scientific and Commercial Co., Limited – Marketing and distributing dairy products
 
Shanxi Feihesantai Biotechnology Scientific and Commercial Co., Limited (“Shanxi Feihesantai”) – Manufacturing and distributing walnut products
 
Heilongjiang Feihe Kedong Feedlots Co., Limited – Breeding and rearing of dairy cows, and distributing fresh milk
 
Heilongjiang Feihe Gannan Feedlots Co., Limited – Breeding and rearing of dairy cows, and distributing fresh milk
 
Qiqihaer Feihe Soybean Co., Limited – Manufacturing and distributing soybean products
 
Heilongjiang Aiyingquan International Trading Co., Limited – Marketing and distributing water and cheese, specifically marketed for consumption by children
 
Heilongjiang Flying Crane Trading Co., Limited (“Feihe Trading”) – Distributing of milk and soybean related products. The subsidiary was registered in Heilongjiang province, China on January 22, 2010. The Group holds an 85% equity interest of the total paid-in capital of RMB 10,000,000 (or approximately $1.5 million) of Heilongjiang Flying Crane Trading Co., Limited

2. 
BASIS OF PREPARATION

The condensed consolidated balance sheet as of December 31, 2009, which has been derived from audited financial statements, and the unaudited condensed consolidated interim financial statements included herein, have been prepared by the Group pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  The condensed consolidated interim financial statements do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).  In the opinion of the Group’s management, the accompanying condensed consolidated financial statements contain all material adjustments (consisting only of normal and recurring accruals) necessary to present fairly its financial position and the results of its operations and cash flows.  These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto filed with the SEC on Form 10-K for the year ended December 31, 2009.  The interim operating results are not necessarily indicative of the results to be expected for an entire year.

In the nine months ended September 30, 2010, the Group incurred a significant loss and, as of September 30, 2010, had a working capital deficit, with current liabilities exceeding current assets by $24,856,424. The Group has taken various actions to conserve cash, procure financing and improve liquidity. Such actions include reducing working capital requirements in operations through improving the Group’s sales process, accelerating accounts receivables collection, strengthening control on operating expenditure and renewing short term borrowings. Considering the forecasted revenue and the Group’s ability to generate operating cash flow, the Group has prepared the condensed consolidated financial statements assuming that the Group will continue as a going concern.
 
- 5 -


For the period ended September 30, 2010, the Group has used the same significant accounting policies and estimates which are discussed in the Annual Report on Form 10-K for the year ended December 31, 2009, except for the following recently adopted accounting pronouncements. 

Recently adopted accounting pronouncements

In January 2010, the Financial Accounting Standards Board (the “FASB”) issued authoritative guidance to improve disclosures about fair value measurements. This guidance amends previous guidance on fair value measurements to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurement on a gross basis rather than on a net basis as currently required. This guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. This guidance is effective for annual and interim periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activities of purchases, sales, issuances, and settlements on a gross basis, which will be effective for annual and interim periods beginning after December 15, 2010. Early application is permitted and, in the period of initial adoption, entities are not required to provide the amended disclosures for any previous periods presented for comparative purposes. The adoption of this guidance did not have a significant impact on the Group’s financial statements.

In March 2010, the FASB issued authoritative guidance to clarify the type of embedded credit derivative that is exempt from embedded derivative bifurcation requirements. Specifically, only one form of embedded credit derivative qualifies for the exemption – one that is related only to the subordination of one financial instrument to another. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination may need to separately account for the embedded credit derivative feature. This guidance also has transition provisions, which permit entities to make a special one-time election to apply the fair value option to any investment in a beneficial interest in securitized financial assets, regardless of whether such investments contain embedded derivative features. This guidance is effective on the first day of the first fiscal quarter beginning after June 15, 2010. Early adoption is permitted at the beginning of any fiscal quarter beginning after March 5, 2010. This adoption of the authoritative guidance did not have a material impact on the Group’s financial statements.

Recently issued accounting pronouncements not yet adopted

In March 2010, FASB issued authoritative guidance regarding the effect of denominating the exercise price of a share-based payment awards in the currency of the market in which the underlying equity securities trades and that currency is different from (1) entity’s functional currency, (2) functional currency of the foreign operation for which the employee provides services, and (3) payroll currency of the employee. The guidance clarifies that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should be considered an equity award assuming all other criteria for equity classification are met. The guidance will be effective for interim and annual periods beginning on or after December 15, 2010, and will be applied prospectively. Affected entities will be required to record a cumulative catch-up adjustment for all awards outstanding as of the beginning of the annual period in which the guidance is adopted. This adoption of the authoritative guidance is not expected to have a material impact on the Group’s financial statements.
 
3.           TAXATION

The Company is subject to U.S. federal and state income taxes, and the Company’s subsidiaries incorporated in the People’s Republic of China (the “PRC”) are subject to enterprise income taxes in the PRC. 

During the three months ended September 30, 2010, the Company recorded an income tax benefit of approximately $0.2 million, which was primarily due to a decrease in profits of Gannan Feihe. During the nine months ended September 30, 2010, the Company recorded an income tax benefit of approximately $0.7 million, which was primarily due to the taxable income from the Company’s operations in the PRC.
 
- 6 -

 
The Company cumulatively accrued approximately $1.5 million for estimated interest and penalties related to uncertain tax positions at September 30, 2010. The Company recorded approximately $0.15 million and $0.46 million of interest and penalties related to unrecognized tax positions as a component of income tax expense during the three and nine months ended September 30, 2010 and approximately $89,000 and $0.3 million of interest and penalties related to unrecognized tax positions as a component of income tax expense during the three and nine months ended September 30, 2009, respectively.

Aggregate undistributed earnings of approximately $118 million as of September 30, 2010 of the Group's PRC subsidiaries that are available for distribution to the Company are considered to be indefinitely reinvested under U.S. GAAP, and, accordingly, no provision has been made for the Chinese dividend withholding taxes that would be payable upon distribution to the Company. Additionally, the Chinese tax authorities have clarified that distributions made out of pre-January 1, 2008 retained earnings would not be subject to the withholding tax.

The Company's tax years from 2005 to 2009 remain open in various jurisdictions.
 
4. 
EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of weighted-average shares outstanding for calculating basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2010 and 2009:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Weighted-average shares – Basic
    22,288,569       19,659,657       22,103,588       18,093,104  
Effect of dilutive securities
                               
  Stock option
    10,448       955,296             354,212  
  Warrants
          403,048             641,878  
  Convertible notes
          388,230             388,230  
  Performance adjustment shares
          190,957             64,351  
Weighted-average shares – Diluted
    22,299,017       21,597,188       22,103,588       19,541,775  

As of September 30, 2010, 1,560,654 performance stock options and 237,937 warrants were excluded from the calculation of diluted income per share for the nine months ended September 30, 2010, and 237,937 warrants were excluded from the calculation of diluted income per share for the three months ended September 30, 2010, because their effects were anti-dilutive using the treasury stock method.

5. 
DISCONTINUED OPERATIONS

Heilongjiang Moveup Co., Limited (“Moveup”) was initially formed in October 2007 to serve as an acquisition vehicle in connection with the Company’s proposed acquisition of 100% of the outstanding equity interest in Ausnutria Dairy (Hunan) Company Ltd. (“Ausnutria”), a distributor of dairy products focused on the high-end segment of the dairy products market in the PRC.  In 2007 and 2008, the Company entered into several agreements with Ausnutria in connection with this transaction, which did not close.
  
In December 2008, the Company and Ausnutria’s owners entered into a letter of intent to unwind the transactions.   Accordingly, the prior transactions to acquire Ausnutria were effectively cancelled and Moveup is reflected in the Company’s consolidated financial statements as a discontinued operation.  In February 2009, the Company, through its subsidiary Feihe Dairy, entered into an equity purchase agreement pursuant to which Feihe Dairy and the minority shareholder of Moveup, Liu Sheng-Hui, one of the Company’s directors and Vice President of Finance of Feihe Dairy, each agreed to sell to Hunan Xindaxin Co., Ltd. 100% of their equity interests in Moveup for an aggregate consideration of approximately $43.3 million.  The Company received approximately $4.4 million in 2008 and approximately $6.6 million in January 2009 from the purchasers. In May 2009, the final tranche of approximately $32.3 million was released from an escrow account to Feihe Dairy and Mr. Liu and a resulting gain on sale of a subsidiary of $2,552,733 was recognized in the consolidated statements of operations during the second quarter of 2009.
 
- 7 -


The following table presents the components of discontinued operations reported in the consolidated statements of operations:

   
For the three months ended
September 30,
   
For the nine months ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
US$
   
US$
   
US$
   
US$
 
                         
Sales
                      10,451,277  
                                 
Income from operations
                      1,301,909  
Gain on sale of subsidiary
                      2,552,733  
Income tax expense
                      (564,734 )
Net income from discontinued operations
                      3,289,908  

6. 
RESTRICTED CASH

Restricted cash consists of bank demand deposits for letters of credit and short term notes payable. These instruments are mainly used by the Group for the short term financing of imported dairy cows and the purchase of whey powder.

7. 
INVENTORIES, NET

The inventory amounts included in the condensed consolidated balance sheets as of September 30, 2010 and December 31, 2009 comprised the following:

   
September 30,
2010
   
December 31,
2009
 
   
US$
   
US$
 
             
Raw materials
   
24,394,959
     
23,360,410
 
Work-in-progress
   
36,313,132
     
34,486,084
 
Finished goods
   
13,143,179
     
 1,716,732
 
Less: Inventory provision
   
(268,559
)
   
(518,561
)
Total inventories, net
   
73,582,711
     
59,044,665
 

8. 
ADVANCES TO SUPPLIERS

Advances to suppliers consist primarily of advance payments for inventories and equipment, not delivered at the balance sheet date.  The Group utilizes advances to suppliers in an effort to keep future purchasing prices stable and consistent.

Advanced amounts are refundable if the transaction is not completed by the other party in accordance with the terms of the contract or agreement.  During the three and nine month periods ended September 30, 2010 and September 30, 2009, no advances to suppliers were refunded in cash, and the Group has a minimal refund history.

9. 
INVESTMENT IN MUTUAL FUNDS – AVAILABLE FOR SALE

The Group had the following investment measured at fair value:

       
   
US$
 
       
Balance as of December 31, 2009
   
136,466
 
Change in fair value
   
(9,048
)
Balance as of September 30, 2010
   
127,418
 
 
 
- 8 -

 
The cost of the investment is $186,620, with fair value measured according to quoted prices in active markets of identical assets (Level 1).

10. 
CONSTRUCTION IN PROGRESS

The construction projects under construction included in the condensed consolidated balance sheets as of September 30, 2010 and December 31, 2009 comprised of the following:

   
September 30,
2010
   
December 31,
2009
 
   
US$
   
US$
 
             
Feihe Dairy processing facilities
   
6,933,456
     
4,671,469
 
Shanxi walnut processing facilities
   
     
51,386
 
Gannan production facilities
   
22,209,345
     
13,721,606
 
Longjiang  production facilities
   
12,569,096
     
 
Gannan Pasture facilities
   
263,798
     
702,116
 
Kedong Pasture facilities
   
25,578
     
 
Soybean processing facilities
   
2,737,595
     
4,015,104
 
Others
   
44,914
     
9,228
 
Total
   
44,783,782
     
23,170,909
 

$283,175 and $1,286,297 of interest expense were capitalized in construction in progress for the three months ended September 30, 2010 and 2009. $920,964 and $2,796,092 of interest expense were capitalized in construction in progress for the nine months ended September 30, 2010.

11. 
OTHER INTANGIBLE ASSETS, NET

Other intangible assets, net as of September 30, 2010 and December 31, 2009 consisted of the following:

   
September 30,
2010
   
December 31,
2009
 
   
US$
   
US$
 
Production permit
   
     
68,254
 
Exclusive right of milk supply
   
625,773
     
753,077
 
Total other intangible assets, net
   
625,773
     
821,331
 

Amortization expense for the nine months ended September 30, 2010 and 2009 was $208,925 and $nil, respectively.

Production permits and exclusive rights of milk supply, which the Group acquired in 2009, are carried at cost less accumulated amortization. Amortization is calculated on a straight-line basis over the expected useful lives of one and 4.7 years, respectively.  Amortization expense of intangible assets is estimated to be approximately $255,000, $187,000, $187,000, $187,000, and $5,000 for 2010, 2011, 2012, 2013, and 2014, respectively.
 
- 9 -


12. 
SHORT TERM BANK LOANS

Short term bank loans included in the condensed consolidated balance sheets as of September 30, 2010 and December 31, 2009 comprised of the following:

   
September 30,
2010
   
December 31,
2009
 
   
US$
   
US$
 
Unsecured, non-interest bearing loan payable to an unrelated party, due on demand
   
442,600
     
442,600
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by machinery, payable with interest on maturity, due on January 4, 2010
   
     
2,193,881
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by machinery, payable with interest on maturity, due on January 5, 2010
   
     
3,656,468
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by machinery, payable with interest on maturity, due on March 31, 2010
   
     
3,773,475
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by machinery, payable with interest on maturity, due on May 22, 2010
   
     
4,972,796
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by machinery, payable with interest on maturity, due on May 22, 2010
   
     
2,340,139
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by buildings of Qiqihaer Feihe Soybean Co., Limited, payable with interest on maturity, due on July 19, 2010 (i)
   
     
1,775,581
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  payable with interest on maturity, due on July 19, 2010 (i)
   
     
1,149,593
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  payable with interest on maturity, due on July 19, 2010 (i)
   
     
5,850,348
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  payable with interest on maturity, due on August 30, 2010 (ii)
   
     
2,925,174
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, payable with interest on maturity, due on September 28, 2010 (ii)
   
     
1,462,587
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by a building, payable with interest on maturity, due on September 14, 2010
   
     
11,846,955
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by a building, payable with interest on maturity, due on September 15, 2010
   
     
2,778,915
 
                 
 
 
- 10 -

 
 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, payable with interest on maturity, due on October 22, 2010 (ii)
   
2,985,921
     
2,925,174
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  payable with interest on maturity, due on November 12, 2010
   
5,971,843
     
5,850,348
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, secured by machinery, payable with interest on maturity, due on December 23, 2010
   
4,777,474
     
4,680,278
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  secured by machinery, payable with interest on maturity, due on January 13, 2011
   
2,388,737
     
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  payable with interest on maturity, due on July 25, 2011 (iii)
   
7,464,803
     
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, payable with interest on maturity, due on August 30, 2011 (iv)
   
2,985,922
     
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, payable with interest on maturity, due on September 7, 2011 (v)
   
7,464,803
     
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum, payable with interest on maturity, due on September 14, 2011 (iv)
   
3,732,402
     
 
                 
Loan payable to a bank in the PRC, bearing interest at 5.31% per annum,  payable with interest on maturity, due on September 27, 2011 (vi)
   
1,492,961