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.

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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.

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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.

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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.

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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.

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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

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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.

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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

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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	—
Total	39,707,466	58,624,312

(i)	In connection with the purchase of raw materials by Qiqihaer Feihe Soybean Co., Limited, Feihe Dairy guaranteed the loans payable to a bank in the PRC for a period of one year, beginning on July 20, 2009 and ending on July 19, 2010. The maximum potential future payment amount under the terms of the guarantee is RMB 63,200,000 (or $9,436,000). The loan was fully repaid on July 19, 2010.
(ii)	Feihe Dairy guaranteed the loans payable to a bank in the PRC for a period of one year, beginning on August 30, 2009 and ending on August 29, 2010. The maximum potential future payment amount under the terms of the guarantee is RMB 100,000,000 (or $14,930,000). The loans, amounting 2,925,174 and 1,462,587, were fully repaid on August 30 and September 28, 2010, respectively.
(iii)	Gannan Dairy guaranteed the loans payable to a bank in the PRC for a period, beginning on July 26, 2010 and ending on the date which is two years after the maturity date or the date of repayment if earlier.
(iv)	Feihe Dairy guaranteed the loans payable to a bank in the PRC for a period of one year, beginning on September 15, 2010 and ending on September 14, 2011. The maximum potential future payment amount under the terms of the guarantee is RMB 35,000,000 (or $5,225,000) as of September 30, 2010.
(v)	Gannan Dairy guaranteed the loans payable to a bank in the PRC for a period, beginning on September 7, 2010 and ending on the date which is two years after the maturity date or the date of repayment if earlier.
(vi)	Feihe Dairy guaranteed the loans payable to a bank in the PRC for a period of two years, beginning on August 30, 2010 and ending on August 30, 2012. The maximum potential future payment amount under the terms of the guarantee is RMB 50,000,000 (or $7,465,000) as of September 30, 2010.

All of the short term bank loans are denominated in RMB and therefore subject to exchange rate fluctuations and none of them have restrictions or covenants attached.

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13.  LONG TERM BANK LOANS

Long term bank loans comprised of the following as of September 30, 2010 and December 31, 2009:

	September 30, 2010			December 31, 2009
	US$			US$
Loan payable to a bank in the PRC, bearing interest at 7.47%, secured by biological assets, and payable on maturity. The loan commenced on October 29, 2008 and matures on September 24, 2014.		4,010,092			3,928,509
Loan payable to a bank in the PRC, bearing interest at 7.47%, secured by biological assets, and payable in installments of $3,523,387 on October 28, 2010 and $564, 339 on October 28, 2011. The loan commenced in October 29, 2008 and matures on September 25, 2014.		4,087,726			4,004,563
Loan payable to a bank in the PRC, bearing interest at six months LIBOR plus 1.95%. The loan commenced in October 13, 2009 and matures on October 13, 2014. (i)		—			4,023,790
Loan payable to a bank in the PRC, bearing interest at 5.94%, secured by biological assets, and payable on maturity. The loan commenced in June 29, 2009 and matures on October 28, 2014.		7,051,253			6,907,798
Loan payable to a bank in the PRC, bearing interest at 5.94%, secured by biological assets, and payable on maturity. The loan commenced in March 27, 2009 and matures on October 28, 2014.		3,930,965			3,850,992
Loan payable to a bank in the PRC, bearing interest at 7.47%, unsecured, and payable in installments of $2,985,921 due on October 28, 2009 but yet paid and $955,495 on October 28, 2010. The loan commenced in October 29, 2008 and matures on October 28, 2014.		3,941,416			3,861,230
Loan payable to a bank in the PRC, bearing interest at 5.76%, secured by land use right, plant and machinery.  The loan commenced in December 24, 2009 and matures on December 24, 2014.		4,971,677			4,870,530
Loan payable to a bank in the PRC, bearing interest at 5.76%. The loan commenced in December 24, 2009 and matures on December 24, 2014.		8,464,971			8,292,753
		36,458,100			39,740,165
Less: current portion of long term bank loans		(7,464,803	)		(7,312,935	)
		28,993,297			32,427,230

(i) In October 2009, the Group entered into a loan agreement with a bank in the PRC for a principal amount of up to $9,227,851 for the purpose of financing the purchase of certain equipment. The loan bore interest at the six-month LIBOR rate plus 1.95%, with principal payable in 10 equal semi-annual installments and interest payable semi-annually. As of December 31, 2009, there was $4,023,790 in principal payable under this loan. The loan was fully repaid in June 2010.

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14.  CONVERTIBLE DEBT, NET

On October 3, 2006, pursuant to a subscription agreement, the Company issued an aggregate principal amount of $18,200,000 in 7.75% Convertible Notes due 2009 (the “2009 Notes”) and warrants to purchase up to an aggregate of 251,000 shares of Common Stock (the “Warrants”).  The value of the warrants of $1,871,859 was recorded as a discount to the value of the 2009 Notes and was to be amortized to interest expense over the term of the 2009 Notes.

On November 12, 2008, the Company entered into an agreement with respect to the 2009 Notes pursuant to which the Company issued to holders of the 2009 Notes an aggregate amount of 216,639 shares of common stock ($2,881,299, excluding $720,000 accrued at December 31, 2007) and such holders waived claims to additional payments under the registration rights agreement relating to the 2009 Notes.  In connection with the agreement, the Company amended the 2009 Notes (the “New 2009 Notes”) and the warrants issued therewith (the “New Warrants”), and amended the prior registration rights agreement.

In July, August and October 2009, the holders of the 2009 Notes elected to convert the 2009 Notes into common stock.  In connection with these conversions, $18.2 million in principal and approximately $4.3 million in accrued interest on the 2009 Notes was converted into 1,549,122 shares of common stock at a conversion price of $14.50 per share. No 2009 Notes remained outstanding as of December 31, 2009.

Interest expense amounting to $nil and $226,788 was recognized during the three month period ended September 30, 2010 and 2009, respectively. Amortization of the notes discount of $nil and $155,991 was recognized during the three month period ended September 30, 2010 and 2009, respectively.

Interest expense amounting to $nil and $1,046,078 was recognized during the nine month period ended September 30, 2010 and 2009, respectively. Amortization of the notes discount of $nil and $467,967 was recognized during the nine month period ended September 30, 2010 and 2009, respectively.

15.  ACCRUED EXPENSES

Accrued expenses as of September 30, 2010 and December 31, 2009 consisted of the following:

	September 30, 2010		December 31, 2009
	US$		US$
Accrued selling expenses		7,746,422		8,050,982
Other accrued expenses		456,753		314,263
		8,203,175		8,365,245

16.  OTHER PAYABLES

Other payables as of September 30, 2010 and December 31, 2009 consisted of the following:

	September 30, 2010		December 31, 2009
	US$		US$
Payable for property and equipment		22,714,739		12,220,117
Payable for purchase of biological assets		6,655,343		—
Payable for leases		960,202		1,082,590
Other tax payable		219,576		1,989,165
Deposit from distributors		1,940,102		1,604,165
Payable to local County Finance Bureau (i)		2,117,018		1,781,430
Prepayment received for purchase of biological assets from Yuanshengtai (see Note 18)		3,562,530		—
Other payables (ii)		6,927,828		5,334,993
Total		45,097,338		24,012,460

(i)   The Group received funding from the local County Finance Department for construction of the production facilities in the region and working capital usage.  Although, no repayment terms were attached with the funds, the Group considers them to be unsecured, non-interest bearing loans from the County Finance Department that are repayable on demand.

(ii) Other payables mainly include deposits received from logistics companies and milk collection stations, prepayment made by employees on behalf of the Group, advertising cost, and other miscellaneous payables.

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17.  CAPITAL LEASE OBLIGATION

In November 2009, the Group entered a six-year capital lease agreement for certain equipment under construction. The terms of the lease required an initial payment of RMB 5 million (or approximately $746,500) and require a RMB 1 million (or approximately $149,300) payment on January 30th of each year after successful completion of production quality tests. The equipment was undergoing trial runs as of September 30, 2010, and will be depreciated over an estimated productive life of 14 years when placed into service after passing production quality tests, which is estimated to be in December 2010.  As of September 30, 2010 and 2009, the Group had $1,472,514 and $nil, respectively, of equipment under construction subject to the capital lease obligation.

Minimum future lease payments under capital leases as of September 30, 2010, are as follows:

	Future payments
	US$
2010		149,296
2011		149,296
2012		149,296
2013		149,296
2014		149,296
2015		149,296
Outstanding at September 30, 2010		895,776
Less amount representing interest		(115,568	)
Net present value of minimum lease payments		780,208
Current portion of capital lease obligation		(167,087	)
Non-current portion of capital lease obligation		613,121

The interest rate on the capitalized lease is 5.31%. There was $9,840 and $nil amortization of interest recorded for the three months ended September 30, 2010 and 2009, respectively. There was $29,363 and $nil amortization of interest recorded for the nine months ended September 30, 2010 and 2009, respectively. Accumulated amortization was $29,363 and $nil as of September 30, 2010 and December 31, 2009, respectively.

18.  RELATED PARTY TRANSACTIONS

Due from/to related parties 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$
Due from related parties:
Due from directors of the Group		52,056		60,978
Due from related companies		1,782,974		2,127,265
Total		1,835,030		2,188,243

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	September 30, 2010		December 31, 2009
	US$		US$
Due to related parties:
Due to directors of the Group		29,859		29,252
Due to related companies		—		10,429,470
Loan payable to a related party		47,775		73,129
Total		77,634		10,531,851

Due from/to Directors of the Group

As part of normal business operations, directors of the Group will from time to time incur routine expenses on behalf of the Group, or receive general advances from the Group for settlement of Group expenses, such as travel, meals, and other business expenses.  The amounts advanced are settled periodically throughout the period and amounts outstanding at period end are short term in nature and due on demand.  During the three month period ended September 30, 2010, advances to directors aggregated to $19,813 and repayments from directors aggregated to $18,968. During the nine month period ended September 30, 2010, advances to directors aggregated to $36,594 and repayments from directors aggregated to $45,516.

As of September 30, 2010 and December 31, 2009, the Group had the following balances due from its directors:

	September 30, 2010		December 31, 2009
	US$		US$
Leng You-Bin		34,022		33,823
Liu Hua		18,034		27,155
Total		52,056		60,978

As of September 30, 2010 and December 31, 2009, the balances due to Leng You-Bin were $29,859 and $29,252, respectively.

Due from/to related companies

Leng You-Bin is the Chairman, Chief Executive Officer, President, and General Manager of the Group.  During the nine months ended September 30, 2010 and 2009, the Group had certain transactions with companies owned by close family members of Mr. Leng, including Yuanshengtai, which was partially owned by Mr. Leng and Liu Sheng-Hui, on an arm’s length basis. Those shares held by Mr. Leng and Liu Sheng-Hui have been transferred to unrelated third parties who held no ownership interests in Yuanshengtai in January 2010. Additionally, subsequent to such date, the Company ceased being a related party of the Group and, accordingly, the balance due to Yuanshengtai has been classified as other payables, as disclosed in Note 16.

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For the three and nine months ended September 30, 2010 and 2009, the Group made sales of goods to the following related companies:

	For the three months ended September 30,				For the nine months ended September 30,
	2010		2009		2010		2009
	US$		US$		US$		US$
Tangshan Feihe Trading Company		—		1,162,572		1,549,572		4,455,690
Qianhuangdao Feihe Trading Company		—		—		—		411,214
Dalian Hewang Trading Company		77,754		31,756		174,498		190,258
Total		77,754		1,194,328		1,724,070		5,057,162

As of September 30, 2010 and December 31, 2009, the Group had the following balances due from its related companies:

	September 30, 2010		December 31, 2009
	US$		US$
Tangshan Feihe Trading Company		1,745,832		1,897,078
Qinhuangdao Feihe Trading Company		30,580		230,187
Dalian Hewang Trading Company		6,562		—
Total		1,782,974		2,127,265

As of September 30, 2010 and December 31, 2009, the Group had the following balances due to its related companies for advance payments for goods or purchase of cattle:

	September 30, 2010		December 31, 2009
	US$		US$
Heilongjiang Feihe Yuanshengtai Co., Ltd (see Note 16)		—		10,428,246
Dalian Hewang Trading Company		—		1,224
Total		—		10,429,470

Loan payable to related parties

The Group has an outstanding loan payable to a charitable organization set up by Leng You-Bin for underprivileged children in the Heilongjiang province of the PRC, of $47,775 and $73,129 as of September 30, 2010 and December 31, 2009, respectively.  The loan is unsecured and bears interest at 5.85% per annum and is payable on demand.

See Note 19 regarding the issuance of shares to Sequoia Capital China Growth Fund I, LP and certain of its affiliates and designees.

19.  REDEEMABLE COMMON STOCK

The Company issued 525,000 redeemable common stock to Sequoia Capital China Growth Fund I, LP and certain of its affiliates and designees (collectively, “Sequoia”) pursuant to a performance adjustment clause in a subscription agreement because the Company failed to meet certain performance targets set out in the subscription agreement as of December 31, 2009. The 525,000 shares issued to Sequoia were valued at $11,382,000 and recorded as a performance share obligation as of December 31, 2009 and were classified as redeemable common stock during the first quarter of 2010.

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Under the terms of the subscription agreement, the common stock issued to Sequoia is redeemable, at the option of the holder, if at any time after the third anniversary of the issuance date the average closing prices for shares of the Company’s common stock for the period of fifteen (15) consecutive trading days is less than $39 per share, for an amount equal to $31.20, subject to certain adjustments.  Due to the redeemable nature of the common stock issued to Sequoia, the Company has classified the common stock as temporary equity upon issuance. When and if the redemption right expires or when redemption becomes improbable, the common stock will be classified as shareholders’ equity.  The amount that would have been paid if the redemption had occurred on September 30, 2010 is $81.9 million.

The Company assesses the probability of redemption and accrues proper accretion on a quarterly basis. Until management determines it is probable that the common stock will become redeemable, the change in the redemption value is not accreted.  Management determined that the probability of redemption was low as of September 30, 2010, considering among other factors that the redemption period was approximately 20 months away.  The Company plans to continue to implement its integrated business model, increase its profitability by increasing sales of high margin branded products, improve the effectiveness of expenditure controls, reduce the Company’s debt levels, and improve its competitive advantage by building out upstream facilities.

20.  SHARE-BASED COMPENSATION

Share Options

The Company has two stock option plans:  the 2009 Stock Incentive Plan (the “2009 Plan”) and the 2003 Stock Incentive Plan (the “2003 Plan”).  The Company applies authoritative guidance issued by FASB regarding share-based payments in accounting for the 2003 Plan and the 2009 Plan, which requires that compensation for services that a corporation receives through share-based compensation plans should be measured by the quoted market price of the stock at the measurement date less the amount, if any, that the individual is required to pay.

(1) 2009 Stock Incentive Plan

On May 7, 2009, the Company’s Board of Directors approved the 2009 Plan, which was approved by the Company’s shareholders at the Company’s 2009 Annual Meeting of Shareholders. The 2009 Plan permits grants of incentive stock options, nonqualified stock options, restricted stock awards, performance stock awards and other equity-based compensation, to certain employees, directors, officers, consultants, agents, advisors and independent contractors of the Company and its subsidiaries. The total number of shares of the Company’s common stock initially authorized for issuance under the 2009 Plan was 2,000,000 plus any authorized shares that, as of May 7, 2009, were available for issuance under the 2003 Plan.

On May 7, 2009, the Compensation Committee of the Board of Directors granted an aggregate of 2,073,190 performance stock options to certain officers and employees of the Company under the 2009 Plan. The performance stock options each have an exercise price of $16.86, a contractual life of 6 years, and vest in two equal tranches on the fourth and fifth anniversaries of the date such options were granted, provided that the recipient has met the performance criteria established in accordance with the 2009 Plan, including performance targets that must be met in each of the Company’s 2009, 2010 and 2011 fiscal years, and the recipient continues to be an employee of, or service provider to, the Company or its subsidiaries at the time of the relevant vesting dates. If the performance criteria are not met, the options that would otherwise vest on the vesting dates are forfeited and cancelled.

The performance targets for the year ended December 31, 2009 were not met for any option recipient.  In December 2009, the performance targets were amended in order to limit the amount of options that would otherwise be forfeited and cancelled by all recipients of the performance stock options. The incremental cost or benefit resulting from the modification is measured as the excess of the fair value of the modified award over the fair value of the original award immediately before its terms are modified and the effect on the number of instruments expected to vest. As a result of this modification, $1,511,623 in incremental compensation cost was recognized during the year ended December 31, 2009. This modification affected 421 employees.

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The fair value of the option awards are estimated on the date of grant using the Black-Scholes option valuation model to be $22,106,218, of which $647,839 and $1,114,012 was recorded as compensation expense in general and administrative expenses in the three months ended September 30, 2010 and 2009, respectively, and of which $1,943,517 and $1,856,685 was recorded as compensation expense in general and administrative expenses in the nine months ended September 30, 2010 and 2009, respectively, on a straight line basis.  The valuation was based on the assumptions noted in the following table.

Expected volatility	74.94	%
Expected dividends	0	%
Expected term (in years)	5.25
Risk-free rate	2.27	%

On October 15, 2009, an option to purchase 50,000 shares was granted to an employee that vests on the 12-month anniversary of the date of grant, conditioned upon continued employment on such date, and has a contractual life of 4 years.  The fair value of the option award is estimated on the date of grant using the Black-Scholes option valuation model to be $1,103,400, of which $281,980 and $nil was recorded as compensation cost in the three months ended September 30, 2010 and 2009, respectively, and of which $833,679 and $nil was recorded as compensation cost in the nine months ended September 30, 2010 and 2009, respectively.  The valuation was based on the assumptions noted in the following table.

Expected volatility		93	%
Expected dividends		0	%
Expected term (in years)	2.5
Risk-free rate		1.24	%

On October 23, 2009, the Compensation Committee of the Board of Directors granted an aggregate of 30,000 new performance stock options to an employee of the Company under the 2009 Plan. The performance stock options have an exercise price of $27.69, a contractual life of 6 years, and vest in two equal tranches on the fourth and fifth anniversaries of the date such options were granted, provided that the recipient has met the performance criteria established in accordance with the 2009 Plan, including performance targets that must be met in each of the Company’s 2009, 2010 and 2011 fiscal years, and the recipient continues to be an employee of, or service provider to, the Company or its subsidiaries at the time of the relevant vesting dates. If the performance criteria are not met, the options that would otherwise vest on the vesting dates are forfeited and cancelled.

The fair value of the option awards are estimated on the date of grant using the Black-Scholes option valuation model to be $565,900, of which $32,329 and $nil was recorded as compensation expense in general and administrative expenses during the three months ended September 30, 2010 and 2009, respectively, and of which $96,987 and $nil was recorded as compensation expense in general and administrative expenses during the nine months ended September 30, 2010 and 2009, respectively, on a straight line basis.  The valuation was based on the assumptions noted in the following table.

Expected volatility	83	%
Expected dividends	0	%
Expected term (in years)	5.2	5
Risk-free rate	2.59	%

On August 27, 2010, options to purchase 84,000 shares were granted to directors of the Company for their services provided for the period from August 1, 2010  through July 31, 2011, that vests in four equal amounts on each three-month anniversary of the grant date until all such shares are fully vested.  The fair value of the option award is estimated on the date of grant using the Black-Scholes option valuation model to be $164,500, of which $32,370 and $nil was recorded as compensation cost in the three and nine months ended September 30, 2010 and 2009, respectively.  The valuation was based on the assumptions noted in the following table.

Expected volatility	54	%
Expected dividends	0	%
Expected term (in years)	0.	81
Risk-free rate	2.23	%

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(2) 2003 Stock Incentive Plan

Effective May 7, 2003, the Company adopted and approved its 2003 Stock Incentive Plan (the “2003 Plan”), which reserved 3,000,000 shares of common stock for issuance under the 2003 Plan. The 2003 Plan allows the Company to issue awards of incentive non-qualified stock options, stock appreciation rights, and stock bonuses to directors, officers, employees and consultants of the Company which may be subject to restrictions.

No stock appreciation rights have been issued under the 2003 Plan.

On October 15, 2008, an option to purchase 80,000 shares was granted under the 2003 Plan to an employee that vests on the 12-month anniversary of the date of grant, conditioned upon continued employment on such date, and have a contractual life of 4 years.  The fair value of the option award is estimated on the date of grant using the Black-Scholes option valuation model to be $562,758, of which $140,690 and $422,069 was recorded as compensation expense in general and administrative expenses in the three and nine months ended September 30, 2009, respectively, on a straight line basis.  The valuation was based on the assumptions noted in the following table.

Expected volatility	90.7%
Expected dividends	0%
Expected term (in years)	4
Risk-free rate	2.7%

A summary of option activity under the 2003 Plan and 2009 Plan as of September 30, 2010 and movement during the nine months then ended are as follow:

	Options		Weighted average grant date fair value		Weighted average exercise price		Aggregate intrinsic value		Weighted average remaining contractual term
			US$		US$		US$
Outstanding at January 1, 2010		1,484,654		11.02		16.79		7,443,232		5.15
Granted		84,000		1.96		7.25		268,000		1.91
Exercised		8,000		7.03		12.00		—		2.01
Forfeited or expired		—		—		—		—		—
Outstanding at September 30, 2010		1,560,654		10.55		16.30		268,000		4.28
Exercisable at September 30, 2010		72,000		7.03		12.00		—		2.01

A summary of the status of the Company’s non-vested options as of September 30, 2010 and movements during the nine months then ended are as follow:

	Options		Weighted average grant date fair value
			US$
Non-vested at January 1, 2010		1,404,654		11.25
Granted		84,000		1.96
Vested		—		—
Forfeited or expired		—		—
Non-vested at September 30, 2010		1,488,654		10.72

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As of September 30, 2010, there was $8,657,435 of unrecognized compensation cost related to non-vested share-based compensation granted under the 2009 Plan and the 2003 Plan.  The cost is expected to be recognized over various periods ranging from 1 month to 48 months.

Warrants

As of September 30, 2010, the Company had 237,937 warrants outstanding with a weighted average remaining contractual life of 2.3 years and a weighted average exercise price of $14.50, which were issued in connection with the 2009 Notes disclosed in Note 14.

During the nine months ended September 30, 2010 and 2009, no warrants were exercised.

	Warrants		Average exercise Price
			US$
Outstanding warrants at January 1, 2010		237,937		14.50
Warrants granted		—		—
Exercised		—		—
Expired		—		—
Outstanding warrants at September 30, 2010		237,937		14.50

Common stock

In April 2010, the Company issued 8,000 shares of common stock, which issued upon exercise of an option granted under the 2003 Plan for services provided by an employee.  $96,000 was received upon the exercise of stock options.

In April, 2010, the Company issued 39,000 shares of common stock at market value of $766,740 for services provided by employees.

In August 2010, the Company issued 16,915 shares of common stock at market value of $122,635 for services provided by employees.

21.  COMMITMENTS AND CONTINGENCIES

Capital commitments for purchase of property and equipment and biological assets as of September 30, 2010 were $8,521,348. The Group has certain purchase commitments of $7,079,682 over six years relating to packaging materials in connection with the capital lease obligation disclosed in Note 17.

22.  SEGMENTS

The segment information for the operating segments for the three months ended September 30, 2010 was as follows:

	Dairy products			Dairy farms		Corporate			Total
	US$			US$		US$			US$
Revenues from external customers		61,141,112			—		—			61,141,112
Intersegment revenues		374,873			9,138,744		—			9,513,617
Segment income tax (expense) benefit		(27,151	)		—		238,629			211,478
Segment profit (loss) before income tax		3,184,684			1,358,218		(1,109,323	)		3,433,579
Segment assets		504,671,089			164,054,787		191,784,303			860,510,179

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The segment information for the operating segments for the three months ended September 30, 2009 was as follows:

	Dairy products		Dairy farms			Corporate			Total
	US$		US$			US$			US$
Revenues from external customers		72,110,934		—			—			72,110,934
Intersegment revenues		—		3,541,682			—			3,541,682
Segment income tax benefit (expense)		1,666,826		(59,088	)		64,429			1,672,167
Segment profit (loss)		14,372,005		(197,401	)		(4,713,222	)		9,461,382

The segment information for the operating segments for the nine months ended September 30, 2010 was as follows:

	Dairy products			Dairy farms			Corporate			Total
	US$			US$			US$			US$
Revenues from external customers		194,771,521			—			—			194,771,521
Intersegment revenues		649,979			19,226,738			—			19,876,717
Segment income tax (expense) benefit		(940,472	)		—			208,329			(732,143	)
Segment profit (loss)		578,183			(6,104,473	)		(5,345,092	)		(10,871,382	)
Segment assets		504,671,089			164,054,787			191,784,303			860,510,179

The segment information for the operating segments for the nine months ended September 30, 2009 was as follows:

	Dairy products			Dairy farms			Corporate			Total
	US$			US$			US$			US$
Revenues from external customers		227,119,247			—			—			227,119,247
Intersegment revenues		71,508			7,199,194			—			7,270,702
Segment income tax expense		(1,818,178	)		(59,088	)		(1,625,308	)		(3,502,574	)
Segment profit (loss)		58,481,670			(1,178,297	)		12,918,341			70,221,714

A reconciliation of operating segment revenue, profit (loss) and assets to the Group’s totals was as follows:

	Three months ended September 30,
	2010			2009
Revenue	US$			US$
Total revenue for operating segments		70,654,729			75,652,076
Elimination of intersegment revenue		(9,513,617	)		(3,541,682	)
Total consolidated revenue		61,141,112			72,110,394

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	Three months ended September 30,
	2010		2009
Profit	US$		US$
Total profit for operating segments		3,433,579		9,461,382
Elimination of intersegment profit distribution (i)		—		—
Income from operations before income taxes and noncontrolling interest		3,433,579		9,461,382

	Nine months ended September 30,
	2010			2009
Revenue	US$			US$
Total revenue for operating segments		214,648,238			234,389,949
Elimination of intersegment revenue		(19,876,717	)		(7,270,702	)
Total consolidated revenue		194,771,521			227,119,247

	Nine months ended September 30,
	2010			2009
(Loss) profit	US$			US$
Total (loss) profit for operating segments		(10,871,382	)		70,221,714
Elimination of intersegment profit distribution (i)		—			(23,499,920	)
(Loss) income from operations before income taxes and noncontrolling interest		(10,871,382	)		46,721,794

	September 30, 2010			December 31, 2009
Assets	US$
Total assets for operating segments		860,510,179			810,033,381
Elimination of investment		(120,592,637	)		(120,256,340	)
Elimination of intercompany receivables		(284,372,223	)		(249,519,304	)
Total consolidated assets		455,545,319			440,257,737

(i) The intersegment profit distribution represented the profits distributed from Feihe Dairy and Gannan Feihe to Feihe International, Inc.

23.  SUBSEQUENT EVENTS

On October 15, 2010, an option to purchase 60,000 shares was granted under the 2009 Plan to an employee that vests on 12-month anniversary of the date of grant, conditioned upon continued employment on such date, and have a contractual life of 4 years.

The Group evaluated events occurring after September 30, 2010 until the date the condensed financial statements were issued and did not note other significant subsequent events.

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FORWARD-LOOKING STATEMENTS

The statements included in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and Section 27A of the Securities Act of 1933, as amended. These statements include, but are not limited to, statements about our plans, objectives, expectations, strategies, intentions or other characterizations of future events or circumstances and are generally identified by the words “may,” “expects,” “anticipates,” “intends,” “plans,” “targets,” “believes,” “seeks,” “estimates,” “could,” “would,” and similar expressions. Because these forward-looking statements are subject to a number of risks and uncertainties, our actual results could differ materially from those expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, as amended, in our Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2010 and June 30, 2010, and in other documents we file from time to time with the U.S. Securities and Exchange Commission, or the SEC. All forward-looking statements included in this report are based on information available to us on the date hereof. Our business and the associated risks may have changed since the date this report was originally filed with the SEC. We assume no obligation to update any such forward-looking statements.

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and related notes appearing elsewhere in this Quarterly Report.  In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report, particularly in “Part II – Item 1A. Risk Factors” below.

Overview

We are a leading producer and distributor of milk powder, soybean milk powder, and related dairy products in the People’s Republic of China, or the PRC.  Using proprietary processing techniques, we make products that are specially formulated for particular ages, dietary needs and health concerns.  We have over 200 company-owned milk collection stations, seven production and distribution facilities with an aggregate milk powder production capacity of approximately 1,250 tons per day, and an extensive distribution network that reaches over 90,000 retail outlets throughout China.

Factors Affecting our Results of Operations

Our operating results are primarily affected by the following factors:

· Dairy Industry Growth.We believe the market for dairy products in China for the long term will be growing rapidly, driven by China’s economic growth, increased penetration of infant formula, and a growing female working population.  Despite the damage to the industry as a result of the melamine crisis in 2008, which did not involve any of our products, we expect these factors to continue to drive industry growth. We believe that the rapid economic growth of our primary markets has become an increasingly important driver of growth.

· Production Capacity.We believe much of the dairy market in China is still underserved, particularly with respect to infant formula.  In addition, since the melamine crisis in 2008, we have expanded the production capabilities at our Gannan facility and added the production facility in Longjiang to our current production capabilities. Accordingly, we believe that the ability to increase production of high quality dairy products will allow well-positioned companies to significantly increase revenues and market share.

· Perceptions of Product Quality and Safety. We believe that rising consumer wealth in China has contributed to a greater demand for higher-priced products with perceived quality advantages.  We believe many consumers in China tend to regard higher prices as indicative of higher quality and higher nutritional value, particularly in the areas of infant formula and nutritional products.  Accordingly, we believe our reputation for quality and safety allows us to command higher average selling prices and generate higher gross margins than competitors who do not possess the same reputation.  Conversely, any decrease in consumer perceptions of quality and safety could adversely impact us.

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· Seasonality.  The dairy industry remains seasonal, with higher production in the summer season and greater demand in winter months. This seasonality is offset by production of powder products with longer shelf lives.

· Raw Material Supply and Prices.  The per unit costs of producing our infant formula are subject to the supply and price volatility of raw milk and other raw materials, which are affected by the PRC and global markets. For example, in 2008 our raw milk prices increased by approximately 45%, in 2009 decreased by approximately 20% and in the first three quarters of 2010 increased by approximately 27%, and we expect they will continue to be affected by factors such as geographic location, rising feed prices, general economic conditions such as inflation and fuel prices, and fluctuations in production, rising production costs and competition, as well as increased competition abroad and currency fluctuations.  Our milk cost associated with fresh milk sourced from our company-owned dairy farms is also impacted by governmental agricultural and environmental policies, subsidies, technical assistance and other agricultural regulations and policies, as well as the productivity of our dairy cows, which can be influenced natural and environmental factors

· Expenses Associated with Expansion and Competition.  In implementing our plan to expand our business, we face corresponding increases in expenses, especially for selling and marketing expenses, in order to pay slotting fees and sales commissions, attract and retain qualified talent, monitor our sales by region and address potential cross-territory selling activities by distributors, implement strategic advertising campaigns, and finance our expansion.    

Results of Operations

The following table sets forth certain information regarding our results of operations.

	Three Months Ended September 30						Nine Months Ended September 30
	2010			2009			2010			2009
	($ in thousands)						($ in thousands)
Sales		61,141			72,111			194,771			227,119
Cost of goods sold		(33,829	)		(35,130	)		(110,557	)		(93,428	)
Gross profit		27,312			36,981			84,214			133,691
Operating expenses:
Sales and marketing expenses		(18,731	)		(27,456	)		(76,585	)		(79,772	)
General and administrative expenses		(6,130	)		(5,656	)		(18,705	)		(16,957	)
Loss on disposal of biological assets		(468	)		(151	)		(9,041	)		(972	)
Income (loss) from continuing operations		2,048			4,028			(19,688	)		37,814
Other income, net		1,385			5,433			8,816			8,907
Income tax benefit (expense)		211			1,672			(732	)		(3,503	)
Net income from discontinued operations, net of tax		—			—			—			3,290
Net income (loss) attributable to Feihe International, Inc.		3,577			11,141			(11,464	)		46,559

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Comparison of Three Month Periods Ended September 30, 2010 and 2009

Sales

Our sales consist primarily of revenues generated from sales of milk powder, raw milk powder, soybean powder, rice cereal, and walnut products.  Sales decreased by approximately $11.0 million, or 15.2%, from approximately $72.1 million for the three month period ended September 30, 2009 to approximately $61.1 million for the three month period ended September 30, 2010.  This decrease was primarily attributable to decrease of sales of milk powder of approximately $14.9 million, offset in part by an increase in sales of raw milk powder of approximately $5.2 million. With new competitors entering into our industry and old competitors aggressively attempting to reclaim market share following the melamine crisis, we expect to face increased competition.

The following table sets forth information regarding the sales of our principal products during the three month periods ended September 30, 2010 and 2009:

	Three months ended September 30, 2010						Three months ended September 30, 2009						Three months ended September 30, 2010 over 2009
Product name	Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)			Amount ($’000)			%
Milk powder		4,641		40,909		66.9		6,561		55,854		77.5		(1,920	)		(14,945	)		(26.8	)
Raw milk powder		4,223		14,384		23.5		3,780		9,216		12.8		443			5,168			56.1
Soybean powder		724		3,945		6.5		957		2,093		2.9		(233	)		1,852			88.5
Rice cereal		147		916		1.5		194		1,189		1.6		(47	)		(273	)		(23.0	)
Walnut products		62		414		0.7		174		878		1.2		(112	)		(464	)		(52.8	)
Other		33		573		0.9		493		2,881		4.0		(460	)		(2,308	)		(80.1	)
Total		9,830		61,141		100		12,159		72,111		100		(2,329	)		(10,970	)		(15.2	)

In the three month period ended September 30, 2010, we had an increase in the average sales price per kilogram of our products, as demonstrated in the table below:

	Three Months Ended September 30,
	2010		2009
Sales revenues (in thousands)	$	61,141	$	72,111
Total sales volume (kilograms in thousands)		9,830		12,159
Average selling prices/kilogram	$	6.22	$	5.93

The increase in average sales price per kilogram, as reflected in the table, was primarily attributable to the increase of sales prices of milk powder and raw milk powder.  The following table reflects the average sales price per kilogram by product for the three month period ended September 30, 2010 and 2009, and the percentage change in the sales price per kilogram.

	Average Price Per Kilogram
	Three Months ended September 30,				Percentage
Product	2010		2009		Change
Milk powder	$	8.81	$	8.51		3.5
Raw milk powder		3.41		2.44		39.8
Soybean powder		5.45		2.19		148.9
Rice cereal		6.23		6.13		1.6
Walnut products		6.68		5.04		32.5
Other		17.36		5.84		197.3
Total	$	6.22	$	5.93		4.9

The average selling price per kilogram of milk powder increased by 3.5% from $8.51 in the three month period ended September 30, 2009 to $8.81 in the three month period ended September 30, 2010.  This increase was primarily attributable to fewer promotional activities, including a decrease in sales discounts provided to distributors. The average selling price per kilogram for raw milk powder increased by 39.8%, from $2.44 in the three month period ended September 30, 2009 to $3.41 in the three month period ended September 30, 2010.  This increase was primarily attributable to increased demand and market prices of raw milk.

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Cost of Goods Sold

Our cost of goods sold consist primarily of direct and indirect manufacturing costs, including production overhead costs and shipping and handling costs for the products sold.  Cost of goods sold decreased approximately $1.3 million, or 3.7%, from approximately $35.1 million for the three month period ended September 30, 2009 to approximately $33.8 million for the three month period ended September 30, 2010.  This decrease was primarily attributable to a decrease in sales quantities.

Gross Profit Margin

Our gross profit margin decreased from 51.3% for the three month period ended September 30, 2009 to 44.7% for the three month period ended September 30, 2010. This decrease was primarily attributable to a decrease in our sales quantities of milk powder and an increase in sales quantities of raw milk powder, which has a lower gross profit margin than milk powder, as well as increases in the price of raw milk. We plan to continue monitoring how our competitors attempt to reclaim market share following the melamine crisis, pursuing strategic market opportunities to maintain and expand our sales of higher margin products, and strengthening our premium quality brand awareness and distribution reach.

Operating Expenses

Our total operating expenses consist primarily of sales and marketing expenses, general and administrative expenses and loss on disposal of biological assets.  Our total operating expenses decreased by approximately $8.0 million, or 23.9%, from approximately $33.3 million in the three month period ended September 30, 2009 to approximately $25.3 million in the three month period ended September 30, 2010. This decrease was primarily attributable to a decrease of approximately $8.7 million, or 31.8%, in sales and marketing expenses from approximately $27.4 million for the three month period ended September 30, 2009 to approximately $18.7 million for the three month period ended September 30, 2010. This decrease was offset in part by an increase of approximately $0.4 million, or 8.4%, in general and administrative expenses from approximately $5.7 million for the three month period ended September 30, 2009 to approximately $6.1 million for the three month period ended September 30, 2010, and an increase of approximately $0.3 million, or 209.9%, in loss on disposal of biological assets from approximately $0.2 million for the three month period ended September 30, 2009 to approximately $0.5 million for the three month period ended September 30, 2010. The decreased sales and marketing expenses primarily relate to a decrease in promotional fees and also reflected of our efforts on to improve the effectiveness of our selling expenses in the three month period ended September 30, 2010.

Income (Loss) from Continuing Operations

As a result of the foregoing, we had income from continuing operations of approximately $2.0 million in the three month period ended September 30, 2010, representing a decrease of approximately $2.0 million, or 49.2%, from income of approximately $4.0 million in the three month period ended September 30, 2009.

Other Income (Expenses)

Our other income (expenses) consists primarily of interest income, interest and finance costs, amortization of deferred debt issuance cost, government subsidies.  Other income (expenses) decreased approximately $4.0 million, or 74.5%, from approximately $5.4 million for the three month period ended September 30, 2009 to approximately $1.4 million for the three month period ended September 30, 2010.  The decrease was primarily attributable to a decrease of government subsidy of approximately $6.1 million, or 77.8%, from approximately $7.9 million for the three month period ended September 30, 2009 to approximately $1.8 million for the three month period ended September 30, 2010. This decrease was offset in part by a decrease in interest and finance costs of approximately $1.3 million, or 74.7%, from approximately $1.7 million for the three month period ended September 30, 2009 to approximately $0.4 million for the three month period ended September 30, 2010.

Income Tax Expense

We are subject to U.S. federal and state income taxes, and our subsidiaries incorporated in the PRC are subject to enterprise income taxes in the PRC.  We recorded an income tax benefit of approximately $0.2 million and $1.7 million for the three months ended September 30, 2010 and 2009, respectively.  The income tax benefit of $0.2 million for the three month period ended September 30, 2010 was primarily due to the decrease in profit of our PRC subsidiary Gannan Flying Crane Dairy Products Co., Limited, which resulted in decreased income tax expense. The income tax benefit of $1.7 million for the three month period ended September 30, 2009 was primarily due to the decrease in profit of our PRC subsidiary Heilongjiang Feihe Diary Co., Limited.

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As of September 30, 2010, unrecognized tax benefits were approximately $5.0 million.  The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $3.2 million at September 30, 2010. As of September 30, 2009, unrecognized tax benefits were approximately $5.0 million.  The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $3.2 million at September 30, 2009.

We have cumulatively accrued approximately $1.5 million and $0.8 million for estimated interest and penalties related to unrecognized tax benefits at September 30, 2010 and at September 30, 2009, respectively.  For the three months ended September 30, 2010 and September 30, 2009, we recorded $152,000 and $89,000 of estimated interest and penalties, respectively.

Comparison of Nine Month Periods Ended September 30, 2010 and 2009

Sales

Sales decreased by approximately $32.3 million, or 14.2%, from approximately $227.1 million for the nine month period ended September 30, 2009 to approximately $194.8 million for the nine month period ended September 30, 2010.  This decrease was primarily attributable to decrease of sales of milk powder of approximately $54.7 million, offset in part by an increase in sales of raw milk powder of approximately $25.0 million.

The following table sets forth information regarding the sales of our principal products during the nine month periods ended September 30, 2010 and 2009:

	Nine months ended September 30, 2010						Nine months ended September 30, 2009						Nine months ended September 30, 2010 over 2009
Product name	Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)			Amount ($’000)			%
Milk powder		18,009		140,742		72.2		23,906		195,483		86.0		(5,897	)		(54,741	)		(28.0	)
Raw milk powder		11,351		40,417		20.7		6,206		15,410		6.8		5,145			25,007			162.3
Soybean powder		4,278		8,092		4.2		2,638		5,569		2.5		1,640			2,523			45.3
Rice cereal		544		3,439		1.8		844		5,116		2.3		(300	)		(1,677	)		(32.8	)
Walnut products		200		1,148		0.6		474		2,288		1.0		(274	)		(1,140	)		(49.8	)
Other		64		933		0.5		528		3,253		1.4		(464	)		(2,320	)		(71.3	)
Total		34,446		194,771		100		34,596		227,119		100		(150	)		(32,348	)		(14.2	)

In the nine month period ended September 30, 2010, we also experienced a decrease in the average sales price per kilogram of our products, as demonstrated in the table below:

	Nine Months Ended September 30,
	2010		2009
Sales revenues (in thousands)	$	194,771	$	227,119
Total sales volume (kilograms in thousands)		34,446		34,596
Average selling prices/kilogram	$	5.65	$	6.56

The decrease in average sales price per kilogram, as reflected in the table, was primarily attributable to a shift in product mix resulting from a decrease in sales of milk powder, a higher margin product, coupled with a decrease in the sales price of milk powder products.  The following table reflects the average sales price per kilogram by product for the nine month period ended September 30, 2010 and the nine month period ended September 30, 2009, and the percentage change in the sales price per kilogram.

	Average Price Per Kilogram
	Nine Months ended September 30				Percentage
Product	2010		2009		Change
Milk powder	$	7.82	$	8.18		(4.4	)
Raw milk powder		3.56		2.48		43.5
Soybean powder		1.89		2.11		(10.4	)
Rice cereal		6.32		6.06		4.3
Walnut products		5.74		4.83		18.8
Other		14.58		6.16		136.7
Total	$	5.65	$	6.56		(13.9	)

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The 4.4% decrease in the average sales price per kilogram in milk powder from $8.18 in the nine month period ended September 30, 2009 to $7.82 in the nine month period ended September 30, 2010, was primarily attributable to an increase in display and slotting fees, which is net with sales. During the nine month period ended September 30, 2010, our display and slotting fees increased about $9.0 million, or 57.3%, to 24.7 million, compared to $ 15.7 million during the nine month period ended September 30, 2009.

Cost of Goods Sold

Cost of goods sold increased approximately $17.1 million, or 18.3%, from approximately $93.4 million for the nine month period ended September 30, 2009 to approximately $110.5 million for the nine month period ended September 30, 2010.  The increase was primarily attributable to an increase in raw milk price.

Gross Profit Margin

Our gross profit margin decreased from 58.9% for the nine month period ended September 30, 2009 to 43.2% for the nine month period ended September 30, 2010. This decrease was primarily attributable to a decrease in our sales quantities of milk powder and an increase in sales quantities of raw milk powder, which has a lower gross profit margin than milk powder, as well as increases in price of raw milk.

Operating Expenses

Our total operating expenses increased by approximately $6.6 million, or 6.8%, from approximately $97.7 million in the nine month period ended September 30, 2009 to approximately $104.3 million in the nine month period ended September 30, 2010. This increase was primarily attributable to an increase of approximately $1.7 million, or 10.3%, in general and administrative expenses from approximately $17.0 million for the nine month period ended September 30, 2009 to approximately $18.7 million for the nine month period ended September 30, 2010, and an increase of approximately $8.1 million, or 830.1%, in loss on disposal of biological assets from approximately $1.0 million for the nine month period ended September 30, 2009 to approximately $9.1 million for the nine month period ended September 30, 2010. The increase was offset in part by a decrease of approximately $3.2 million, or 4.0%, in sales and marketing expenses from approximately $79.8 million for the nine month period ended September 30, 2009 to approximately $76.6 million for the nine month period ended September 30, 2010.  Decreased sales and marketing expenses primarily relate to our decreased sales, and also reflect decreased promotional fees in the nine month period ended September 30, 2010.  Increased general and administrative expenses primarily attributable to an increase of stock compensation expenses as a result of stock options granted under the 2009 Plan and salary expenses, offset by a decrease in professional fees.  The increased loss on disposal of biological assets primarily reflects our sale of under-producing cows at our company-owned dairy farms in the nine month period ended September 30, 2010.

(Loss) Income from Continuing Operations

As a result of the foregoing, we had a loss from continuing operations of approximately $19.7 million in the nine month period ended September 30, 2010, representing a decrease of approximately $57.5 million, or 152.1%, from income of approximately $37.8 million in the nine month period ended September 30, 2009.

Other Income (Expenses)

Other income (expenses) decreased approximately $0.1 million, or 1.0%, from other income of approximately $8.9 million for the nine month period ended September 30, 2009 to approximately $8.8 million for the nine month period ended September 30, 2010.  The decrease was primarily attributable to a decrease in government subsidies of approximately $3.7 million, or 25.5%, from approximately $14.6 million for the nine month period ended September 30, 2009 to approximately $10.9 million for the nine month period ended September 30, 2010, and was offset in part by a decrease in interest and finance costs of approximately $3.1 million, or 61.1%, from approximately $5.1 million for the nine month period ended September 30, 2009 to approximately $2.0 million for the nine month period ended September 30, 2010, which was due to repayment of debts in 2009.

Income Tax Expense

We recorded a provision for income tax of approximately $(0.7) million and $(3.5) million for the nine month periods ended September 30, 2010 and 2009, respectively.  The decrease was primarily due to the decreased income generated by our subsidiaries in the PRC, resulting in reduced income tax.

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Net Income from Discontinued Operations, net of tax

Our net income from discontinued operations, net of tax, decreased by approximately $3.3 million, or 100%, from approximately $3.3 million for the nine month period ended September 30, 2009 to $nil for the nine month period ended September 30, 2010.

Liquidity and Capital Resources

We had retained earnings of approximately $62.2 million at September 30, 2010 and $73.7 million at December 31, 2009.  As of September 30, 2010, we had cash and cash equivalents of approximately $22.2 million and total current assets of approximately $161.8 million.  As of September 30, 2010, we had a working capital deficit of approximately $24.9 million.  We have taken various actions to conserve cash, procure additional financing and improve liquidity.  Such actions include reducing working capital requirements in operations through improving sales processes, accelerating accounts receivables collection, strengthening control on operating expenditures and renewing short term borrowings.  We have financed our activities to date principally from cash generated from operations, proceeds from sales of convertible notes, proceeds from short term loans and notes payable, and proceeds from common stock financing.

Our summary cash flow information is as follows:

	Nine Months Ended September 30
Net cash provided by (used in):	2010			2009
	($ in thousands)
Operating activities		21,657		15,787
Investing activities		(25,147	)	(23,714	)
Financing activities		(23,236	)	37,565

Net Cash Provided by Operating Activities

Net cash provided by operating activities increased approximately $5.9 million, from approximately $15.8 million in the nine month period ended September 30, 2009 to approximately $21.7 million in the nine month period ended September 30, 2010.  This increase was primarily attributable to an increase in loss on sale of biological assets of approximately $8.1 million, a decrease in net income from discontinued operations of approximately $3.3 million, a decrease in trade receivable of approximately $32.0 million, a decrease in income tax receivable of approximately $3.3 million, a decrease in input value-added taxes of approximately $2.3 million, an increase in accounts payable of approximately $10.0 million, and an increase in advance from customers of approximately of $20.0 million. This decrease was offset in part by a decrease in net (loss) income of approximately $58.1 million, a decrease in interest expense from amortization of note discounts of approximately $4.5 million, an increase in advances to suppliers of approximately $4.4 million, an increase in short term notes receivables of approximately $3.5 million, a decrease in other payables of approximately $6.4 million, and a decrease in deferred income of approximately $5.2 million.

Net Cash Used in Investing Activities

Net cash used in investing activities increased approximately $1.4 million, from approximately $23.7 million in the nine month period ended September 30, 2009 to approximately $25.1 million in the nine month period ended September 30, 2010.  This increase was primarily attributable to a decrease of approximately $39.0 million in proceeds from sale of a subsidiary and an increase of approximately $2.5 million in restricted cash. This decrease was offset in part by a decrease of approximately $31.7 million in purchase of property and equipment, a decrease of approximately $3.7 million in purchase of biological assets and a decrease of approximately $3.3 million in purchase of a dairy operation. The expenditures on property and equipment mainly related to the construction of our Gannan Dairy Phase II production facilities and our Longjiang production facilities in the nine month period ended September 30, 2010, and to the construction of our Kedong Pasture facilities and Gannan Pasture facilities in the nine month period ended September 30, 2009.

Net Cash (Used in) Provided by Financing Activities

Net cash (used in) provided by financing activities decreased approximately $60.8 million, from net cash provided by financing activities of approximately $37.6 million in the nine month period ended September 30, 2009 to net cash used in financing activities of approximately $23.2 million in the nine month period ended September 30, 2010.  This decrease was primarily attributable to a decrease of approximately $63.0 million in proceeds from issuance of new shares, a decrease of approximately $13.4 million in proceeds from short term bank loans, a decrease of approximately $7.5 million in proceeds from long term bank loans and an increase of approximately $7.0 million in repayment of long term bank loans. This decrease was offset in part by a decrease of approximately $31.4 million in repayment of short term bank loans.

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Outstanding Indebtedness

Equipment Financing

In October 2009, we entered into a loan agreement with a bank in the PRC for a principal amount of up to $9.2 million for the purpose of financing the purchase of certain equipment. The loan bore interest at the six-month LIBOR rate plus 1.95%, with principal payable in 10 equal semi-annual installments and interest payable semi-annually. As of December 31, 2009, there was approximately $4 million in principal payable under this loan. The loan was fully repaid in June 2010.

In November 2009, we entered into a six-year capital lease agreement for certain equipment under construction. The terms of the lease required an initial payment of approximately $746,500 and require a payment of approximately $149,300 on January 30th of each year after successful completion of production quality tests. The equipment was undergoing trial runs as of September 30, 2010, and will be depreciated over an estimated productive life of 14 years when placed into service after passing production quality tests, which is estimated to be in December 2010.  As of September 30, 2010 and 2009, we had approximately $1.5 million and $nil, respectively, of equipment under construction subject to the capital lease obligation.

Short and Long Term Loans Payable

As of September 30, 2010, we had short term notes and loans from PRC banks or local suppliers of approximately $42.1 million.  During the three month period ended September 30, 2010, the largest aggregate amount of short term notes and loans was approximately $46.9 million  The maturity dates of the short term loans outstanding from PRC banks at September 30, 2010 ranged from October 2010 to September 2011.  The weighted average interest rate on short term loans from PRC banks outstanding at September 30, 2010 was 5.31%.  The loans were secured by pledges of certain fixed assets held by our subsidiaries or by guarantees of certain of our subsidiaries.  All outstanding short term loans from local banks that have become due have been repaid, and we believe the remaining outstanding short term loans from PRC banks can be renewed upon request.

As of September 30, 2010, we had long term loans from PRC banks of approximately $36.4 million, which was also the largest aggregate amount of long term loans during the three month period ended September 30, 2010.  The maturity dates of the long term loans outstanding from PRC banks at September 30, 2010 ranged from March 2011 to December 2014. The weighted average interest rate on long term loans outstanding from PRC banks at September 30, 2010 was 6.38%. The loans were secured by pledges of certain fixed assets, land use rights, and biological assets held by our subsidiaries or by guarantees of certain of our subsidiaries.

Other Factors Affecting our Liquidity and Capital Resources

Expansion Strategy

We believe the market for dairy products in China is growing rapidly, including the market for high quality dairy products. Our growth strategy involves capturing as much of this market as possible during this rapid growth phase. To implement this strategy we plan to expand our sales and marketing capabilities by implementing new targeted strategies and promotions, strengthen and expand our distribution points as well as improve sales at focused distribution points. We also plan to invest in marketing, which will strengthen our premium quality brand awareness, and to strategically align sourcing, production and distribution by region. Our expansion strategy will require the continued retention and investment of our earnings from operations and, we believe, additional funding from private debt and equity financing. In general, the commitment of funds toward expansion tends to impair liquidity. However, we believe that because of the upward trend in our revenues in recent years, even if this trend levels off, our income from continuing operations coupled with such additional financing should provide sufficient liquidity to meet our overall needs.

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As of September 30, 2010, we had a working capital deficit, with current liabilities exceeding current assets by approximately $24.8 million, and cash and cash equivalents of $22.2 million.  We have taken various actions to conserve cash, procure financing and improve liquidity.  Such actions include reducing working capital requirements in operations through improving sales processes, accelerating accounts receivables collection, strengthening control on operating expenditure and renewing short term borrowings.  Given our future planned operating and capital expenditure, we may need to borrow additional short term debt.

Investments in a New Subsidiary

In January 2010, our subsidiary Heilongjiang Flying Crane Trading Co., Limited, or Heilongjiang Trading, was registered in Heilongjiang Province, China. As of September 30, 2010, we had contributed approximately $1.2 million of the total registered capital of approximately $1.5 million, and we held an 85% equity interest in this subsidiary. The primary business of Heilongjiang Trading is to sell milk and soybean related products.

Common Stock Financing

In August 2009, we entered into a subscription agreement with Sequoia Capital China Growth Fund I, L.P. and certain of its affiliates, or the Purchasers, pursuant to which we issued 2,100,000 shares of our common stock for an aggregate purchase price of $63.0 million, including $47.0 million in cash and the conversion of a $16.0 million bridge loan we previously received fromthe Purchasers. We used a portion of the proceeds from the transaction to repurchase our 2012 Notes. In connection with the subscription agreement, we entered into a registration rights agreement, pursuant to which we have registered the resale of the securities issued or issuable pursuant to the subscription agreement.

In the subscription agreement, we also agreed, until August 2012, not to issue new shares of our common stock at a price below $24.00 per share without the prior written consent of a majority in interest of the Purchasers, subject to certain exceptions. We also granted each of the Purchasers a participation right to purchase up to such person’s pro rata share of any new securities we may, from time to time, propose to issue after the closing date, subject to certain exceptions. Furthermore, if the average of the closing prices of our common stock for the fifteen trading days commencing on the third anniversary of the closing date is less than $39.00 per share, the Purchasers will have the right to cause us to repurchase all (but not less than all) of the securities acquired by the Purchasers in connection with the agreement. The repurchase price would be an amount equal to $31.20, subject to certain adjustments. In addition, because we did not meet certain earnings per share targets for 2009, we issued the maximum 525,000 additional shares of our common stock in March 2010 to the Purchasers pursuant to the agreement. Therefore, we will have no earnings per share targets for 2010 to satisfy under the agreement.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Critical Accounting Policies

The consolidated financial statements include the financial statements of us and our subsidiaries.  All transactions and balances among us and our subsidiaries have been eliminated upon consolidation. Certain amounts included in or affecting our consolidated financial statements and related disclosures must be estimated, requiring us to make certain assumptions with respect to values or conditions that cannot be known with certainty at the time the financial statements are prepared. These estimates and assumptions affect the amounts we report for assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates, and the reported amounts of revenues and expenses during the reporting periods.  We routinely evaluate these estimates, utilizing historical experience, consulting with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates. Any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.

We believe that certain accounting policies are of more significance in our consolidated financial statement preparation process than others, which policies are discussed below.

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Estimates of allowances for bad debts – We periodically review our trade and other receivables to determine if all are collectible or whether an allowance is required for possible uncollectible balances. We perform this review quarterly, and in determining the allowances, a number of factors are considered, including the length of time the receivable is past due, past loss history, the counter party’s current ability to pay and the general condition of the economy and industry. As a result of this review and collection of older receivables, we have increased our estimated allowance for bad debts by $68,860 for the nine months ended September 30, 2010 and increased it by $311,555 for the nine months period ended September 30, 2009. Although our write-offs of bad debts have been minimal in recent years and we have no write-offs in the nine months ended September 30, 2010, events and circumstances could occur that would require that we increase our allowance in the future.

Estimate of the useful lives of property and equipment and biological assets – We estimate the useful lives and residual values of our property and equipment and biological assets. We also review property and equipment and biological assets for possible impairment whenever events and circumstances indicate that the carrying value of those assets may not be recovered from the estimated future cash flows expected to result from their use and eventual disposition.  We recognized no impairments in the nine month period ended September 30, 2010 and the nine month period ended September 30, 2009.

Inventory – We value inventories at the lower of cost or market value. We determine the cost of inventories using the weighted average cost method and include any related production overhead costs incurred in bringing the inventories to their present location and condition. We determine whether we have any excessive, slow moving, obsolete or impaired inventory. We perform this review quarterly, which requires management to estimate the future demand of our products and market conditions. We make provisions on the value of inventories at period end equal to the difference between the cost and the estimated market value. If actual market conditions change, additional provisions may be required. As a result of these reviews, we reduced our estimated reserve for obsolescence by $256,245 for the nine months ended September 30, 2010 and reduced it by $30,789 for the nine months period ended September 30, 2009.

Goodwill – We test goodwill annually for impairment or more frequently if events or changes in circumstances indicate that it might be impaired. We perform impairment tests at the reporting unit level to identify potential goodwill impairment. We recognize a goodwill impairment loss in our statements of operations when the carrying amount of goodwill exceeds its implied fair value. We perform the impairment test at the end of the fourth quarter each year.

Revenue recognition – Revenue from the sale of goods is recognized on the transfer of risks and rewards of ownership, which generally coincides with the time when the goods are shipped to customers and the title has passed. Revenue is shown net of sales returns, which amounted to 0% and less than 0.50% of total sales for the nine months ended September 30, 2010 and September 30, 2009, respectively, and net of sales discounts, which is determined based on our distributors’ sales volumes.

Share-based compensation – Share-based compensation to employees is measured by reference to the fair value of the equity instrument as at the date of grant using the Black-Scholes model, which requires assumptions for dividend yield, expected volatility and expected life of stock options. The expected life of stock options is estimated by observing general option holder behavior. The assumption of the expected volatility has been set by reference to the implied volatility of our shares in the open market and historical patterns of volatility. Performance and service vesting conditions attached to the options are included in assumptions about the number of shares that the option holder will ultimately receive. On a regular basis we review the assumptions made and revise the estimates of the number of options expected to be settled, where necessary.

In connection with the 2,073,190 performance stock options granted to certain employees on May 7, 2009, the fair value of the option awards was estimated on the date of grant to be $22,106,218. The performance targets for the year ended December 31, 2009 were not met for any option recipient.  In December 2009, the performance targets were amended in order to limit the amount of options that would otherwise be forfeited and cancelled by all recipients of the performance stock options. The incremental cost or benefit resulting from the modification is measured as the excess of the fair value of the modified award over the fair value of the original award immediately before its terms are modified and the effect on the number of instruments expected to vest. For the three and nine months ended September 30, 2010, $647,839 and $1,943,517 were recorded as compensation expense, on a straight line basis.  The valuation was based on the assumptions noted in the following table.

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Expected volatility	74.94%
Risk-free rate	2.27%
Expected dividends	0%
Expected term (in years)	5.25

Significant differences in employee option activity and market performance may materially affect future compensation expense.

Redeemable common stock –The value of redeemable common stock is measured at the fair value on the date of issuance. When and if the redemption right expires or when redemption becomes improbable, the common stock will be classified as shareholders’ equity. We assess the probability of redemption and accrue proper accretion on a quarterly basis. Until management determines it is probable that the common stock will become redeemable, the change in the redemption value is not accreted. Management determined that the probability of redemption was low as of September 30, 2010, considering among other factors that the redemption period was approximately 20 months away.  We plan to continue to implement our integrated business model, increase our profitability by increasing sales of our high margin branded products, improve the effectiveness of expenditure controls, reduce our debt levels, and improve our competitive advantage by building out our upstream facilities.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We conduct all of our operations in the PRC, and the Renminbi is the national currency in which our operations are conducted. We have not utilized any derivative financial instruments or any other financial instruments, nor do we utilize any derivative commodity instruments in our operations, nor any similar market sensitive instruments.

The exchange rate between the Renminbi and the U.S. dollar is subject to the PRC government’s foreign currency conversion policies, which may change at any time.  The exchange rates at September 30, 2010 and December 31, 2009 were approximately 6.7 and 6.8 Renminbi to 1 U.S. dollar, respectively. The exchange rate is currently permitted to float within a very limited range.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

Management evaluated the effectiveness of our disclosure controls and procedures for the year ended December 31, 2009, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, and identified a material weakness in our internal control over financial reporting, which we view as an integral part of our disclosure controls and procedures. Consequently, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at December 31, 2009. This weakness relates to not effectively and timely assessing the accounting treatment for certain routine and non-routine transactions. Management is still in the process of evaluating the effectiveness of our disclosure controls and procedures for 2010.

Because of this weakness and our historical weaknesses and deficiencies, management has taken additional steps to ensure the reliability of our financial reporting. These steps included additional internal review, additional Audit Committee review, efforts to remediate historical material weaknesses and significant deficiencies in internal control over financial reporting, and the performance of additional procedures by management with respect to the financial statements contained in this report.

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Remediation Plan

We are devoting significant resources to remediating the material weakness identified above and to improving our internal controls, including hiring additional accounting, internal audit and finance staff, engaging consultants to assist with these functions, upgrading our systems, and implementing additional financial and management controls, reporting systems and procedures. We have spent an aggregate of approximately $1 million to date on improving our internal controls. However, we do not expect that our plan will fully remediate the material weakness identified above until at least the fourth quarter of 2010, and it may not ensure the adequacy of our internal controls over our financial reporting and processes in the future.

If we experience additional material weaknesses or significant deficiencies in our internal controls over financial reporting in the future, investors may lose confidence in our reported financial information, which could lead to a decline in our stock price, limit our ability to access the capital markets in the future, and require us to incur additional costs to further improve our internal control systems and procedures.

Changes in Internal Controls

We have implemented certain remedial measures described above, including hiring additional accounting, internal audit and finance staff, engaging consultants to assist with these functions and training our staff. We continue to work on staff training, upgrading our systems, and implementing more rigorous and additional financial and management controls, reporting systems, policies and procedures and increasing our corporate audit focus on key accounting controls and processes, including documentation requirements. We expect to continue to implement these and additional financial and management controls, reporting systems and procedures.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may become involved in various claims and lawsuits incidental to our business.  We know of no material existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. We were a plaintiff in a lawsuit entitled American Dairy, Inc. v. Murrell, Hall, McIntosh & Co. PLLP et al., filed on April 15, 2008 in the United States District Court for the Western District of Oklahoma. This suit had alleged that Murrell, Hall, McIntosh & Co. LLP, or MHM, formerly our independent registered public accounting firm, breached its duties of due care and professional competence by failing to perform its audits in accordance with professional standards of care in that MHM improperly and negligently (i) accepted Henny Wee & Co.’s representation that it was independent and otherwise failed to make sufficient inquiries concerning Henny Wee & Co.’s independence, and (ii) permitted Henny Wee & Co. to perform such a significant and material part of the audit work that MHM should have evaluated whether it could act as principal auditor and report on our financial statements. We were seeking compensatory damages of not less than $10.0 million in connection with this suit. In September, 2010, we agreed, and the court entered an order, to dismiss our suit without prejudice.

Item 1A. Risk Factors

Set forth below are the risk factors we have revised from those appearing in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, filed with the SEC on March 16, 2010, as amended on April 30, 2010, or the 2009 Form 10-K, and in Part II, Other Information, Item 1A of our Quarterly Reports on Form 10-Q for the periods ended March 31, 2010 and June 30, 2010, filed with the SEC on May 10, 2010 and August 9, 2010, respectively, or the 2010 Forms 10-Q. Investing in our common stock involves a high degree of risk. In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed under the heading “Risk Factors” in our 2009 Form 10-K and 2010 Forms 10-Q, as well as information in our other reports filed with the SEC from time to time. Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial could also materially and adversely affect our business, financial condition, operating results and/or cash flow.

We have recently incurred operating losses and had a working capital deficit, which may have a harmful effect on the value of our common stock.

In the nine month period ended September 30, 2010, we incurred a net loss, primarily attributable to a decrease in revenue, an increase in cost of goods sold, and an increase in operating expenses.  As of September 30, 2010, we had a working capital deficit of approximately $25.2 million.  Under-producing cows at our company-owned dairy farms contributed to our increased cost of goods sold and increased operating expenses, and our sale of under-producing cows contributed to our working capital deficit. If our revenue does not meet our forecasted revenue or if we fail to control and improve the effectiveness of our expenditures, including expenses associated with managing our dairy farms, we may not be able to achieve or sustain operating profitability on a consistent basis. Our lack of profitability may have an adverse effect on the market value of our common stock and on our cash flow and liquidity.

Item 6. Exhibits

			Incorporated by Reference
Exhibit No.	Exhibit Title	Filed Herewith	Form	Exhibit No.	File No.	Filing Date
31.1	Certification of Principal Executive Officer pursuant to Rules 13a-14 and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
31.2	Certification of Principal Financial Officer pursuant to Rules 13a-14 and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
32.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X

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SIGNATURES

In accordance with 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.

	FEIHE INTERNATIONAL, INC.
Date: November 9, 2010	By:	/s/ Leng You-Bin
		Leng You-Bin Chief Executive Officer and President (Principal Executive Officer)
	By:	/s/ Jonathan H. Chou
		Jonathan H. Chou Chief Financial Officer (Principal Accounting and Principal Financial Officer)

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EXHIBIT INDEX

			Incorporated by Reference
Exhibit No.	Exhibit Title	Filed Herewith	Form	Exhibit No.	File No.	Filing Date
31.1	Certification of Principal Executive Officer pursuant to Rules 13a-14 and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
31.2	Certification of Principal Financial Officer pursuant to Rules 13a-14 and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
32.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X