Feihe International Inc - FORM 10-Q

Attached files

file	filename
EX-31.2 - SECTION 302 CERTIFICATION OF PFO - Feihe International Inc	v230207_ex31-2.htm
EX-32.1 - SECTION 906 CERTIFICATION OF PEO - Feihe International Inc	v230207_ex32-1.htm
EX-31.1 - SECTION 302 CERTIFICATION OF PEO - Feihe International Inc	v230207_ex31-1.htm
EX-32.2 - SECTION 906 CERTIFICATION OF PFO - Feihe International Inc	v230207_ex32-2.htm

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 June 30, 2011

o	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)

N/A

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

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

Indicate by check mark whether the registrant 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 o No o

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

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

The number of shares outstanding of the registrant’s common stock as of August 3, 2011 was 21,680,041.

FOR THE QUARTER ENDED JUNE 30, 2011

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	32

Item 4.	Controls and Procedures	32

PART II — OTHER INFORMATION

Item 6.	Exhibits	34

SIGNATURES		35

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.

PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

FEIHE INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

	June 30,		December 31,
	2011		2010
	US$		US$
Assets
Current assets:
Cash and cash equivalents		18,746,728		17,529,582
Restricted cash		512,546		3,078,564
Notes and loans receivable, net of allowance for doubtful accounts of $3,350,056 and $3,500,028, as of June 30, 2011 and December 31, 2010, respectively		310,977		136,120
Trade receivables, net of allowance for doubtful accounts of $1,752,547 and $1,084,308, as of June 30, 2011 and December 31, 2010, respectively		18,336,874		15,885,708
Due from related parties		1,844,896		1,806,889
Advances to suppliers		12,732,113		7,520,804
Inventories, net		63,295,800		71,683,471
Prepayments and other current assets		118,390		266,935
Income taxes receivable		3,647,847		4,970,271
Recoverable value-added taxes		2,250,889		6,886,531
Other receivables		19,349,823		7,275,903
Investment in mutual funds – available-for-sale		140,198		139,294
Accrued interest income – current		596,865		-
Assets held for sale		2,317,655		-
Total current assets		144,201,601		137,180,072

Investment:
Investment at cost		278,486		272,239

Property, plant and equipment:
Property, plant and equipment, net		169,291,714		170,354,132
Construction in progress		47,379,785		43,152,905
		216,671,499		213,507,037
Biological assets:
Immature biological assets		19,356,663		26,713,971

Mature biological assets, net	35,014,573		27,683,821
	54,371,236		54,397,792

Other assets:
Advance to suppliers – non-current	19,312,229		22,643,263
Long term deposit	11,554,620		-
Accrued interest income – non-current	442,311		-
Deferred tax assets – non-current	5,522,990		5,522,990
Prepaid leases for land use rights	32,361,676		29,754,376
Other intangible assets, net	500,355		585,671
Goodwill	514,408		445,842
Total assets	485,731,411		464,309,282

Liabilities
Current liabilities:
Notes payable	1,548,697		378,112
Short term bank loans	75,462,211		68,816,359
Accounts payable	47,077,412		43,729,571
Accrued expenses	5,633,299		6,436,898
Income tax payable	2,035,992		1,589,165
Advances from customers	11,347,628		12,183,444
Due to related parties	90,655		79,257
Advances from employees	403,760		456,261
Employee benefits and salary payable	6,914,498		7,018,794
Other payables	45,681,451		45,957,104
Current portion of long term bank loans	11,128,226		9,756,193
Current portion of capital lease obligation	199,978		116,770
Accrued interest expenses – current	404,273		-
Redeemable common stock ($0.001 par value, 1,986,750 shares issued and outstanding as of June 30, 2011)	48,952,255		-
Total current liabilities	256,880,335		196,517,928

Long term bank loans, net of current portion	22,033,026		28,102,786
Capital lease obligation, net of current portion	481,788		532,467
Other long term loan	15,701,533		-
Accrued interest expenses – non-current	294,194	-
Unrecognized tax benefits – non-current	5,048,906		5,062,336

Deferred income	6,366,155	6,241,661
Total liabilities	306,805,937	236,457,178

Commitments and contingencies (see Note 22)

Redeemable common stock ($0.001 par value, 2,625,000 shares issued and outstanding as of December 31, 2010)	-	66,113,715

Equity
Feihe International, Inc. shareholders’ equity:
Common stock ($0.001 par value, 50,000,000 shares authorized; 19,671,291 shares issued and outstanding as of June 30, 2011 and December 31, 2010, respectively)	19,671	19,671
Additional paid-in capital	57,964,281	57,177,680
Common stock warrants	1,774,151	1,774,151
Statutory reserves	9,132,581	9,132,581
Accumulated other comprehensive income	38,296,746	32,836,344
Retained earnings	71,627,738	60,731,029
Total Feihe International, Inc. shareholders’ equity	178,815,168	161,671,456
Noncontrolling interests	110,306	66,933

Total equity	178,925,474	161,738,389

Total liabilities, redeemable common stock and equity	485,731,411	464,309,282

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

FEIHE INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three months ended June 30,						Six months ended June 30,
	2011			2010			2011			2010
	US$			US$			US$			US$

Sales		72,620,639			52,194,506			149,070,061			133,630,409

Cost of goods sold		(41,243,712	)		(33,730,167	)		(89,821,888	)		(76,728,349	)

Gross profit		31,376,927			18,464,339			59,248,173			56,902,060

Operating expenses:
Sales and marketing expenses		(20,198,015	)		(29,571,923	)		(36,368,281	)		(57,853,747	)
General and administrative expenses		(5,615,549	)		(7,080,692	)		(11,844,697	)		(12,574,515	)
Loss on disposal of biological assets		(838,311	)		(5,788,171	)		(2,439,996	)		(8,573,433	)
Total operating expenses		(26,651,875	)		(42,440,786	)		(50,652,974	)		(79,001,695	)

Other operating income, net		730,449			155,343			2,824,029			364,025
Operating income (loss)		5,455,501			(23,821,104	)		11,419,228			(21,735,610	)

Other income (expenses):
Interest income		27,974			109,550			50,402			207,186
Interest and finance costs		(1,467,522	)		(714,099	)		(2,906,602	)		(1,558,962	)
Amortization of deferred debt issuance cost		-			(356,737	)		-			(376,057	)
Government subsidy		2,459,982			3,419,709			3,994,133			9,158,482
Income (loss) before income taxes		6,475,935			(21,362,681	)		12,557,161			(14,304,961	)

Income tax (expenses) benefits		(1,290,696	)		642,196			(2,632,379	)		(943,621	)
Net income (loss)		5,185,239			(20,720,485	)		9,924,782			(15,248,582	)
Net (loss) income attributable to noncontrolling interests		(18,942	)		145,893			(61,809	)		207,586
Net income (loss) attributable to common shareholders of Feihe International, Inc.		5,166,297			(20,574,592	)		9,862,973			(15,040,996	)

Net income (loss) per share of common stock
Basic		0.24			(0.95	)		0.50			(0.69	)
Diluted		0.24			(0.95	)		0.50			(0.69	)
Net income (loss) per share of redeemable common stock
Basic		0.24			(0.95	)		0.45			(0.69	)
Diluted		0.24			(0.95	)		0.45			(0.69	)
Weighted average shares used in calculating net income (loss) per share of common stock
Basic		19,671,291			19,648,266			19,671,291			19,627,934
Diluted		19,685,851			19,648,266			19,687,893			19,627,934
Weighted average shares used in calculating net income (loss) per share of redeemable common stock
Basic		2,170,673			2,100,000			2,396,581			2,100,000
Diluted		2,170,673			2,100,000			2,396,581			2,100,000

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

FEIHE INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY AND COMPREHENSIVE INCOME

(unaudited)

	Feihe International, Inc. Shareholders
	Common Stock
	($0.001 par value)										Accumulated
	Number of Shares		Par Value		Additional Paid-in Capital		Common Stock Warrants		Statutory Reserves		Other Comprehensive Income		Retained Earnings		Noncontrolling Interests		Total Equity		Total Comprehensive Income (Loss)
			US$		US$		US$		US$		US$		US$		US$		US$		US$

Balance as of January 1, 2011		19,671,291		19,671		57,177,680		1,774,151		9,132,581		32,836,344		60,731,029		66,933		161,738,389
Share-based compensation		-		-		786,601		-		-		-		-		-		786,601			-
Net income		-		-		-		-		-		-		9,862,973		61,809		9,924,782		9,924,782
Currency translation adjustments		-		-		-		-		-		5,459,498		-		(18,436)		5,441,062		5,441,062
Change in fair value of available-for-sale investment, net of tax $226		-		-		-		-		-		904		-		-		904		904
Comprehensive income																				15,366,748
Settlement of redeemable common stock		-		-		-		-		-		-		1,033,736		-		1,033,736		-
Balance as of June 30, 2011		19,671,291		19,671		57,964,281		1,774,151		9,132,581		38,296,746		71,627,738		110,306		178,925,474

	Feihe International, Inc. Shareholders
	Common Stock
	(US$0.001 par value)										Accumulated
	Number of Shares		Par Value		Additional Paid-in Capital		Common Stock Warrants		Statutory Reserves		Other Comprehensive Income			Retained Earnings			Noncontrolling Interests			Total Equity			Total Comprehensive Income (Loss)
			US$		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		-		-		1,912,035		-		-		-			-			-			1,912,035
Option exercise		8,000		8		95,992		-		-		-			-			-			96,000
Net income		-		-		-		-		-		-			(15,040,996	)		(207,586	)		(15,248,582	)		(15,248,582	)
Currency translation adjustments		-		-		-		-		-		916,358			-			2,785			919,143			919,143
Change in fair value of available-for-sale investment, net of tax $(8,471)		-		-		-		-		-		(33,885	)		-			-			(33,885	)		(33,885	)
Comprehensive income		-		-		-		-		-		-			-			-			-			(14,363,324	)
Investment in a new subsidiary		-		-		-		-		-		-			-			219,372			219,372
Share issued for service		39,000		39		766,701		-		-		-			-			-			766,740
Balance as of June 30, 2010		19,654,376		19,654		57,256,826		1,774,151		6,861,224		26,534,044			58,631,883			360,022			151,437,804

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

FEIHE INTERNATIONAL, INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(unaudited)

	Six months ended June 30,
	2011			2010
	US$			US$

Cash flows from operating activities:
Net income (loss)		9,924,782			(15,248,582	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		5,024,851			4,334,069
Depreciation of biological assets		3,471,383			1,595,621
Amortization of capital lease obligation		17,432			19,523
Loss (gain) on disposal of property, plant and equipment		44,350			(3,632	)
Loss on disposal of biological assets		2,439,996			8,573,433
Provision for (reversal of) doubtful accounts		634,832			(199,776	)
Compensation expense for option awards		786,601			1,912,035
Compensation expense from shares issued for services		-			766,740
Amortization of deferred charges		-			376,057
Changes in assets and liabilities:
(Increase) decrease in trade receivables, net		(1,935,445	)		4,656,768
Increase in due from related parties		(23,837	)		(220,786	)
Decrease in inventories, net		5,260,495			759,842
Increase in advances to suppliers		(3,268,376	)		(2,472,245	)
Decrease in prepayments and other assets		93,163			1,533,501
Decrease in income taxes receivable		829,385			76,663
Decrease in input value-added taxes		2,907,335			1,055,948
Increase in prepaid leases for land use rights		(2,419,960	)		-
(Increase) decrease in other receivables		(5,773,171	)		1,556,902
(Increase) decrease in notes receivable		(109,665	)		246,310
Increase (decrease) in notes payable		734,156			(2,005,098	)
(Decrease) increase in accrued expenses		(503,993	)		2,469,342
Increase in accounts payable		2,965,344			3,429,594
Increase (decrease) in income taxes payable		280,236			(1,872,113	)
Decrease in advances from customers		(524,199	)		(17,069	)
Increase in due to related parties		7,148			947
Decrease in advances from employees		(32,927	)		(40,576	)
(Decrease) increase in employment benefits and salary payable		(65,411	)		576,254
(Decrease) increase in other payable		(1,240,293	)		2,280,634
Decrease in deferred income		-			(1,590,848	)
(Decrease) increase in unrecognized tax benefit – non-current		(8,423	)		310,421
Net cash provided by operating activities		19,515,789			12,859,879

Cash flows from investing activities:
Purchase of property, plant and equipment		(3,226,279	)		(12,694,632	)
Expenditures on biological assets		(5,882,718	)		(7,179,417	)
Purchase of short term investment		-			(2,937,461	)
Proceeds from disposal of property, plant and equipment		-			32,182
Payment for long term deposit		(12,469,936	)		-
Change in restricted cash		2,606,688			(9,607,045	)
Proceeds from disposal of biological assets		495,818			1,362,592
Net cash used in investing activities		(18,476,427	)		(31,023,781	)

Cash flows from financing activities:
Proceeds from short term bank loans		7,182,966			2,754,033
Repayment of short term bank loans		(2,127,230	)		(17,796,514	)
Proceeds from long term loans		-			3,266,638
Repayment of long term loans		(5,557,060	)		(7,404,199	)
Redemption of redeemable common stock		(16,127,724	)		-
Proceeds from other long term loans		16,400,000			-
Capital injection in a new subsidiary by noncontrolling interests		-			219,372
Proceeds from option exercise		-			96,000
Net cash used in financing activities		(229,048	)		(18,864,670	)

Effect of exchange rate changes on cash		406,832			774,559

Net increase (decrease) in cash and cash equivalents		1,217,146			(36,254,013	)

Cash and cash equivalents, beginning of period		17,529,582			48,949,524
Cash and cash equivalents, end of period		18,746,728			12,695,511

Supplemental disclosure of cash flow information:
Cash paid during the period for income tax		(1,151,320	)		(1,037,333	)
Cash received during the period for tax refund		-			4,713,328
Interest paid during the period		(3,266,761	)		(2,394,782	)

Supplemental disclosure of non-cash investing and financing activities:
Issuance of performance shares of common stock		-			11,382,000

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

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., formerly known as American Dairy, Inc. (the “Company” or “Feihe International”) and its subsidiaries. The Company and its subsidiaries are collectively referred to as the “Group.” Substantially 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 (“Langfang Feihe”) – 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 Feihe”) – Manufacturing and distributing walnut products
	•	Heilongjiang Feihe Kedong Feedlots Co., Limited (“Kedong Farm”) – Breeding and rearing of dairy cows, and distributing fresh milk
	•	Heilongjiang Feihe Gannan Feedlots Co., Limited (“Gannan Farm”) – Breeding and rearing of dairy cows, and distributing fresh milk
	•	Qiqihaer Feihe Soybean Co., Limited (“Feihe Soybean”) – 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 RMB10,000,000 (or approximately $1.5 million) of Heilongjiang Flying Crane Trading Co., Limited

2.	BASIS OF PREPARATION

The accompanying unaudited condensed consolidated financial statements of the Group have been prepared by the Group in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and the accounting principles generally accepted in the United States of America (“US GAAP”) for interim reporting. In the opinion of the Group’s management, the accompanying condensed consolidated financial statements contain all material adjustments (consisting only of normal and recurring adjustments) 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, as amended, for the year ended December 31, 2010. The interim operating results are not necessarily indicative of the results to be expected for an entire year.

As of June 30, 2011, the Group had a working capital deficit of $112.7 million. The Group has significant cash commitments in the next 12 months, including maturity of short term bank loans of $75.5 million, current portion of long-term bank loans of $11.1 million and redemption of redeemable common stock of $49.0 million. However, the Group believes it will be able to refinance much of its short term bank loans when they become due and intends to do so. In the first quarter of 2011, the Group refinanced a short term bank loan with its respective bank upon the maturity of that bank loan. In the second quarter of 2011, the Company repaid $6.3 million short term and long term bank loans, and borrowed $5.8 million under a new short term bank loan. If the Group is able to continue refinancing short-term bank loans, it believes that its cash generated from operations, existing cash, ability to draw down on unutilized credit lines, and proceeds from the planned sales of its farms will be sufficient to fund its expected cash flow requirements, including the cash payments for the redemption of its redeemable common stock and planned capital expenditures, for at least the next 12 months. The Group expects to realize its assets and satisfy its liabilities in the normal course of business. As a result, the accompanying condensed consolidated financial statements have been prepared assuming the Group will continue as a going concern. The accompanying condensed consolidated financial statements do not reflect any adjustments relating to the recoverability and reclassification of assets and liabilities as that might be necessary if the Group is unable to continue as a going concern.

For the period ended June 30, 2011, the Group has used the same significant accounting policies and estimates which are discussed in the Annual Report on Form 10-K, as amended, for the year ended December 31, 2010, except for the following recently adopted accounting pronouncements.

In January 2010, the Financial Accounting Standards Board (“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 July 2010, the FASB issued authoritative guidance on disclosure about the credit quality of financing receivables and the allowance for credit losses. The objective of this guidance is to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. This guidance requires an entity to provide disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. This guidance includes additional disclosure requirements about financing receivables, including: (1) credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables; (2) the aging of past due financing receivables at the end of the reporting period by class of financing receivables; and (3) the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. In January 2011, the FASB issued another authoritative pronouncement that temporarily defers the effective date for disclosures about troubled debt restructurings (each, a “TDR”) by creditors until it finalizes its project on determining what constitutes a TDR for a creditor. The deferral in this amendment is effective upon issuance. The deferred TDR disclosures were slated to be effective in the first quarter of 2011 for public companies with calendar year-ends. The adoption of this guidance is not expected to have a significant impact on the Group’s financial statements.

In December 2010, the FASB issued authoritative guidance on when to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. This guidance modifies Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This guidance is effective for impairment tests performed during entities’ fiscal years (and interim periods within those years) that begin after December 15, 2010. Early adoption is permitted. The adoption of this guidance is not expected to have a significant impact on the Group’s financial statements.

In December 2010, the FASB issued authoritative guidance on disclosure of supplementary pro forma information for business combinations. The objective of this guidance is to address diversity in practice regarding the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. This guidance specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This guidance will be effective for business combinations consummated in periods beginning after December 15, 2010, and should be applied prospectively as of the date of adoption. Early adoption is permitted. The adoption of this guidance did not have a significant impact on the Group’s financial statements.

In June 2011, the FASB issued authoritative guidance that provides an entity the option of presenting total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The guidance eliminates the option of presenting the components of other comprehensive income as part of the statement of changes in shareholders’ equity. This guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This guidance should be applied retrospectively. For public entities, the amendments are effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The Group has not yet adopted this guidance and does not expect that its adoption will have a significant impact on the Group’s financial statements.

TAXATION

The Company and American Flying Crane Corporation are 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 June 30, 2011, the Company recorded an income tax expense of approximately $1.3 million, which was primarily due to the increase in profits of Heilongjiang Feihe when compared to the three months ended June 30, 2010. During the six months ended June 30, 2011, the Company recorded an income tax expense of approximately $2.6 million, which was primarily due to the increase in profits of Heilongjiang Feihe and Gannan Feihe when compared to the six months ended June 30, 2010.

The Company had cumulatively accrued approximately $1.6 million and $1.4 million for estimated interest and penalties related to uncertain tax positions as of June 30, 2011 and 2010, respectively. For the three months ended June 30, 2011 and June 30, 2010, the Company recorded a benefit of $0.21 million and an expense of $0.15 million for estimated interest and penalties, respectively.

Aggregate undistributed earnings of approximately $137.2 million as of June 30, 2011 of the Group’s PRC subsidiaries that are available for distribution to the Company are considered to be indefinitely reinvested, and, accordingly, no provision has been made for the Chinese dividends 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 2006 to 2010 remain open in various jurisdictions.

4.	EARNINGS PER SHARE OF COMMON STOCK

The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations:

	For the three months ended					For the six months ended
	June 30,					June 30,
	2011		2010			2011		2010

Net income (loss) attributable to Feihe International, Inc.		5,166,297		(20,574,592	)		9,862,973		(15,040,996	)
Net income (loss) attributable to Feihe International, Inc. allocated for computing net income per common stock - basic		4,652,866		(18,587,921	)		8,791,849		(13,587,287	)
Settlement of redeemable common stock	-			-			1,033,736		-
Net income (loss) attributable to Feihe International, Inc. for computing net income per common stock - basic		4,652,866		(18,587,921	)		9,825,585		(13,587,287	)
Net income (loss) attributable to Feihe International, Inc. for computing net income per redeemable common stock - basic		513,431		(1,986,671	)		1,071,124		(1,453,709	)

Net income (loss) attributable to Feihe International, Inc. allocated for computing net income per common stock - diluted		4,653,208		(18,587,921	)		8,792,655		(13,587,287	)
Settlement of redeemable common stock	-			-			1,033,736		-
Net income (loss) attributable to Feihe International, Inc. for computing net income per common stock - diluted		4,653,208		(18,587,921	)		9,826,391		(13,587,287	)
Net income (loss) attributable to Feihe International, Inc. for computing net income per redeemable common stock - diluted		513,089		1,986,671			1,070,318		(1,453,709	)

Weighted-average common stock outstanding used in computing net income (loss) per share of common stock - basic		19,671,291		19,648,266			19,671,291		19,627,934
Weighted-average common stock outstanding used in computing net income (loss) per share of common stock – diluted(i)		19,685,851		19,648,266			19,687,893		19,627,934
Weighted-average shares of redeemable common stock outstanding used in computing net income (loss) per share of redeemable common stock – basic		2,170,673		2,100,000			2,396,581		2,100,000
Weighted-average shares of redeemable common stock outstanding used in computing net income (loss) per share of redeemable common stock – diluted		2,170,673		2,100,000			2,396,581		2,100,000

Net income (loss) per share of common stock –
Basic		0.24		(0.95	)		0.50		(0.69	)
Diluted		0.24		(0.95	)		0.50		(0.69	)

Net income (loss) per share of redeemable common stock –
Basic		0.24		(0.95	)		0.45		(0.69	)
Diluted		0.24		(0.95	)		0.45		(0.69	)

(i)	The following table sets forth the computation of weighted-average shares outstanding for calculating basic and diluted earnings per share for the three months and six months ended June 30, 2011 and 2010:

	Three months ended				Six months ended
	June 30,				June 30,
	2011		2010		2011		2010
Weighted-average shares – Basic		19,671,291		19,648,266		19,671,291		19,627,934
Effect of dilutive securities
Stock option		14,560		-		16,602		-
Warrants		-		-		-		-
Weighted-average shares – Diluted		19,685,851		19,648,266		19,687,893		19,627,934

For the three months and six months ended June 30, 2011, 650,245 shares of the Company’s common stock issuable upon exercise of options and 237,937 shares of the Company’s common stock issuable upon exercise of warrants were excluded from the calculation of diluted income per share because their anti-dilutive effects.

5.	RESTRICTED CASH

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

6.	ADVANCES TO SUPPLIERS

Advances to suppliers consist primarily of advance for purchase of dairy cows, as well as advances for inventories and equipment, not delivered at the balance sheets 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 month and six month periods ended June 30, 2011 and June 30, 2010, no advances to suppliers were refunded in cash, and the Group has a minimal refund history.

7.	INVENTORIES, NET

The inventory amounts included in the condensed consolidated balance sheets as of June 30, 2011 and December 31, 2010 consisted of the following:

	June 30, 2011		December 31, 2010
	US$		US$

Raw materials		18,008,261		27,983,563
Work-in-progress		38,043,017		37,400,104
Finished goods		7,244,522		6,299,804
Total inventories, net		63,295,800		71,683,471

8.	OTHER RECEIVABLES

Other receivables as of June 30, 2011 and December 31, 2010 consisted of the following:

	June 30, 2011		December 31, 2010
	US$		US$

Advances to employees		921,395		405,941
Deposits with third parties		1,040,826		658,191
Loans to third parties (i)		1,913,856		199,674
Due from Heilongjiang Feihe Yuanshengtai Co., Ltd. (ii)		13,557,533		4,945,177
Others		1,916,213		1,066,920
Total		19,349,823		7,275,903

(i)	These are funds lent to third parties, which are unsecured, non-interest bearing, and repayable within one year.

(ii)

Heilongjiang Feihe Yuanshengtai Co., Ltd. (“Yuanshengtai”) was partially owned by two officers and directors of the Company, Mr. Leng You-Bin and Mr. Liu Sheng-Hui, before January 2010. Those shares held by Mr. Leng You-Bin and Mr. Liu Sheng-Hui have been transferred to unrelated third parties who held no ownership interests in Yuanshengtai in January 2010. The balances are payments made by the Group on behalf of Yuanshengtai to purchase biological assets and property, plant and equipment. The balances are unsecured, non-interest bearing and repayable on demand.

9.	ASSETS HELD FOR SALE

On April 12, 2011, the Company entered a letter of intent with a PRC company to sell the property, plant and equipment and the land use right at Baiquan Feihe Dairy Co., Limited. Accordingly, the assets have been recognized as assets held for sale as of June 30, 2011. As of June 30, 2011, the Company has not entered into any definitive agreement on sales of the stated assets.

10.	INVESTMENT IN MUTUAL FUNDS – AVAILABLE-FOR-SALE

The Group had the following investment measured at fair value as of the dates indicated:

	US$

Balance as of December 31, 2010		139,294
Change in fair value		904
Balance as of June 30, 2011		140,198

The cost of the investment is $193,394, with fair value measured according to quoted prices in active markets of identical assets (Level 1, which is based upon quoted prices in active markets for identical assets and liabilities).

11.	CONSTRUCTION IN PROGRESS

Construction in progress included in the condensed consolidated balance sheets as of June 30, 2011 and December 31, 2010 comprised the following:

	June 30, 2011		December 31, 2010
	US$		US$

Gannan Feihe production factory facilities		42,403,960		39,208,398
Gannan Farm facilities		2,261,174		1,326,026
Kedong Farm facilities		2,205,325		1,260,399
Feihe Soybean processing facilities		482,944		1,333,098
Others		26,382		24,984
Total		47,379,785		43,152,905

$322,598 and $386,610 of interest expenses were capitalized in construction in progress for the three months ended June 30, 2011 and 2010, respectively. $589,294 and $636,949 of interest expenses were capitalized in construction in progress for the six months ended June 30, 2011 and 2010, respectively.

12.	OTHER INTANGIBLE ASSETS, NET

Other intangible assets, net as of June 30, 2011 and December 31, 2010 represent the Group’s exclusive right of milk supply.

	June 30, 2011		December 31, 2010
	US$		US$
Exclusive right of milk supply		500,355		585,671

Amortization expense for the three months ended June 30, 2011 and 2010 was $50,080 and $63,783, respectively. Amortization expense for the six months ended June 30, 2011 and 2010 was $98,754 and $161,669, respectively.

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 4.7 years. Amortization expense of intangible assets is estimated to be approximately $98,754, $197,508, $197,508, and $6,585 for the second half of 2011, 2012, 2013, and 2014, respectively.

13.	SHORT TERM BANK LOANS

Short term bank loans included in the condensed consolidated balance sheets as of June 30, 2011 and December 31, 2010 consisted of the following:

	June 30,		December 31,
	2011		2010
	US$		US$

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 17, 2011		-		1,361,203

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 (i)		7,735,747		7,562,237

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)		3,094,299		3,024,895

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 (iii)		7,735,747		7,562,237

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 (ii)		4,641,447		5,293,566

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 (iv)		1,547,149		1,512,447

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, payable with interest on maturity, due on October 26, 2011(iv)		3,094,299		3,024,895

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, payable with interest on maturity, due on November 7, 2011		24,290,244		23,745,426

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, secured by plant and land use right, payable with interest on maturity, due on November 7, 2011		6,652,742		6,503,524

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, secured by machinery, payable with interest on maturity, due on November 17, 2011		1,392,433		1,361,203

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, secured by machinery, payable with interest on maturity, due on December 23, 2011		4,022,588		3,932,363

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, payable with interest on maturity, due on December 23, 2011		4,022,588		3,932,363

Loan payable to a bank in the PRC, bearing interest at 5.56% per annum, secured by machinery, payable with interest on maturity, due on January 25, 2012		1,392,439		-

Loan payable to a bank in the PRC, bearing interest at 6.31% per annum, secured by machinery, payable with interest on maturity, due on April 6, 2012		5,840,489		-

Total		75,462,211		68,816,359

(i)	Gannan Feihe 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.
(ii)	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 RMB30,000,000 (approximately $4,641,000) as of June 30, 2011.
(iii)	Gannan Feihe 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.

(iv)	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 RMB50,000,000 (approximately $7,736,000) as of June 30, 2011.

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.

14.	ACCRUED EXPENSES

Accrued expenses as of June 30, 2011 and December 31, 2010 consisted of the following:

	June 30, 2011		December 31, 2010
	US$		US$

Accrued selling expenses		4,828,175		5,885,595
Other accrued expenses		805,124		551,303
		5,633,299		6,436,898

15.	OTHER PAYABLES

Other payables as of June 30, 2011 and December 31, 2010 consisted of the following:

	June 30, 2011		December 31, 2010
	US$		US$

Payable for property, plant and equipment		25,613,987		23,473,721
Payable for purchase of biological assets		6,896,906		6,742,211
Payable for land use rights		971,793		1,001,325
Other tax payable		2,748,757		385,050
Deposits from distributors		2,234,703		2,057,685
Payable to local County Finance Bureau (i)		309,430		2,144,650
Advance received from Yuanshengtai for purchase of biological assets		-		891,436
Dividend payable to noncontrolling interests		-		208,226
Payable to an unrelated party, due on demand		442,600		442,600
Others (ii)		6,463,275		8,610,200
Total		45,681,451		45,957,104

(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)	Others 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.

16.	LONG TERM BANK LOANS

Long term bank loans consisted of the following as of June 30, 2011 and December 31, 2010:

	June 30, 2011		December 31, 2010
	US$		US$

Loan payable to a bank in the PRC, bearing interest at 7.47%, unsecured, guaranteed by Feihe Dairy (i), and payable on maturity. The loan commenced in October 29, 2008 and matures on October 28, 2014		1,389,765		1,552,679

Loan payable to a bank in the PRC, bearing interest at 7.47%, secured by biological assets, guaranteed by Feihe Dairy (i), and payable on maturity. The loan commenced on October 29, 2008 and matures on October 28, 2014		3,636,188		4,062,434

Loan payable to a bank in the PRC, bearing interest at 7.47%, secured by biological assets, guaranteed by Feihe Dairy (i), and payable on maturity. The loan commenced on October 29, 2008 and matures on October 28, 2014		3,706,582		4,141,081

Loan payable to a bank in the PRC, bearing interest at 5.94%, secured by biological assets, guaranteed by Feihe Dairy (i) and payable on maturity. The loan commenced on June 29, 2009 and matures on October 28, 2014		6,393,786		7,143,289

Loan payable to a bank in the PRC, bearing interest at 5.94%, secured by biological assets, guaranteed by Feihe Dairy (i) and payable on maturity. The loan commenced on March 27, 2009 and matures on October 28, 2014		3,564,438		3,982,274

Loan payable to a bank in the PRC, bearing interest at 5.76%, secured by land use rights, plant and machinery. The loan commenced on December 24, 2009 and matures on December 23, 2011		2,574,577		5,036,569

Loan payable to a bank in the PRC, bearing interest at 5.76%, guaranteed by Langfang Feihe and payable on maturity. The loan commenced on December 24, 2009 and matures on December 23, 2013		8,453,509		8,575,458

Loan payable to a bank in the PRC, bearing interest at 5.96%, secured by land use right of Gannan Feihe. The loan commenced on December 24, 2010 and matures on December 23, 2013		3,442,407		3,365,195
		33,161,252		37,858,979
Less: current portion of long term bank loans		(11,128,226)		(9,756,193	)
		22,033,026		28,102,786

(i)

In connection with the purchase of property, plant and equipment of Kedong Farm, Feihe Dairy guaranteed the loans payable to a bank in the PRC for a period of one year, beginning on October 29, 2008 and ending on October 28, 2009. The maximum potential amount under the terms of the guarantee was RMB 251,510,000 (approximately $38,913,000).

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 $774,000) and require a RMB 1 million (or approximately $155,000) payment on January 30th of each year after successful completion of production quality tests. The installment and trial run of the equipment had been completed by December 31, 2010, and the equipment under the capital lease is depreciated over an estimated productive life of 14 years when placed into service after passing production quality tests. As of June 30, 2011 and December 31, 2010, the Group had $1,495,737 and $1,516,343, respectively, of equipment subject to the capital lease obligation.

Minimum future lease payments under capital leases as of June 30, 2011 were as follows:

	Future payments
	US$

2011		154,715
2012		154,715
2013		154,715
2014		154,715
2015		154,715
Total minimum lease payments at June 30, 2011		773,575
Less amount representing interest		(91,809	)
Net present value of minimum lease payments		681,766
Current portion of capital lease obligation		(199,978	)
Non-current portion of capital lease obligation		481,788

The interest rate on the capital lease is 5.31%. There was $8,730 and $9,763 amortization of interest recorded for the three months ended June 30, 2011 and 2010, respectively. There was $17,432 and $19,523 amortization of interest recorded for the six months ended June 30, 2011 and 2010, respectively. Accumulated amortization was $56,800 and $39,368 as of June 30, 2011 and December 31, 2010, respectively.

18.	LONG TERM DEPOSIT AND OTHER LONG TERM LOAN

Other long term loan reflects a loan the Company obtained to make the payment of the first installment of redeemable common stock to Sequoia (Note 20) on April 27, 2011. As the Company did not have enough US dollars to redeem the redeemable common stock, the Company entered into an agreement with a group of overseas third party companies to borrow a total amount of $16.4 million. The loan is interest free with a period of two years starting from the day when the Company received the loan.

As a security for the loan, the Company deposited a total amount of RMB 81.4 million (equivalent to $12.6 million) with two domestic companies designated by the oversea third party companies. The deposit will not be returned to the Company until the Company pays the loan of $16.4 million in full.

19.	RELATED PARTY TRANSACTIONS

Due from/to related parties included in the condensed consolidated balance sheets as of June 30, 2011 and December 31, 2010 comprised the following:

	June 30, 2011		December 31, 2010
	US$		US$
Due from related parties:
Due from directors of the Group		43,254		52,735
Due from related companies		1,801,642		1,754,154
Total		1,844,896		1,806,889

	June 30, 2011		December 31, 2010
	US$		US$
Due to related parties:
Due to directors of the Group		41,146		30,249
Due to related companies		-		610
Loan payable to a related party		49,509		48,398
Total		90,655		79,257

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 June 30, 2011, advances to directors aggregated to $70,694 and repayments from directors aggregated to $45,887. During the three month period ended June 30, 2010, advances to directors aggregated to $10,980 and repayments from directors aggregated to $26,062. During the six month period ended June 30, 2011, advances to directors aggregated to $71,944 and repayments from directors aggregated to $81,426. During the six month period ended June 30, 2010, advances to directors aggregated to $16,781 and repayments from directors aggregated to $26,548.

As of June 30, 2011 and December 31, 2010, the Group had the following balances due from its directors:

	June 30, 2011		December 31, 2010
	US$		US$

Leng You-Bin		23,207		34,466
Liu Hua		20,047		18,269
Total		43,254		52,735

As of June 30, 2011 and December 31, 2010, the Group had the following balances due to its directors:

	June 30, 2011		December 31, 2010
	US$		US$

Leng You-Bin		30,943		30,249
Liu Sheng-Hui		10,203		-
Total		41,146		30,249

Due from/to related companies

For the three and six months ended June 30, 2011 and 2010, the Group made sales of goods to the following related companies:

	For the three months ended June 30,				For the six months ended June 30,
	2011		2010		2011		2010
	US$		US$		US$		US$

Tangshan Feihe Trading Company		-		142,704		-		1,549,572
Dalian Hewang Trading Company		41,660		348		97,933		96,744
Total		41,660		143,052		97,933		1,646,316

As of June 30, 2011 and December 31, 2010, the Group had the following balances due from its related companies:

	June 30, 2011		December 31, 2010
	US$		US$

Tangshan Feihe Trading Company		1,767,360		1,727,719
Qinhuangdao Feihe Trading Company		27,041		26,435
Dalian Hewang Trading Company		7,241		-
Total		1,801,642		1,754,154

The above related companies are owned by relatives of Leng You-Bin, the Chairman, chief executive officer, president and general manager of the Company.

Loan payable to related parties

The Group has an outstanding loan payable to a charitable organization established by Leng You-Bin for underprivileged children in the Heilongjiang province of the PRC of $49,509 and $48,398 as of June 30, 2011 and December 31, 2010, respectively. The loan is unsecured and bears interest at 5.85% per annum and is payable on demand.

See Note 20 regarding the issuance of shares to Sequoia Capital China Growth Fund I, LP and certain of its affiliates and designees.

20.	REDEEMABLE COMMON STOCK

On July 24, 2009, the Company entered into a Summary of Terms with Sequoia Capital China Growth Fund I, LP and certain of its affiliates and designees (collectively, “Sequoia”) in which Sequoia agreed to provide a 90-day bridge loan in the amount of $16 million. The bridge loan was funded on July 29, 2009. On August 26, 2009, pursuant to a subscription agreement (the “Subscription Agreement”) with Sequoia, the Company issued 2.1 million shares of its common stock for an aggregate purchase price of $63 million, including $47 million in cash and the conversion of the $16 million bridge loan. On August 26, 2009, the Company also entered into a registration rights agreement with Sequoia with respect to the shares. Pursuant to the registration rights agreement, the Company filed a registration statement covering the resale of the securities issued or issuable pursuant to the Subscription Agreement, which the SEC declared effective in October 2009. The registration rights agreement also granted demand and piggy-back registration rights to Sequoia.

The Company issued 525,000 shares of redeemable common stock to Sequoia in March 2010 pursuant to a performance adjustment clause in the Subscription Agreement because the Company failed to meet certain performance targets 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.

Under the terms of the Subscription Agreement, the common stock issued to Sequoia was redeemable, at the option of the holder, if at any time after the third anniversary of the issuance date the average share closing prices of the Company’s common stock for the period of fifteen consecutive trading days were 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 classified the common stock as temporary equity upon issuance.

The Company assessed the probability of redemption and accrued proper accretion on a quarterly basis. As of December 31, 2010, management determined that the probability of redemption was high and recognized $1,086,622 as accretion premium. The carrying value of redeemable common stock was $66,113,715 as of December 31, 2010.

On February 1, 2011, the Company entered into a redemption agreement (the “Redemption Agreement”) with Sequoia, pursuant to which the Company agreed to redeem and purchase from Sequoia an aggregate of 2,625,000 shares (the “Shares”) of the Company’s common stock. Pursuant to the Redemption Agreement, the Company agreed to redeem the Shares in four equal installments on or around March 31, 2011, September 30, 2011, December 31, 2011 and March 31, 2012 (each, a “Closing Date”), for an aggregate payment of $65,079,979. On April 27, 2011, the Company paid $16.1 million to Sequoia as the first installment payment to redeem 656,250 shares of common stock. The outstanding liability of redeemable common stock was $48,952,255 as of June 30, 2011.

21.	SHARE-BASED COMPENSATION

Stock 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 years ended December 31, 2009 and 2010 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, $610,054 and $1,511,623 in incremental compensation cost was recognized during the years ended December 31, 2010 and 2009. This modification affected 421 employees.

The fair value of the option awards were estimated on the date of grant using the Black-Scholes option valuation model to be $22,106,218, of which $335,002 and $647,839 was recorded as compensation expense in general and administrative expenses in the three months ended June 30, 2011 and 2010, respectively, and of which $670,004 and $1,295,678 was recorded as compensation expense in general and administrative expenses in the six months ended June 30, 2011 and 2010, respectively. 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 vested on the 12-month anniversary of the date of grant, conditioned upon continued employment on such date, and had an exercise price of $16 and a contractual life of 4 years. The fair value of the option award was estimated on the date of grant using the Black-Scholes option valuation model to be $1,103,400, of which $nil and $278,913 was recorded as compensation cost in the three months ended June 30, 2011 and 2010, respectively, and of which $nil and $551,699 was recorded as compensation expense in general and administrative expenses in the six months ended June 30, 2011 and 2010, 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 and 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 were estimated on the date of grant using the Black-Scholes option valuation model to be $565,900, of which $30,822 and $32,329 was recorded as compensation expense in general and administrative expenses during the three months ended June 30, 2011 and 2010, respectively, and of which $61,644 and $64,658 was recorded as compensation expense in general and administrative expenses in the six months ended June 30, 2011 and 2010, respectively. The valuation was based on the assumptions noted in the following table.


Expected volatility	83	%
Expected dividends	0	%
Expected term (in years)	5.25
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. The options vested in four equal amounts on each three-month anniversary of the grant date until all such shares are fully vested. The options have an exercise price of $7.25 and a contract life of 2 years. 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 $18,623 and $nil was recorded as compensation cost in the three months ended June 30, 2011 and 2010, respectively, and of which $54,953 and $nil was recorded as compensation expense in general and administrative expenses in the six months ended June 30, 2011 and 2010, 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	0.22	%

(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 to an employee that vested on the 12-month anniversary of the date of grant, conditioned upon continued employment on such date, and had an exercise price of $12.00 and a contractual life of 4 years. The fair value of the option award were estimated on the date of grant using the Black-Scholes option valuation model to be $562,758, of which $422,069 and $140,689 were recorded as compensation cost in the general and administrative expenses during the years ended December 31, 2009 and 2008. The valuation was based on the assumptions noted in the following table.

Expected volatility	90.7	%
Expected dividends	0	%
Expected term (in years)	2.	5
Risk-free rate	2.7	%

A summary of option activity under the 2009 Plan and 2003 Plan as of June 30, 2011 and movement during the six 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 as of January 1, 2011		856,245			10.45		15.84		71,190		3.97
Granted		-			-		-		-		-
Exercised		-			-		-		-		-
Forfeited or expired		(122,000	)		13.19		13.64		-		1.67
Outstanding as of June 30, 2011		734,245			10		16.2		-		3.54
Exercisable as of June 30, 2011		63,000			1.96		7.25		-		1.15

A summary of the status of the Company’s non-vested options as of June 30, 2011 and movements during the six months then ended are as follow:

	Options			Weighted average grant date fair value
				US$
Non-vested as of January 1, 2011		713,245			10.24
Granted		-			-
Vested		(42,000	)		1.96
Forfeited or expired		-			-
Non-vested as of June 30, 2011		671,245			10.75

As of June 30, 2011, there was $3,508,333 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 2 months to 43 months.

Warrants

As of June 30, 2011, the Company had 237,937 warrants outstanding with a weighted average remaining contractual life of 1.25 years and a weighted average exercise price of $14.50. The warrants will expire on October 4, 2012.

During the three and six months ended June 30, 2011 and 2010, no warrants were exercised.

	Warrants		Average exercise price
			US$
Outstanding warrants as of January 1, 2011		237,937		14.50
Warrants granted		-		-
Exercised		-		-
Expired		-		-
Outstanding warrants as of June 30, 2011		237,937		14.50

22.	COMMITMENTS AND CONTINGENCIES

Capital commitments for purchase of property, plant and equipment as of June 30, 2011 were $2,860,825. The Group has certain purchase commitments of $7,189,277 over six years relating to packaging materials in connection with the capital lease obligation disclosed in Note 17.

23.

SEGMENTS

The segment information for the operating segments for the three months ended June 30, 2011 was as follows:

	Dairy products		Dairy farms		Corporate		Total
	US$		US$		US$		US$
Revenues from external customers		62,863,489		9,757,150		-		72,620,639
Intersegment revenues		981		1,880,691		-		1,881,672
Segment income tax expenses (benefits)		1,294,345		-		(3,649)		1,290,696
Segment income (loss) before income tax		7,380,147		(196,363)		(707,849)		6,475,935
Segment assets		602,957,492		174,187,248		200,726,966		977,871,706

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

	Dairy products		Dairy farms		Corporate		Total
	US$		US$		US$		US$
Revenues from external customers		52,194,506		-		-		52,194,506
Intersegment revenues		198,263		6,271,224		-		6,469,487
Segment income tax expenses (benefits)		642,496		-		(300)		642,196
Segment loss before income tax		(13,425,059)		(5,525,243)		(2,412,379)		(21,362,681)
Segment assets		473,527,865		156,097,318		191,499,857		821,125,040

The segment information for the operating segments for the six months ended June 30, 2011 was as follows:

	Dairy products		Dairy farms		Corporate			Total
	US$		US$		US$			US$
Revenues from external customers		130,542,002		18,528,059		-			149,070,061
Intersegment revenues		6,471		5,825,959		-			5,832,430
Segment income tax expenses		2,632,145		-		234			2,632,379
Segment income (loss) before income tax		13,345,856		369,081		(1,157,776	)		12,557,161
Segment assets		602,957,492		174,187,248		200,726,966			977,871,706

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

	Dairy products		Dairy farms		Corporate		Total
	US$		US$		US$		US$
Revenues from external customers		133,630,409		-		-		133,630,409
Intersegment revenues		275,106		10,087,994		-		10,363,100
Segment income tax expenses		913,321		-		30,300		943,621
Segment loss before income tax		(2,606,501)		(7,462,691)		(4,235,769)		(14,304,961)
Segment assets		473,527,865		156,097,318		191,499,857		821,125,040

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

	Three months ended June 30,
	2011			2010
Revenues	US$			US$
Total revenues for operating segments		74,502,311			58,663,993
Elimination of intersegment revenues		(1,881,672	)		(6,469,487	)
Total consolidated revenues		72,620,639			52,194,506

	Six months ended June 30,
	2011			2010
Revenues	US$			US$
Total revenues for operating segments		154,902,491			143,993,509
Elimination of intersegment revenues		(5,832,430	)		(10,363,100	)
Total consolidated revenues		149,070,061			133,630,409

	June 30, 2011			December 31, 2010
Assets	US$
Total assets for operating segments		977,871,706			874,738,492
Elimination of investment		(132,997,363	)		(120,808,394	)
Elimination of intercompany receivables		(359,142,932	)		(289,620,816	)
Total consolidated assets		485,731,411			464,309,282

24.	SUBSEQUENT EVENTS

The Company evaluated all events subsequent to the balance sheet date (June 30, 2011) until the date these consolidated financial statements were issued.

On August 1, 2011, the Company entered into an Equity Purchase Agreement (the “Agreement”) with Haerbin City Ruixinda Investment Company Ltd. (the “Purchaser”). Pursuant to the Agreement, the Company agreed to sell to the Purchaser all of its equity interests of its consolidated subsidiaries, Kedong Farm and Gannan Farm for an aggregate purchase price of RMB849 million (approximately $131.4 million), comprised of RMB114.5 million (approximately $17.7 million) in cash and six equal quarterly deliveries of raw milk in an aggregate value of RMB734.5 million (approximately $113.7 million). As the equity interests of Kedong Farm and Gannan Farm were not available for immediate sale in its present condition as of June 30, 2011, they were not accounted for as assets held for sale as of June 30, 2011.

On July 29, 2011, the Compensation Committee (the “Committee”) of the Board of Directors granted performance options to acquire up to an aggregate of 1,332,000 shares of the Company’s common stock to certain officers and employees of the Company pursuant to the 2009 Plan. The performance stock options each have an exercise price of $8.32 per share, a contractual life of 6 years, and vest in three tranches of 25%, 35% and 40% on each of the three years ended December 31, 2012, 2013 and 2014, provided that the recipient has met the certain performance criteria, 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 Committee also awarded an aggregate of 33,000 shares of restricted stock of the Company to directors of the Company for services rendered from August 1, 2010 through July 31, 2011, pursuant to the 2009 Plan.

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, as amended, for the fiscal year ended December 31, 2010, as amended 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.

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 1,950 tons per day, and an extensive distribution network that reaches over 80,000 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 which is currently under expansion that we expected to be complete before the end of 2011. 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.

		·	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 2010 increased by approximately 24%, 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 is also impacted by governmental agricultural and environmental policies, subsidies, technical assistance and other agricultural regulations and policies, as well as the productivity of the dairy cows, which can be influenced natural and environmental factors. On August 1, 2011, we entered into an equity purchase agreement with Haerbin City Ruixinda Investment Company Ltd., or the Purchaser. Pursuant to the agreement, we agreed to sell to the Purchaser all of our equity interests in our two dairy farms for an aggregate purchase price of approximately $131.4 million, comprised of approximately $17.7 million in cash and six equal quarterly deliveries of raw milk in an aggregate value of approximately $113.7 million. In addition to these deliveries, we would have exclusive rights to purchase raw milk from these two farms at prevailing market prices for an unlimited time period.

		·	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 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						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
	($ in thousands)						($ in thousands)
Sales		72,621			52,194			149,070			133,630
Cost of goods sold		(41,244	)		(33,730	)		(89,822	)		(76,728	)
Gross profit		31,377			18,464			59,248			56,902
Operating expenses:
Sales and marketing expenses		(20,198	)		(29,572	)		(36,368	)		(57,854	)
General and administrative expenses		(5,615	)		(7,080	)		(11,845	)		(12,575	)
Loss on disposal of biological assets		(838	)		(5,788	)		(2,440	)		(8,573	)
Other operating income, net		730			155			2,824			364
Operating income (loss)		5,456			(23,821	)		11,419			(21,736	)
Other income (expenses)		1,020			2,459			1,138			7,431
Income tax (expenses) benefits		(1,291	)		642			(2,632	)		(944	)
Net income (loss) attributable to common shareholders of Feihe International, Inc.		5,166			(20,575	)		9,863			(15,041	)

Comparison of Three Month Periods Ended June 30, 2011 and 2010

Sales

Our sales consist primarily of revenues generated from sales of milk powder, raw milk powder, soybean powder, rice cereal, and walnut products. Sales increased by approximately $20.4 million, or 39.1%, from approximately $52.2 million for the three month period ended June 30, 2010 to approximately $72.6 million for the three month period ended June 30, 2011. This increase was primarily attributable to an increase in sales of milk powder of approximately $19.0 million and an increase in sales of raw milk of approximately $9.8 million from our company-owned dairy farms, which prior to 2011 we had not previously sold to external customers. This increase was offset in part by a decrease in sales of raw milk powder of approximately $8.4 million. Our sales in the three month period ended June 30, 2011 decreased sequentially by approximately 5.0%, from approximately $3.8 million in the first quarter of 2011, primarily reflecting a decrease in our sales of raw milk powder, offset by improved sales of our high margin infant formula milk powder, particularly our premium Feifan series and our super-premium Astro Baby series launched in the third quarter of 2010. We are also continuing our strategy to increase sales at our existing retail sales points, as well as our commitment to improve the effectiveness of all functions of our operations.

The following table sets forth information regarding the sales of our principal products during the three month periods ended June 30, 2011 and 2010:

	Three Months Ended June 30, 2011						Three Months Ended June 30, 2010						Three Months Ended June 30, 2011 Over 2010
Product name	Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)			Amount ($’000)			%

Milk powder		5,436		54,062		74.4		4,824		35,027		67.1		612			19,035			54.3
Raw milk powder		1,343		5,201		7.2		3,603		13,610		26.1		(2,260	)		(8,409	)		(61.8	)
Raw milk		9,290		9,757		13.4		0		0		0.0		9,290			9,757			N/A
Soybean powder		1,303		1,957		2.7		2,022		2,220		4.3		(719	)		(263	)		(11.8	)
Rice cereal		125		821		1.1		140		900		1.7		(15	)		(79	)		(8.8	)
Walnut products		36		261		0.4		50		283		0.5		(14	)		(22	)		(7.8	)
Other		78		562		0.8		11		154		0.3		67			408			264.9
Total		17,611		72,621		100.0		10,650		52,194		100		6,961			20,427			39.1

In the three month period ended June 30, 2011, we also experienced a decrease in the average sales price per kilogram of our products, as demonstrated in the table below:

	Three Months Ended June, 30
	2011		2010
Sales revenues (in thousands)	$	72,621	$	52,194
Total sales volume (kilograms in thousands)		17,611		10,650
Average selling prices/kilogram	$	4.12	$	4.90

The decrease in average sales price per kilogram, as reflected in the table, is primarily attributable to a shift in product mix resulting from an increase in sales of raw milk, a low margin product. If our planned sale of our two company-owned dairy farms closes, our sales of raw milk would decrease and we expect to continue to focus on sales of higher margin milk powder products. The following table reflects the average sales price per kilogram by product for the three month period ended June 30, 2011 and 2010, and the percentage change in the sales price per kilogram.

	Average Price Per Kilogram
	Three Months Ended June 30				Percentage
Product name	2011		2010		Change
Milk powder	$	9.95	$	7.26		37.0
Raw milk powder		3.87		3.78		2.5
Raw milk		1.05		-		N/A
Soybean powder		1.50		1.10		36.6
Rice cereal		6.57		6.43		2.2
Walnut products		7.25		5.66		28.1
Other		7.21		14.00		(48.5)
Average selling price per kilogram	$	4.12	$	4.90		(15.9)

The average selling price per kilogram of milk powder increased by 37.0% from $7.26 in the three month period ended June 30, 2010 to $9.95 in the three month period ended June 30, 2011. This increase was primarily attributable to fewer promotional activities, including provisions of sales discounts to distributors and decreased display fees, which were deducted from gross sales and the increase in sales of high end milk powder.

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 increased approximately $7.5 million, or 22.3%, from approximately $33.7 million for the three month period ended June 30, 2010 to approximately $41.2 million for the three month period ended June 30, 2011. This increase was primarily attributable to general increases in the cost of raw milk and added nutrients, as well as increases in our sales volume.

Gross Profit Margin

Our gross profit margin increased from 35.4% for the three month period ended June 30, 2010 to 43.2% for the three month period ended June 30, 2011. This increase was primarily attributable to an increase in sales quantities of high-end milk powder, which has a higher gross profit margin than raw milk, and a decrease in sales quantities of raw milk powder, which has a low gross profit margin. We plan to continue our efforts to expand our sales of higher margin products and strengthen our premium quality brand awareness, enhance market recognition of our secured raw milk sources, and improve the efficiency of our distribution network.

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 $15.8 million, or 37.2%, from approximately $42.4 million in the three month period ended June 30, 2010 to approximately $26.7 million in the three month period ended June 30, 2011. This decrease was primarily attributable to an decrease of approximately $9.4 million, or 31.7%, in sales and marketing expenses from approximately $29.6 million for the three month period ended June 30, 2010 to approximately $20.2 million for the three month period ended June 30, 2011, a decrease of approximately $1.5 million, or 20.7%, in general and administrative expenses from approximately $7.1 million for the three month period ended June 30, 2010 to approximately $5.6 million for the three month period ended June 30, 2011, and a decrease of approximately $5.0 million, or 85.5%, in loss on disposal of biological assets from approximately $5.8 million for the three month period ended June 30, 2010 to approximately $0.8 million for the three month period ended June 30, 2011. The decreased sales and marketing expenses primarily related to a decrease in advertisement fees and promotional fees, and also reflected our efforts to improve the effectiveness of our selling expenses for the three month period ended June 30, 2011. The decreased general and administrative expenses primarily relate to a decrease in share-based compensation expenses and stricter expenditure control. The decreased loss on disposal of biological assets primarily reflected our sales of under-producing cows in 2010 at our company-owned dairy farms, which has been less of a concern as our experience with operating the farms has increased.

Operating Income (Loss)

As a result of the foregoing, we had operating income of approximately $5.5 million in the three month period ended June 30, 2011, representing an increase of approximately $29.3 million, as compared to an operating loss of approximately $23.8 million in the three month period ended June 30, 2010.

Other Income (Expenses)

Our other income (expenses) consists primarily of interest income, interest and finance costs and government subsidy. Other income (expenses) decreased approximately $1.4 million, or 58.5%, from approximately $2.5 million for the three month period ended June 30, 2010 to approximately $1.0 million for the three month period ended June 30, 2011. The decrease was primarily attributable to a decrease in government subsidy of approximately $1.0 million, or 28.1%, from approximately $3.4 million for the three month period ended June 30, 2010 to approximately $2.5 million for the three month period ended June 30, 2011, and an increase in interest and finance costs of approximately $0.8 million, or 105.5%, from approximately $0.7 million for the three month period ended June 30, 2010 to approximately $1.5 million for the three month period ended June 30, 2011.

Income Tax (Expenses) Benefits

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 expense of approximately $1.3 million for the three months ended June 30, 2011 and an income tax benefit of approximately $0.6 million for the three months ended June 30, 2010. The increase in income tax expense was primarily due to the increase in profits of Heilongjiang Feihe, which is one of our major operations.

As of June 30, 2011 and 2010, unrecognized tax benefits were approximately $4.7 million and $5.0 million, respectively. We cumulatively accrued approximately $1.6 million and $1.4 million for estimated interest and penalties related to unrecognized tax benefits as of June 30, 2011 and 2010, respectively. For the three months ended June 30, 2011 and 2010, we recorded a benefit of $0.21 million and an expense of $0.15 million for estimated interest and penalties, respectively.

Comparison of Six Month Periods Ended June 30, 2011 and 2010

Sales

Sales increased by approximately $15.4 million, or 11.6%, from approximately $133.6 million for the six month period ended June 30, 2010 to approximately $149.1 million for the six month period ended June 30, 2011. This increase was primarily attributable to increased sales of raw milk of approximately $18.5 million from our company-owned dairy farms, which prior to 2011 we had not previously sold to external customers and an increase of sales of milk powder of approximately $2.1 million, offset in part by a decrease in sales of raw milk powder of approximately $4.7 million. The increase in sales primarily reflected our efforts to improve the sales of our high margin infant formula milk powder, particularly our Feifan series and our premium Astro Baby series launched in the third quarter of 2010. We are also continuing our strategy to increase sales at our existing retail sales points, as well as our commitment to improve the effectiveness of all functions of our operations.

The following table sets forth information regarding the sales of our principal products during the six month periods ended June 30, 2011 and 2010:

	Six Months Ended June 30, 2011						Six Months Ended June 30, 2010						Six Months Ended June 30, 2011 Over 2010
Product name	Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)		Amount ($’000)		% of Sales		Quantity (Kg’000)		Amount ($’000)		%

Milk powder		10,443		101,963		68.4		13,368		99,833		74.7		(2,925)		2,130		2.1
Raw milk powder		5,311		21,330		14.3		7,128		26,033		19.5		(1,817)		(4,703)		(18.1)
Raw milk		22,308		18,528		12.4		0		0		0.0		22,308		18,528		N/A
Soybean powder		2,520		3,897		2.6		3,554		4,147		3.1		(1,034)		(250)		(6.0)
Rice cereal		298		1,973		1.3		397		2,523		1.9		(99)		(550)		(21.8)
Walnut products		86		568		0.4		138		734		0.5		(52)		(166)		(22.6)
Other		149		811		0.6		31		360		0.3		118		451		125.3
Total		41,115		149,070		100		24,616		133,630		100		16,499		15,440		11.6

In the six month period ended June 30, 2011, we also experienced a decrease in the average sales price per kilogram of our products, as demonstrated in the table below:

	2011		2010
Sales revenues (in thousands)	$	149,070	$	133,630
Total sales volume (kilograms in thousands)		41,115		24,616
Average selling prices/kilogram	$	3.63	$	5.43

The decrease in average sales price per kilogram, as reflected in the table, is primarily attributable to a shift in product mix resulting from a decrease in sales of milk powder, a higher margin product, coupled with an increase in the sales of raw milk. If our planned sale of our two company-owned dairy farms closes, our sales of raw milk would decrease and we expect to continue to focus on sales of higher margin milk powder products. The following table reflects the average sales price per kilogram by product for the six month period ended June 30, 2011 and the six month period ended June 30, 2010, and the percentage change in the sales price per kilogram.

	Average Price Per Kilogram
	Six Months Ended June 30				Percentage
Product name	2011		2010		Change
Milk powder	$	9.76	$	7.47		30.7
Raw milk powder		4.02		3.65		10.1
Raw milk		0.83		0.00		N/A
Soybean powder		1.55		1.17		32.5
Rice cereal		6.62		6.35		4.3
Walnut products		6.60		5.32		24.1
Other		5.44		11.61		(53.1	)
Average selling price per kilogram	$	3.63	$	5.43		(33.1	)

The average selling price per kilogram of milk powder increased by 30.7% from $7.47 in the six month period ended June 30, 2010 to $9.76 in the six month period ended June 30, 2011. This increase was primarily attributable to fewer promotional activities, including a decrease in sales discounts provided to distributors and decreased display fees, which were deducted from gross sales, and an increase in sales of high-end milk powder product, which has a higher selling price and gross profit margin. The average selling price per kilogram for raw milk powder increased by 10.1%, from $3.65 in the six month period ended June 30, 2010 to $4.02 in the six month period ended June 30, 2011.

Cost of Goods Sold

Cost of goods sold increased approximately $13.1 million, or 17.1%, from approximately $76.7 million for the six month period ended June 30, 2010 to approximately $89.8 million for the six month period ended June 30, 2011. This increase was primarily attributable to general increases in the cost of raw milk and added nutrients, as well as increases in our sales volume.

Gross Profit Margin

Our gross profit margin decreased from 42.6% for the six month period ended June 30, 2010 to 39.7% for the six month period ended June 30, 2011. This decrease was primarily attributable to a decrease in our sales quantities of milk powder and an increase in sales quantities of raw milk, which has a lower gross profit margin than milk powder.

Operating Expenses

Our total operating expenses decreased by approximately $28.3 million, or 35.9%, from approximately $79.0 million in the six month period ended June 30, 2010 to approximately $50.7 million in the six month period ended June 30, 2011. This decrease was primarily attributable to a decrease of approximately $21.5 million, or 37.1%, in sales and marketing expenses from approximately $57.9 million for the six month period ended June 30, 2010 to approximately $36.4 million for the six month period ended June 30, 2011, a decrease of approximately $0.73 million, or 5.8%, in general and administrative expenses from approximately $12.6 million for the six month period ended June 30, 2010 to approximately $11.8 million for the six month period ended June 30, 2011, and a decrease of approximately $6.1 million, or 71.5%, in loss on disposal of biological assets from approximately $8.6 million for the six month period ended June 30, 2010 to approximately $2.4 million for the six month period ended June 30, 2011. The decreased sales and marketing expenses primarily related to a decrease in advertisement fees and promotional fees, and also reflected our efforts to improve the effectiveness of our selling expenses for the six month period ended June 30, 2011. Decreased general and administrative expenses primarily related to a decrease in share-based compensation expenses. The decreased loss on disposal of biological assets reflected a decrease in sales of under-producing cows at our company-owned dairy farms.

Operating Income (Loss)

As a result of the foregoing, we had operating income of approximately $11.4 million in the six month period ended June 30, 2011, representing an increase of approximately $33.2 million, as compared to an operating loss of approximately $21.7 million in the six month period ended June 30, 2010.

Other Income (Expenses)

Other income decreased approximately $6.3 million, or 85.1%, from approximately $7.4 million for the six month period ended June 30, 2010 to approximately $1.1 million for the six month period ended June 30, 2011. The decrease was primarily attributable to a decrease in government subsidy of approximately $5.2 million, or 56.5%, from approximately $9.2 million for the six month period ended June 30, 2010 to approximately $4.0 million for the six month period ended June 30, 2011, and an increase in interest and finance costs of approximately $1.3 million, or 81.3%, from approximately $1.6 million for the six month period ended June 30, 2010 to approximately $2.9 million for the six month period ended June 30, 2011.

Income Tax Expense

We recorded an income tax expense of approximately $2.6 million and $0.9 million for the six months ended June 30, 2011 and 2010, respectively. The increase in income tax expense was primarily due to the increase in profits of Heilongjiang Feihe and Gannan Feihe, which are two of our major operations.

Liquidity and Capital Resources

In general, our primary uses of cash are providing for working capital purposes, which principally represent the purchase of inventory, servicing debt and financing construction related to our expansion plans. Our largest source of operating cash flows is cash collections from our customers. We have been able to meet our cash needs principally by using cash on hand, cash flows from operations, bank loans and borrowings under our line of credit.

The accompanying unaudited condensed consolidated financial statements have been prepared assuming we will continue as a going concern. We had a working capital deficiency of approximately $112.7 million as of June 30, 2011. We have significant cash commitments in the upcoming year, including maturity of short term bank loans and the current portion of long term bank loans of $86.6 million and redemption of redeemable common stock of $49.0 million plus interest. However, we believe we will be able to refinance much of our short-term bank loans when they become due and intend to do so. In the first quarter of 2011, we refinanced a short-term bank loan upon its maturity, and in the second quarter we paid off another short-term bank loan and entered into a new short-term bank loan. Accordingly, we believe that our cash generated from operations, existing cash, ability to draw down on unutilized credit lines, and proceeds from the planned sale of our dairy farms will be sufficient to fund our expected cash flow requirements for at least next 12 months, including the cash payments for the redemption of our redeemable common stock and planned capital expenditures.

Cash Flows

We had retained earnings of approximately $71.6 million as of June 30, 2011 and $60.7 million as of December 31, 2010. As of June 30, 2011, we had cash and cash equivalents of approximately $18.7 million and total current assets of approximately $144.2 million. As of June 30, 2011, we had a working capital deficit of approximately $112.7 million.

Our summary cash flow information is as follows:

	Six Months Ended June 30
Net cash provided by (used in):	2011			2010
	($ in thousands)
Operating activities		19,516			12,860
Investing activities		(18,476	)		(31,024	)
Financing activities		(229	)		(18,865	)

Net Cash Provided by Operating Activities

Net cash provided by operating activities increased approximately $6.7 million, from approximately $12.9 million for the six month period ended June 30, 2010 to approximately $19.5 million for the six month period ended June 30, 2011. This increase primarily reflected the following changes in working capital items:

·	Increase in net income of approximately $25.2 million, reflecting our strengthened profitability as discussed above;

·	Decrease of $6.1 million in loss of disposal of biological assets, reflecting our improvement in our dairy farms operations;

·	Increase in trade receivable of approximately $6.6 million, reflecting our increased sales, compared to lower trade receivables and lower sales in the six months ended June 30, 2010;

·	Decrease in inventory of approximately $4.5 million, reflecting our efforts to improve inventory turnover; and

·	Increase in other receivable of approximately $7.3 million, primarily due to the increase in the amount we paid on behalf of Yuanshengtai to purchase cattle and equipment.

Net Cash Used in Investing Activities

Net cash used in investing activities decreased approximately $12.5 million from approximately $31.0 million for the six month period ended June 30, 2010 to approximately $18.5 million for the six month period ended June 30, 2011. This decrease was primarily attributable to a decrease of approximately $9.5 million in purchase of property, plant and equipment and a decrease of approximately $12.2 million in restricted cash, offset by an increase of approximately $12.5 million in long term deposits. Net cash used in investing activities primarily relates to our bank loans and expenditures associated with our construction of new facilities.

Net Cash Used in Financing Activities

Net cash used in financing activities decreased approximately $18.6 million, from approximately $18.9 million for the six month period ended June 30, 2010 to approximately $0.2 million for the six month period ended June 30, 2011. This decrease was primarily attributable to a decrease of approximately $15.7 million in repayment of short term bank loans and an increase in repayment of redeemable shares of approximately $16.1 million, offset in part by proceeds from other long term loan of approximately $16.4 million.

Outstanding Indebtedness

Redemption Obligation

In August 2009, pursuant to a subscription agreement, we issued 2,100,000 shares of our common stock to Sequoia, for an aggregate purchase price of $63.0 million. Because we did not meet certain earnings per share targets for 2009, we issued 525,000 additional shares to Sequoia pursuant to the subscription agreement. In February 2011, we entered into a redemption agreement with Sequoia to redeem and repurchase 2,625,000 shares issued pursuant to the subscription agreement in four equal installments on or around March 31, 2011, September 30, 2011, December 31, 2011 and March 31, 2012, for an aggregate payment of $65 million.

On April 27, 2011, we paid Sequoia $16.1 million to redeem 656,250 shares of common stock. The outstanding liability of redeemable common stock was $48,952,255 as of June 30, 2011. All shares of our common stock we redeem constitute authorized but unissued shares.

Short and Long Term Loans Payable

As of June 30, 2011, we had short term bank loans of approximately $75.5 million and long term bank loans of approximately $33.2 million from PRC banks. Our bank loans do not contain financial covenants. During the six month period ended June 30, 2011 and 2010, the largest aggregate amount of short term bank loans was approximately $76.2 million and $58.7 million, respectively. The maturity dates of the short term bank loans outstanding from PRC banks as of June 30, 2011 ranged from July 25, 2011 to April 6, 2012. All short term bank loans that have become due have been refinanced or repaid. During the six month period ended June 30, 2011, the largest aggregate amount of long term bank loans was approximately $38.7 million. The maturity dates of the long term bank loans outstanding from PRC banks as of June 30, 2011 ranged from December 23, 2011 to October 28, 2014. The weighted average annual interest rate on short term bank loans and long term bank loans from PRC banks outstanding as of June 30, 2011 was 5% and 6.3%, respectively. The loans were secured by pledges of certain property, plant and equipment held by our subsidiaries or by guarantees of certain of our subsidiaries. Our ability to incur additional secured indebtedness depends in part on the value of our assets, which depends, in turn, on the strength of our cash flows, results of operations, economic and market conditions and other factors

Line of Credit

We have a one year, unsecured line of credit with a bank of approximately $103 million (RMB 677 million) scheduled to expire in the last fiscal quarter of 2011. The line of credit entitles us to draw demand loans for general corporate purposes. If we were to draw on the line of credit, interest would be a base rate established by the People’s Bank of China on the unpaid principal amount. As of June 30, 2011, there were borrowings of approximately $31 million under the line of credit. The net availability of the line of credit was approximately $72 million as of June 30, 2011.

Equipment Financing

We have a six-year capital lease agreement for certain equipment under construction. The terms of the lease required an initial payment of approximately $774,000 and require a payment of approximately $155,000 on January 30th of each year after successful completion of production quality tests. The equipment is depreciated over its estimated productive life of 14 years. As of each of June 30, 2011 and December 31, 2010, we had approximately $1.5 million of equipment under construction subject to the capital lease obligation.

Off-Balance Sheet Arrangements

We have not entered into any transactions, agreements or other contractual arrangements to which an entity unconsolidated with us is a party and under which we have (i) any obligation under a guarantee, (ii) any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity, (iii) any obligation under derivative instruments that are indexed to our shares and classified as shareholders’ equity in our consolidated balance sheets, or (iv) any obligation arising out of a variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

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, our disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenues and expenses during the reported periods. We routinely evaluate these estimates, utilizing historical experience, consulting with experts and utilizing 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.

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 $636,049 for the six months ended June 30, 2011 and reduced it by $199,284 for the six months ended June 30, 2010. Although our write-offs of bad debts have been minimal in recent years and we had no write-offs in the six months ended June 30, 2011, events and circumstances could occur that would require that we increase our allowance in the future.

Estimate of the useful lives of property, plant and equipment and biological assets – We estimate the useful lives and residual values of our property, plant and equipment and biological assets. We also review property, plant 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 periods ended June 30, 2011 and 2010. For our cows included in the biological assets, we regularly monitor their production level and intend to dispose of under producing cows. We recognized approximately $2.4 million and $8.6 million of loss on such disposal for the six months ended June 30, 2011 and 2010, respectively.

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.

Goodwill – We test goodwill annually for impairment or more frequently if events or changes in circumstances indicate that it might be impaired. We currently have ten reporting units and only one reporting unit carries assigned goodwill: Gannan Feihe. We perform annual impairment test on December 31 on this reporting unit. We recognize a goodwill impairment loss in our statements of operations when the carrying amount of goodwill exceeds its implied fair value based on undiscounted cash flows. These analyses require management to make assumptions and to apply judgment, including forecasting future sales, expenses, and discount rates, which can be affected by economic conditions and other factors that can be difficult to predict. 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 less than 0.8% of total sales for the six months ended June 30, 2011 and 2010, 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. Significant factors affecting the fair value of option awards include the estimated future volatility of our stock price and the estimated expected term until the option award is exercised or cancelled.

The fair value of awards is amortized over the requisite service period, except for 2,073,190 options granted in May 2009 that vest upon performance conditions. For such performance based awards, we assess the probability of meeting such conditions in order to determine the compensation cost to be recognized. For six months ended June 30, 2011 and 2010, we determined that it was improbable for the performance targets to be met for the performance awards. Total compensation expense recognized in general and administrative expenses for the six months ended June 30, 2011 and 2010, were approximately $0.8 million and $1.9 million, respectively.

Redeemable common stock – On February 1, 2011, we entered into a redemption agreement committing us to redeem the common stock we issued to Sequoia at a total price of $65 million. We agreed to consummate the redemption in four closings from March 31, 2011 through March 31, 2012. As a result, the redeemable common stock was reclassified into current liabilities from temporary equity.

Taxation – Current income taxes are provided for in accordance with the laws of the relevant tax authorities. Deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. Net operating loss carry forwards and credits are applied using enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics.

We adopted ASC 740-10, “Income Taxes” (previously FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109,” or FIN 48) effective April 1, 2007. In accordance with ASC 740-10, we recognize a tax benefit associated with an uncertain tax position when, in our judgment, it is more likely than not that the position will be sustained upon examination by a taxing authority. For a tax position that meets the more-likely-than-not recognition threshold, we initially and subsequently measure the tax benefit as the largest amount that we judge to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. Our liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances, such as the progress of tax audits, case law developments and new or emerging legislation. Such adjustments are recognized entirely in the period in which they are identified. Our effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent adjustments as considered appropriate by management. We classify interest and penalties recognized on the liability for unrecognized tax benefits as income tax expense.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

We invest in fixed and variable income investments classified as cash and cash equivalents and short-term investments. Our cash and cash equivalents are placed primarily in demand deposits, with maturities of three months or less and short-term investments are mutual funds. Our borrowings bear fixed interest rates. As of June 30, 2011, we had short term loans of approximately $75.5 million and long term loans of approximately $33.2 million from PRC banks, the weighted average interest rates on our outstanding short term bank loans and long term loans was 5.7% and 6.3%, respectively, and we paid interest expenses of approximately $1.0 million and $0.6 million on our short and long term loans during the six months ended June 30, 2011, respectively. If interest rates on our short and long term loans were to increase by 10% to 6.28% and 6.93%, respectively, our interest expenses would potentially increase by approximately $0.1 million and $52,000, respectively. If interest rates on our short and long term loans were to decrease by 10% to 5.14% and 5.67%, respectively, our interest expenses would potentially decrease by approximately $0.1 million and $52,000, respectively. In addition, if we were to draw on our line of credit, interest would be a base rate established by the People’s Bank of China on the unpaid principal amount. We have not used derivative financial instruments to manage our interest rate risk exposure.

Foreign Currency Risk

We conduct substantially 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 June, 2011 and December 31, 2010 were approximately 6.5 and 6.6 Renminbi to 1 U.S. dollar, respectively. The exchange rate is currently permitted to float within a very limited range. However, there remains significant international pressure on the PRC government to adopt a substantial liberalization of its currency policy, which could result in a further and more significant appreciation in the value of the Renminbi against the U.S. dollar. Any devaluation of the Renminbi against the U.S. dollar would consequently have an adverse effect on our financial performance and asset values when measured in terms of U.S. dollars. We recognized a foreign currency translation gain of approximately $5.5 million and $0.9 for the six month period ended June 30, 2011 and 2010. If the exchange rate were to increase by 10% to $1.00 = RMB7.1, our foreign currency translation gain would potentially decrease by approximately $8.4 million. If the exchange rate were to decrease by 10% to $1.00 = RMB5.8, our foreign currency translation gain would potentially increase by approximately $10.3 million.

Inflation

In recent years, China has not experienced significant inflation, and thus inflation has not had a material impact on our results of operations. According to the National Bureau of Statistics of China, the change in Consumer Price Index in China was 5.9%, -0.7% and 4.6% in 2008, 2009 and 2010, respectively.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective.

Management evaluated the effectiveness of our disclosure controls and procedures for the year ended December 31, 2010, 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 internal control over financial reporting was not effective at December 31, 2010, because we had insufficient accounting personnel with appropriate knowledge of US GAAP. We are still in the process of remediating this material weakness, which substantially influenced the conclusion of our Chief Executive Officer and Chief Financial Officer that our disclosure controls and procedures were not effective as of June 30, 2011.

Remediation Plan

After the identification of the material weakness as of December 31, 2010, we have undertaken or are in the process of undertaking a number of measures to improve our internal controls over financial reporting to address the material weakness. Management has taken additional steps to ensure the reliability of our financial reporting, including 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 our financial statements. In addition, we have launched a recruitment program to hire additional qualified accounting personnel. We plan to hire additional qualified accounting personnel, as necessary to fulfill our reporting obligations and to reinforce our internal audit function. We have also implemented regular GAAP accounting and financial reporting training programs for our existing accounting and reporting personnel, including senior financial officers. The costs for such remediation plan cannot yet be quantified but are not likely to be significant. However, we do not expect that our plan will fully remediate the material weakness identified above until at least September 30, 2011, 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 and 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

As discussed above in connection with our remediation plans, we have undertaken or are in the process of undertaking a number of measures to improve our internal controls over financial reporting in order to address the material weakness identified as of December 31, 2010. Except for such measures, there have not been any changes in our internal control over financial reporting for the six months ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

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

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

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

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

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: August 9, 2011	By:	/s/ Leng You-Bin
		Leng You-Bin Chief Executive Officer and President (Principal Executive Officer)

	By:	/s/ Liu Hua
		Liu Hua Chief Financial Officer (Principal Accounting and Financial Officer)

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

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

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

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

Feihe International Inc - FORM 10-Q - August 9, 2011

Attached files

Feihe International Inc Reports