---

---

U.S. Securities and Exchange CommissionWashington, D.C. 20549



Form 10-K/A






x ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT
OF 1934 for the fiscal year
ended December 31, 2006

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ________________

Commission File Number: 0-27351

|                                                        
|--------------------------------------------------------
|American Dairy, Inc.                                    
|                                                        
|(Exact
  name of registrant as specified in its charter)

|                                  |                      
|--------------------------------- | ---------------------
|Utah                              | 87-0445575           
|                                  |                      
|(State
  or other jurisdiction of | (I.R.S.
  Employer   
|Incorporation
  or organization)  | Identification
  No.)

|                                             
|---------------------------------------------
|C-16
  Shin Chen International Building      
|No.
  10, Jiu-shen Road, Zho Yan Chu, Beijing
|The
  Peoples Republic of China             
|                                             
|(Address
  of principal executive offices)   

Registrants
telephone number, including area code: 011-0452-4312688

Securities
registered under Section 12(b) of the Exchange Act:

| |                     |                                          
| | ------------------- | -----------------------------------------
| | Title of each class | Name of each exchange on
which registered
| |                     |                                          
| | Common Stock        | NYSE Archipelago Exchange
  (ArcaEx)     
| |                     |                                          

Securities
registered under Section 12(g) of the Exchange Act:

|                  
|------------------
|N/A               
|                  
|(Title
  of class)

Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.o Yes
x No

Indicate by
check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. o
Yes x No

Indicate by check mark
whether the registrant (1) has filed all reports required to be filed pursuant
to Section 13 or Section 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. x  Yes o
No

---

---



Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o  Non-accelerated filer x

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

State the aggregate market
value of the voting and non-voting common equity held by non-affiliates
computed by reference to the price at which the common equity was last sold, or
the average bid and asked price of such common equity, as of the last business
day of the registrants most recently completed second fiscal quarter closing
price: $34,187,947

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark
whether the registrant has filed all documents and reports required to be filed
by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to
the distribution of securities under a plan confirmed by a court. o Yes
o  No

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)

Indicate the number of shares
outstanding of each of the registrants classes of common stock, as of the
latest practicable date: the number of shares of the registrants common stock
outstanding as of March 29, 2007 was 15,881,070 shares.

DOCUMENTS INCORPORATED BY REFERENCE

None

ii

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TABLE OF CONTENTS

|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|PART I   |                                                                                                   
|Item 1.  | Business                                                                                          
|Item 1A. | Risk Factors                                                                                      
|Item 1B. | Unresolved
  Staff Comments                                                                       
|Item 2.  | Properties                                                                                        
|Item 3.  | Legal
  Proceedings                                                                               
|Item 4.  | Submission
  of Matters to a Vote of Security Holders                                             
|         |                                                                                                   
|PART II  |                                                                                                   
|Item 5.  | Market for
  the Registrants Common Stock and Related Stockholder Matters                        
|Item 6.  | Selected
  Financial Data                                                                         
|Item 7.  | Managements
  Discussion and Analysis of Financial Condition and Results of Operations           
|Item 7A. | Quantitative
  and Qualitative Disclosures About Market Risk                                      
|Item 8.  | Financial
  Statements and Supplementary Data                                                     
|Item 9.  | Changes in
  and Disagreements With Accountants on Accounting and Financial Disclosure            
|Item 9A. | Disclosure
  Controls and Procedures                                                              
|         |                                                                                                   
|PART III |                                                                                                   
|Item 10. | Directors,
  Executive Officers and Corporate Governance                                          
|Item 11. | Executive
  Compensation                                                                          
|Item 12. | Security
  Ownership of Certain Beneficial Owners and Management and Related Stockholder
  Matters
|Item 13. | Certain
  Relationships and Related Transactions, and Director Independence                       
|Item 14. | Principal
  Accountant Fees and Services                                                          
|         |                                                                                                   
|PART IV  |                                                                                                   
|Item 15. | Exhibits,
  Financial Statement Schedules                                                         

iii

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EXPLANATORY NOTE


American Dairy, Inc. is
filing this Form 10-K/A to amend certain sections of its Form 10-K for the year
ended December 31, 2006. We originally filed our Form 10-K for the year ended
December 31, 2006 (the Original Filing) on April 2, 2007. We are
amending the Original Filing solely to revise Item 1. Business, Item 1A. Risk
Factors, Item 2, Managements Discussion and Analysis, (1) General and (2)
Plan of Operation and Item 10., Directors, Executive Officers and Corporate Governance
as well as Note 13 to the financial statements which begins on page F-1 hereto.
This Form 10-K/A does not otherwise amend the Original Filing.

iv

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PART I

Item 1. Business.

General

American Dairy, Inc was incorporated
under the corporate laws of the State of Utah on December 31, 1985, originally
with the corporate name of Gaslight, Inc. It was inactive until March 30, 1988
when it changed its corporate name to Lazarus Industries, Inc. and engaged in
the business of manufacturing and marketing medical devices. This line of
business was discontinued in 1991, and it became a non-operating public company
shell.

Effective May 7, 2003,
American Dairy completed the acquisition of 100% of the issued and outstanding
capital stock of American Flying Crane Corporation (formerly called American
Dairy Holdings, Inc.) (AFC), a Delaware corporation. As a result, AFC become
a wholly-owned subsidiary of American Dairy. In addition, American Dairy
amended its Articles of Incorporation to change its name to American Dairy,
Inc. and completed a one-for-nineteen (1-for-19) reverse split of its Common
Stock. For financial reporting purposes, this transaction was treated as a
recapitalization of American Flying Crane and the historical figures prior to
May 7, 2003 represent the activities of American Flying Crane.

AFC holds 100% of the issued
and outstanding capital of Heilongjiang Feihe Dairy Co., Limited (Feihe
Dairy) in The Peoples Republic of China. The principal activity of Feihe
Dairy is the production and distribution of milk powder and other dairy
products. Feihe Dairy has one wholly-owned subsidiary, BaiQuan Feihe Dairy Co.,
Limited, that is engaged in the production and supply of processed milk and
soybean products for Feihe Dairy, and has a 95%-owned subsidiary Beijing Feihe
Biotechnology Scientific and Commercial Co., which is the marketing company for
Feihe Dairy.

American Dairy purchased all
of the outstanding capital stock of AFC from its stockholders in exchange for
9,650,000 restricted shares (post-split) of the common stock of American Dairy.
In addition to the shares issued as consideration for the merger, at the time
of the closing, AFC paid a dividend in the approximate amount of $860,000 to
its sole shareholder as an adjustment for the significant increase in value in
AFC which occurred between the signing of the agreement and the closing.
Holders of approximately 66% of the outstanding common stock of American Dairy
approved the following:

1. an amendment to the
Articles of Incorporation of American Dairy to change its corporate name to
American Dairy, Inc.;

2. a one-for-nineteen
(1-for-19) reverse split of the Common Stock of American Dairy; and

3. the establishment of its
2003 Stock Incentive Plan covering 3,000,000 shares of Common Stock for its key
employees, including officers, employees, directors and consultants.

American Dairy also has three
other wholly-owned subsidiaries, Lang Fang FeiHe, Gan Han FeiHe and Shanxi
Feihesantai Biotechnology Scientific and Commercial Co., Limited (the third of
which was originally formed to develop and operate a walnut processing plant).

American Dairy processes and
markets milk powder, soybean powder, and related dairy products, primarily in
the northeastern area of The Peoples Republic of China (China), known as the
milk belt of China. American Dairys production plants have a processing
capability of approximately 720,000 kilograms of fresh milk per day. American
Dairys affiliated farmers have grazing rights covering approximately 514,640
acres in Kedong County in northeastern China. Although our name is American
Dairy, substantially all of our business operations are in China. We employ a
limited number of professionals, consultants and employees in the United States
for purposes of assisting us in obtaining funding and compliance with legal and
financial reporting requirements under US law. However, we have no operations
in the United States.

Current Corporate Structure

The following chart reflects
the current corporate structure of the American Dairy entities:

1

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Lang FangFeiHe 100% 100% 100% 100% 100% 100% Gan Nan   FeiHe American Flying  Crane ShanxiFeidesantai ADY Heilongjang FeiHeDairy 5%Leng You-Bin Bai QuanFeiHe BeijingFeiHe 95%


2

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Heilongjiang Feihe Dairy Co., Limited and
Other Subsidiaries

Heilongjiang
Feihe Dairy Co., Limited (Feihe Dairy) and its subsidiaries are companies
organized under the laws of The Peoples Republic of China.

The history of
Feihe Dairy commenced in 1962 when its predecessor, Heilongjiang Zhaoguang
Hongguang Dairy Plants (Hongguang Dairy Plant) was established as a wholly -
owned State Enterprise, whose principal activities were the production and
distribution of powdered milk in China. The Hongguang Dairy Plant was located
at Zhaoguang Livestock Farm of Zhaoguang Agro-Cultivated Bureau, its production
capability was five tons a day and its main sales territory was Shangdong
Province.

In 1982,
Heilongjiang Zhaoguang Dairy Plants (Zhaoguang Dairy), another State
Enterprise, was established at Zhaoguang Plantation near BeiAn City. In 1984,
Hongguang Dairy Plants and Zhaoguang Dairy were merged into Heilongjiang
Zhaoguang Dairy Plants. The State continued to retain ownership of the merged
Heilongjiang Zhaoguang Dairy Plants.

In 1997, the
merged Heilongjiang Zhaoguang Dairy Plants was further reorganized and its name
changed to Heilongjiang Feihe Dairy Group Limited. In February 2000,
Heilongjiang Feihe Dairy Group Limited completed its registered capital restructuring
to become a private company with registered capital of $894,226.

In March 2001,
the restructured Heilongjiang Feihe Dairy Group Limited changed its name to its
present name of Heilongjiang Feihe Dairy Co., Limited and acquired all of the
fixed assets (including land use rights, plant and equipment and factory
buildings) of Kedong Gongmu Dairy Plants. Heilongjiang Sanhao Dairy Co.,
Limited (Sanhao Dairy) was incorporated on March 28, 2001 with registered
capital of $433,110. Feihe Dairy owned 99% of Sanhao Dairy and Fu Man Guo held
the remaining 1% in trust for Feihe Dairy. Under a Sale and Purchase Agreement
dated February 6, 2001 between Feihe Dairy and Kedong County Economic
Committee, Feihe Dairy agreed to acquire all the fixed assets including land
use rights from Kedong Gongmu Dairy Plants at a consideration of $364,269.
Following the incorporation of Sanhao Dairy, Feihe Dairy, as its contribution
towards the registered capital, injected all the fixed assets from Kedong
Gongmu Dairy Plants, except for its land uses rights to 47,640 square meters of
land, into Sanhao Dairy, plus cash of $68,841.

In August
2001, Feihe Dairys new production facilities in Kedong County commenced
production of milk powder.

During 2004,
American Dairy merged Sanhao Dairy into BaiQuan Feihe Dairy Co., Limited and
consolidated their operations.

During April
2004, American Dairy established a 60% owned subsidiary called Shanxi
Feihesantai Biotechnology Scientific and Commercial Co., Limited (Shanxi
Feihesantai), a limited liability company registered in Shanxi Province in The
Peoples Republic of China. The remaining 40% owner of Shanxi Feihesantai was
Licheng Santai Technology Enterprises Limited, an unaffiliated company. During
the third quarter of 2006, American Dairy entered into an agreement to purchase
the additional 40% interest in Shanxi Feihesantai from Licheng Santai. The
purchase was completed in the fourth quarter of 2006. The business of Shanxi
Feihesantai is the production and distribution of walnut power and other walnut
products.

During June
2005, American Dairy purchased a milk powder processing facility from Nutricia
Nutritionals Co. of Heilongjiang Province for $7,300,000 and its inventory for
$130,000. American Dairy also acquired 19 milk collection stations in this
transaction.

On June 15,
2006, the Company formed Langfang Feihe Dairy Company Limited (Langfang
Feihe) as a wholly owned subsidiary of American Dairy. Langfang has a
registered capital of $15,000,000. Langfang Feihe was formed to own dairy
facilities which are now being constructed.

On March 22,
2006, the Company formed GanHan Feihe Dairy Company Limited (GanHan Feihe) as
a wholly-owned subsidiary of American Dairy. GanHan Feihe has a registered
capital of 40,000,000 RMB ($5,000,000). GanHan Feihe was also formed to own
dairy facilities which are now being constructed.

3

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Principal Products

Our products
fall into three main product categories, milk powder, soybean powder and walnut
products.

Milk Powder

This is our
primary product and itself is divided into several sub-categories. We produce
milk powder for babies and young children formulated for 0 to six months, six
months to one year, one to three years and three to five years of age. We also
produce milk powder for students and for the middle aged and elderly
population.

Soybean Powder

Soybean Powder
is an auxiliary product to our milk powders and represents a low fat, high
calcium alternative to cows milk, particularly for seniors.

Walnut Powder and
Other Products

We produce
other auxiliary products which we market in conjunction with our baby milk
powder as well as to health-conscious adults. These products include walnut
powder, walnut dew, walnut oil and rice powder/rice cereal.

Sources of Milk

Under supply contracts
with numerous small dairy farmers who have cattle grazing rights and use rights
to approximately 514,640 acres of land in Kedong County in northeastern China,
American Dairy has been able to receive supplies of raw milk without having to
make capital investments in farms and cattle. Historically, the milk industry
in China has been very fragmented and segmented with most production being
generated by farmers owning and milking one to ten cows. Approximately 27% of
this acreage is arable pasture land, and approximately 30% is planted with
beans and corn.

American Dairy
also has a milk powder processing plant called BaiQuan Dairy. American Dairy
acquired this plant in January 2003 for $700,483. Additional land was
subsequently acquired for $293,450 in March 2004. The land is approximately
40,000 square meters. The plant building has approximately 5,458 square meters
of production space and has 800 square meters of office space, and is
approximately 15 years old. BaiQuan Dairy has approximately 62 production and
packaging employees.

American Dairy
has a milk powder packaging plant called Feihe Dairy in Kedong County in China
that commenced milk powder processing production in August 2001. This plant is
located at 1st Qingxiang Street, Kedong County, in the City of QiQiHaEr, in
Heilongjiang Province, China. Feihe Dairy has approximately 134 packaging
employees at this plant.

Raw Milk Processing

American Dairy
believes that through purchasing raw milk locally and employing minimal
processing techniques, we are able to preserve the fresh taste of milk. The
industry standard for the time it takes for raw milk to be converted to milk
powder is approximately 48 hours. Most large regional dairies, we believe,
process raw milk which may be three to four days old. Milk processed by
conventional farms for sale to regional dairies is typically stored at the farm
for a minimum of two days, commonly spends a full day in transit to the dairy
facility, and is only processed the following day.

However,
American Dairys standard is to process the raw milk within 24-36 hours after
milking, depending upon the time of day the raw milk is delivered to us. Within
this time, the milk is chilled, transported, separated, sterilized and
spray-dried. The raw milk is first received from milk collection centers. Fully
enclosed, stainless-steel vacuum milking machines are used to receive the raw
milk. Once received, the raw milk will no longer have any contact with air and
is immediately processed with refrigeration equipment that cools the raw milk
within three seconds to

4

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about 4°
Celsius. The raw milk is then stored in air-tight tanks in preparation for
advanced processes, which include milk fat separation, sterilization and
spray-drying.

American
Dairys milk is not homogenized. During homogenization, pressurized milk is
forced through openings smaller than the size of the fat globules present in
milk, breaking them into smaller particles. Thus treated, the milk fat remains
suspended and does not separate out in the form of cream. American Dairy
believes that this process adversely affects the taste and feel of milk. In
addition, American Dairys milk is pasteurized at the lowest temperatures
allowed by law to avoid imparting a cooked flavor to the milk. When the milk is
clarified and the butterfat removed to yield cream and skim milk, a process of
cold separation is used, rather than the more commonly employed hot separation
which we believe adversely affects the flavor of the milk.

Dairy Product Processing

American
Dairys products are made in small batches using minimal processing techniques
to maintain freshness and allow maximum flavor and nutrition retention. They
are made with wholesome ingredients. No chemicals or additives are employed.
Because they are produced locally, our dairy products arrive to consumers in
American Dairys marketing area sooner after production than most other dairy
products. To assure product quality, the beginning of each production run is
sampled for flavor, aroma, texture and appearance. In addition, inspectors
conduct spot-checks for bacteria and butterfat content in its products, as well
as sanitary conditions in its facilities.

Milk Processing Facilities

American Dairy
has the following principal operating milk powder production and packaging
plants:

Kedong I (Sanhao
Dairy)

Located in
Kedong County in the City of QiQiHaEr, in Heilongjiang Province, China,
American Dairy acquired this plant in March 2001 for $461,632. The land is
approximately 47,640 square meters. The plant buildings have approximately
4,500 square meters of production space and 720 square meters of office space.
The plant is approximately 14 years old. Sanhao Dairy has approximately 236
production and packaging employees at this plant and has a capacity of 50 tons
per day.

BaiQuan Feihe Dairy

American Dairy
acquired this plant in January 2003 for $700,483. Additional land was
subsequently acquired for $293,450 in March 2004. The land is approximately
40,000 square meters. The plant building has approximately 5,458 square meters
of production space and 800 square meters of office space, and is approximately
15 years old. BaiQuan Dairy has approximately 62 production and packaging
employees and has a capacity of 100 tons per day.

Kedong II

American Dairy
began building a new milk powder processing plant during 2004 in close
proximity to its Sanhao Dairy plant in Kedong County. We acquired the land use
rights to this location for $400,966 and entered into a construction contract
to build the new plant for approximately $4,200,000 (Rmb. 34,866,000). This
plant has a capacity of 300 tons per day.

Numico

American Dairy
holds the land use rights and buildings of this milk powder plant in
Heilongjiang Province, including milk powder processing equipment located at
this plant which it purchased in 2005 from Nutricia Nutritionals Co., Ltd. We
also have 19 milk collection stations for the collection of raw milk to supply
the processing plant. This milk powder plant is capable of processing
approximately 8,100 tons of raw milk per month into approximately 1,620 tons of
milk powder per month and has a capacity of 270 tons per day.

The combined
capacity of all of these existing plants is approximately 720 tons per day. The
existing production facilities of American Dairy employ approximately 578 total
production personnel.

5

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Processing and Packaging Plants under
Development

Feihe Gannan Processing Plant Construction Project. The milk
processing plant constructed by this project is to be situated on 300,000
square meters of land with facilities occupying 60,000 square meters. The
project is being carried out in two phases. Construction on the first phase was
completed in December 2006 with machinery and equipment being installed in
2007. Phase one focuses on the infrastructure of the facilities and is set to
begin its milk processing operations by the end of 2007. After phase one is
complete, the facility is expected to be able to process at least 300 tons of
fresh milk and will be equipped to allow for the expansion of its operations.
The second phase is scheduled to begin in 2008, and we plan to have it
completed by the end of 2009. Phase two will focus on the improvement and
expansion of the facility in order to increase production and lower costs. This
phase is expected to cost approximately $25 million.

The production
equipment is being manufactured and provided to us by a Germany-based company,
which is one of the worlds leading process engineering and equipment
manufacturers. Thus far, we have paid this company $2 million to begin
production of the milking equipment and other equipment including fillers,
product tanks, pasteurizers, and storage. The project costs also include
acquiring supplies and licenses, etc.

As planned,
the facility will be able to process at least 300 tons of fresh milk by the end
of the first phase in 2007, and will process at least 1,000 tons of fresh milk
by the end of 2009. To date, we have used approximately $10 million of our
existing cash to fund the Gannan Processing Plant.

Langfang Flying
Crane Construction Project. We believe that once
fully developed and constructed, the Langfang Flying Crane construction project
will be one of Chinas biggest milk powder packaging plants. As planned, the
facility will have an initial production rate of 35,000 tons of milk powder in
tin containers. The plant has been substantially completed so the facilities
are expected to be ready to begin packaging operations in 2007.

The facility
has workshops, storehouses and equipment which will allow for expansion. We
believe that production at the plant can grow to at least 50,000 tons. The
total cost is expected to be approximately $15 million. To date, approximately
$5 million has been spent on construction and the installation of the
equipment.

All aspects of
production of American Dairys products are based on traditional practices
designed to yield premium quality and wholesome and superior tasting foods.
Because of the consistent quality of the milk powder products of American
Dairy, it was awarded an ISO9002 quality Assurance Certificate in October 2000.
In accordance with the requirements of ISO9002, American Dairy established a
Quality Assurance Handbook that provides standardized requirements and
procedures regarding the purchase of raw milk, its milk processing systems,
storage and packaging standards, the distribution of its products, and employee
training.

Walnut Powder Operations

American Dairy
produces and distributes walnut powder and other walnut products through its
subsidiary, Shanxi Feihesantai Biotechnology Scientific and Commercial Co.,
Limited. The plant was completed and began operations during October 2005.

Soy Bean and Rice Cereal

American Dairy
also produces soy bean powder and rice cereal which each comprised 3% of sales
during the fiscal year ended December 31, 2006.

Product Sales

The following
table reflects the sales of the five principal products of American Dairy
during the fiscal years ended December 31, 2006 and 2005:

6

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|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|------------------ |  | --------------- | ---------- | ------ | - | ------------ | - | --------------- | --- | ------ |  | ------------ |  | ------------ | ---------- | - |  | --- | - |  | ---------- | -
|                   |  | 2006            |            | 2005   |   |              |  
|                   |  |                 |            |        |   |              |  
|Product name       |  | Quantity
  (Kg) |            | Amount |   | % of
  sales |   | Quantity
  (Kg) |     | Amount |  | % of
  sales |  | Variance(Kg) |           
|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|CPP series         |  |                 | 7,467,289  |        | $ | 37,524,523   |   |                 | 30  | %      |  | 4,503,308    |  | $            | 24,700,822 |   |  | 35  | % |  | 2,963,981  |  
|Nucleotides series |  |                 | 3,857,615  |        |   | 34,921,188   |   |                 | 28  | %      |  | 1,094,676    |  |              | 11,017,136 |   |  | 16  | % |  | 2,762,939  |  
|Ca+Zn series       |  |                 | 9,788,881  |        |   | 27,040,611   |   |                 | 21  | %      |  | 4,722,624    |  |              | 13,348,008 |   |  | 19  | % |  | 5,066,257  |  
|Rice cereal        |  |                 | 913,927    |        |   | 3,898,860    |   |                 | 3   | %      |  | 2,664,230    |  |              | 7,319,683  |   |  | 11  | % |  | (1,750,303 | )
|Soybean series     |  |                 | 2,096,727  |        |   | 3,604,251    |   |                 | 3   | %      |  | 1,781,052    |  |              | 3,065,612  |   |  | 4   | % |  | 315,675    |  
|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|Total              |  |                 | 24,124,439 |        |   | 106,989,433  |   |                 | 85  | %      |  | 14,765,890   |  |              | 59,451,261 |   |  | 85  | % |  | 9,358,549  |  
|Others*            |  |                 | 5,000,857  |        |   | 18,546,443   |   |                 | 15  | %      |  | 2,582,741    |  |              | 10,372,650 |   |  | 15  | % |  | 2,418,116  |  
|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|                   |  |                 | 29,125,296 |        |   | 125,535,876  |   |                 | 100 | %      |  | 17,348,631   |  |              | 69,823,911 |   |  | 100 | % |  | 11,776,665 |  
|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|Less:              |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|Slotting Fees      |  |                 |            |        |   | (2,736,685   | ) |                 |     |        |  |              |  |              | (1,800,008 | ) |  |     |   |  |            |  
|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  
|                   |  |                 | 29,125,296 |        | $ | 122,799,191  |   |                 |     |        |  | 17,348,631   |  | $            | 68,023,903 |   |  |     |   |  | 11,776,665 |  
|                   |  |                 |            |        |   |              |   |                 |     |        |  |              |  |              |            |   |  |     |   |  |            |  

* Other products included
(1) butter, (2) non-fat milk powder, (3) milk powder for the middle-aged, (4)
milk powder for the elderly, (5) light milk powder, (6) walnut powder, and (7)
raw infant milk powder products produced under private labels for, and pursuant
to formulas specified by, original equipment manufacturers.

Product Distribution

Currently,
FeiHes products are sold in stores nationwide in China except in Hong Kong
SAR, Macau SAR and Taiwan. The company has a distribution team working out of
its headquarters and coordinating a network of over 300 dealers or
representatives in key provinces across China. The dealers, in turn, each hire
one or two secondary agents who assist in the distribution process, including
inventory management, product sales and service and payments. Dealer agents
display and sell our products in specially designated areas in stores.

Generally,
product is delivered only after receipt of payment from the dealer. Dealers
have new agreements each year which specify sales targets and territories among
other provisions. We seek to expand the number of key provinces served by our
dealer network as part of our growth strategy and ultimately to establish a
distribution system based upon local production at local dairies. American
Dairy distributed its products to over 25 provinces in China during 2006.

Customers

No customers
of American Dairy equaled or exceeded 10% of its sales during the years ended
December 31, 2006, 2005 or 2004, except that one customer, Heilongjiang
Changxin Dairy, represented approximately 15% of sales during 2005.

Research and Development

American Dairy
has six technicians engaged in research and development activities. These
technicians monitor quality control at the milk processing plants of American
Dairy to ensure that the processing, packaging and distribution of the milk
products result in high quality premium milk products that are safe and healthy
for its customers. These technicians also pursue methods and techniques to
improve the taste and quality of its milk products and to evaluate new milk
products for further production based upon changes in consumer tastes, trends
and the introduction of competitive products by other milk producers.

During each of
the fiscal years ended December 31, 2004, 2005 and 2006, we spent less than
$10,000 per year on research and development and all of such amount was paid in
compensation to our six quality control technicians described above.

Growth Strategy

Our research indicates that the market for dairy
products in China is growing rapidly partly due to changing consumer tastes,
government promotion and better production and distribution methods. According
to a July 2006 report published by Access Asia, Dairy
products are now one of the fastest growing sectors of the market in China. The
report goes on to discuss changing consumer tastes in China from a general avoidance
of milk and dairy products due to lactose intolerance and poor production methods
to

7

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acceptance and increasing demand for them. Also in July 2006, an unrelated
report by the International Marketing Program for Agricultural Commodities
& Trade at Washington State University titled Chinas Dairy Industry
Poised for Growth , cites a rapid rise in income, changes in urban
lifestyles, promotion of the dairy industry by the government and improved
marketing channels as factors contributing to the growth of dairy consumption
in China. This report goes on to indicate that although analysts disagree about
the extent of continued growth, it is expected to continue. Moreover, the
report indicates that Chinas imports of milk products will decline as a
percentage of overall consumption as China meets its growing demand through
domestic production. We believe that our dairy business must grow to meet the
demand for milk in China, and to increase our market share, particularly by
expanding our milk powder production and distribution system.

Our growth
strategy involves capturing as much of this market as possible while it is in
this rapid growth phase. This includes plans to acquire additional grazing
rights and collection stations to secure our supply of raw milk and to acquire
or construct additional processing and distribution facilities. We believe that
our milk powder products enjoy a reputation for high quality among those
familiar with them. We believe that this reputation has spread principally by
word-of-mouth and also as a result of favorable press coverage. We have also
increased our marketing efforts through national television. Pursuant to our
marketing plan, we will seek to build upon our products reputation and create
strong brand identities, making our products more widely recognizable.

We will seek
to extend the distribution of our products to contiguous markets with high
population concentrations. If we can successfully implement our growth
strategy, we will also seek to enter other markets through joint ventures,
licensing or other arrangements with local dairy farms which we believe would
benefit significantly from selling their raw milk to newly established local
dairies that will produce and sell American Dairy brand milk powder products
and soybean products in their local markets. The key elements of American
Dairys growth strategy to reach its goal, include:

* emphasizing
local production and distribution of our products, beginning with purchasing
raw milk from local farmers, resulting in premium quality milk powder products;
and

* increasing
regional and national television advertising to better establish the Feihe
brand name and increase the scope of our market area.

Brand Development and Marketing

American
Dairys marketing will emphasize the local production and national distribution
of our products, which begins with local dairy herds and results in premium
quality products to a national market. We believe that American Dairys story
adds legitimacy to our marketing claim that we produce farm fresh products and
helps to instill confidence in consumers as to the purity and wholesomeness of
our products.

We also seek
to convey this story through the packaging we use for our products. Our
products have also received marketing benefits from a considerable volume of
favorable press and other publications of mass circulation which has rated our
products highly.

American
Dairys marketing and promotional efforts will continue to include:

|  |                                                                                                                         
|- | ------------------------------------------------------------------------------------------------------------------------
|* | Redesigning
  packaging of non-fluid products to promote a premium quality image.                                       
|  |                                                                                                                         
|* | Refining and
  targeting our message, which to date has largely been the product of
  word-of-mouth and product reviews.
|  |                                                                                                                         
|* | Developing
  trade material, including four-color trade sell sheets and brochures.                                      
|  |                                                                                                                         
|* | Further
  distinguishing our products from other dairy products.                                                        
|  |                                                                                                                         
|* | Expanding
  retail advertising, including print advertising, televised advertising and
  focused public relations.      

American Dairy
incurred advertising costs of $12,392,655 during fiscal 2006, $3,380,218 during
fiscal 2005, and incurred advertising costs of $2,742,257 during fiscal 2004.

Competition

The food and
beverage business is highly competitive and, therefore, American Dairy faces
substantial competition in connection with the marketing and sale of our milk
powder products and soybean products. Our products are positioned as premium
products and, accordingly, are generally priced higher than certain similar
competitive products. We believe that the principal competitive factors in
marketing our products are quality, taste, freshness, price and product
recognition. While we believe that we compete favorably in terms of quality,
taste and freshness, our products are more expensive and less well known than
certain other established brands. Our premium products may also be considered
in competition with non-premium quality dairy products for discretionary food
dollars.

8

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Government Regulation

American Dairy
is regulated under national and county laws in China. The following information
summarizes certain aspects of those regulations applicable to American Dairy
and is qualified in its entirety by reference to all particular statutory or
regulatory provisions.

Regulations at
the national, province and county levels are subject to change. To date,
compliance with governmental regulations has not had a material impact on
American Dairys level of capital expenditures, earnings or competitive
position, but, because of the evolving nature of such regulations, management
is unable to predict the impact such regulation may have in the foreseeable
future.

As a
manufacturer and distributor of food products, American Dairy is subject to
regulations of Chinas Agricultural Ministry. This regulatory scheme governs
the manufacture (including composition and ingredients), labeling, packaging
and safety of food. It also regulates manufacturing practices, including
quality assurance programs, for foods through its current good manufacturing
practices regulations, and specifies the standards of identity for certain foods,
including the products sold by American Dairy, and prescribes the format and
content of many of the products sold by American Dairy, prescribes the format
and content of certain nutritional information required to appear on food
products labels and approves and regulates claims of health benefits of food
products.

In addition,
Chinas Agricultural Ministry authorizes regulatory activity necessary to
prevent the introduction, transmission or spread of communicable diseases.
These regulations require, for example, pasteurization of milk and milk
products. American Dairy and its products are also subject to province and
county regulations through such measures as the licensing of dairy
manufacturing facilities, enforcement of standards for its products, inspection
of its facilities and regulation of its trade practices in connection with the
sale of dairy products.

Employees

As of December
31, 2006, we have approximately 10,000 employees on our payroll. Of these,
eight are group administrators, approximately 8,250 are in marketing,
approximately 24 provide marketing support, approximately 82 work in our
Nutrition Department as consultants and managers, approximately 18 perform
administrative functions, including financing, auditing and human resources and
approximately 750 are in production, storage and distribution.

9

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Item 1A. Risk Factors.

General

We expect to incur costs related to our
planned expansion and growth into new plants and ventures which may not prove
to be profitable. Moreover, any delays in our expansion plans could cause our
profits to decline and jeopardize our business. We
anticipate that our proposed expansion of our milk processing plants may
include the construction of new or additional facilities. American Dairys cost
estimates and projected completion dates for construction of new production
facilities may change significantly as the projects progress. In addition,
American Dairys projects will entail significant construction risks, including
shortages of materials or skilled labor, unforeseen environmental or
engineering problems, weather interferences and unanticipated cost increases,
any of which could have a material adverse effect on the projects and could
delay their scheduled openings. A delay in scheduled openings will delay
American Dairys receipt of increased sales revenues, which, when coupled with
the increased costs and expenses of our expansion, could cause a decline in our
profits.

Our plans to
finance, develop, and expand American Dairys milk processing facilities will
be subject to the many risks inherent in the rapid expansion of a high growth
business enterprise, including unanticipated design, construction, regulatory
and operating problems, and the significant risks commonly associated with
implementing a marketing strategy in changing and expanding markets. These
projects may not become operational within their estimated time frames and
budgets as projected at the time American Dairy enters into a particular
agreement, or at all. In addition, American Dairy may develop projects as joint
ventures in an effort to reduce its financial commitment to individual
projects. The significant expenditures required to expand our milk processing
plants may not ultimately result in increased profits.

When our
future expansion projects become operational, American Dairy will be required
to add and train personnel, expand our management information systems and
control expenses. If we do not successfully address American Dairys increased
management needs or are otherwise unable to manage our growth effectively,
American Dairys operating results could be materially and adversely affected.

Our products may not achieve market
acceptance. We are currently selling our products
principally in northern China. Achieving market acceptance for American Dairys
products, particularly in new markets, will require substantial marketing
efforts and the expenditure of significant funds. There is substantial risk
that any new markets may not accept or be as receptive to our products. Market acceptance
of our current and proposed products will depend, in large part, upon our
ability to inform potential customers that the distinctive characteristics of
our products make them superior to competitive products and justify their
pricing. Our current and proposed products may not be accepted by consumers or
able to compete effectively against other premium or non-premium dairy
products. Lack of market acceptance would limit our revenues and profitability.

Changing consumer preferences make demand for
our products unpredictable. American Dairy is subject
to changing consumer preferences and nutritional and health-related concerns.
Our business could be affected by certain consumer concerns about dairy
products, such as the fat, cholesterol, calorie, sodium and lactose content or
contamination of such products. A significant percentage of customers in China
are lactose intolerant, and may therefore prefer other beverages. American
Dairy could become subject to increased competition from companies whose products
or marketing strategies address these consumer concerns more effectively.

Adverse
medical research relating to milk and demand for milk could decrease the demand
for our products. Periodically, medical and other studies are released and
announcements by medical and other groups are made which raise concerns over
the healthfulness of cows milk in the human diet. A study may be published or
an announcement made concerning the healthfulness of cows milk which may
result in a decrease in demand for dairy products in China.

Our planned growth may require more raw milk
than is available and could diminish the quality of our dairy products.
The supply of raw milk may be insufficient to meet demand which would limit our
growth. Moreover, as we attempt to implement our growth strategy, it may become
difficult to maintain current levels of quality control. Thus, concerns over
quality control could also limit our growth. The raw milk used in our products
is supplied to American Dairy by numerous local farms under output contracts.
We believe that our farmers can increase their

10

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production of
raw milk. We further believe, however, that this supply may not be sufficient
to meet increased demand for our products associated with our proposed
marketing efforts and that such increase may compromise quality. Though we
believe that additional raw milk is available locally, if needed, we may not be
able to enter into arrangements with the producers of such milk on terms
acceptable to American Dairy, if at all. An inadequate supply of raw milk,
coupled with concern over quality control, could limit our ability to grow,
cause our earnings to decline and make our business less profitable.

Possible volatility of raw milk costs makes
our operating results difficult to predict, and a steep cost increase could
cause our profits to diminish significantly. The
current policy of China since the mid-1990s has focused on moving the industry
in a more market-oriented direction. These reforms have resulted in the
potential for greater price volatility relative to past periods, as prices are
more responsive to the fundamental supply and demand aspects of the market.
These changes in Chinas dairy policy could increase the risk of price
volatility in the dairy industry, making our net income difficult to predict.
Also, if prices are allowed to escalate sharply, our costs will rise which will
lead to a decrease in profits.

The loss of any of our key executives could
cause an interruption of our business and an increase in our expenses if we are
forced to recruit a replacement; we have no key-man life insurance covering
these executives. American Dairy is highly dependent
on the services of Leng You-Bin and Liu Hua, and the loss of their services
would have a material adverse impact on our operations. These individuals have
been primarily responsible for the development of American Dairy and the
development and marketing of our products. American Dairy has not applied for
key-man life insurance on the lives of these executives but may do so in the
future.

The milk business is highly competitive and,
therefore, we face substantial competition in connection with the marketing and
sale of our products. In general, milk products are
price sensitive and affected by many factors beyond our control, including
changes in consumer tastes, fluctuating commodity prices and changes in supply
due to weather, production, feed costs and natural disasters. Our products
compete with other premium quality dairy brands as well as less expensive,
non-premium brands. American Dairys milk faces competition from non-premium
milk producers distributing milk in our marketing area and other milk producers
packaging their milk in glass bottles and other special packaging which serve
portions of our marketing area. Most of our competitors are well established,
have greater financial, marketing, personnel and other resources, have been in
business for longer periods of time than American Dairy, and have products that
have gained wide customer acceptance in the marketplace. The largest
competitors of American Dairy are state-owned dairies owned by the government
of China. Large foreign milk companies have also entered the milk industry in
China. The greater financial resources of such competitors will permit them to
procure retail store shelf space and to implement extensive marketing and
promotional programs, both generally and in direct response to advertising
claims by American Dairy. The milk industry is also characterized by the
frequent introduction of new products, accompanied by substantial promotional
campaigns. We may be unable to compete successfully or our competitors may
develop products which have superior qualities or gain wider market acceptance
than ours.

If we were unable to obtain extensions on our existing credit facilities, we
would be required to utilize capital earmarked for our expansion strategy to
pay down the outstanding amounts on these lines. We have three credit facilities with the
Construction Bank of China which are scheduled to mature in the next three
months. We currently have an aggregate outstanding balance on these credit
facilities in excess of ¥ 15 million RMB (approximately $1,894,000 USD). All
principal amounts are due on maturity, and no payment schedules apply. We may
not receive extensions on the loans. If we do not receive such extensions, the
bank will have the right to demand payment of the amounts outstanding. In such
a case, we would be required to utilize funds presently earmarked for our
expansion plan to make such payment.

Lack of property and general liability
insurance expose American Dairy to the risk of loss of our property as well as
liability risks in the event of litigation against our company.
American Dairy and its subsidiaries do not carry any property insurance,
general liability insurance, or any other insurance that covers the risks of
our business operations. As a result, any material loss or damage to our
properties or other assets could lead to an increase in costs to replace or
repair lost or damaged property and, possibly, a decline in revenues from lost
use of the lost or damaged property. Also, personal injuries arising from our
business operations, could significantly increase our costs for attorneys fees
as well as the payment of any damages arising out of the litigation. Any of the
above would cause lost profits.

Our lack of insurance also constitutes a breach of covenants requiring such
insurance in our long-term financing agreements and could impede our ability to
obtain future financing. We
are in violation of certain loan covenants which require insurance coverage.
Under the provisions of our financing agreements, we are considered to be in
default of these covenants, and all debt under the relevant financing
agreements may be due upon demand. As of December 31, 2006, our long-term debt
obligations were $16,936,654 in the aggregate (net of current portion). If
these lenders demand repayment we would have to utilize funds currently
earmarked for expansion and acquisitions programs to repay these loans. This
risk, coupled with our lack of insurance in general, could impede our ability
to obtain future funding.

11

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As we increase the scale of our operations, we may be unable to maintain the
level of quality we currently attain by producing our products in small
batches. Our products are manufactured in small batches with milk
from the farms of local farmers. We may be unable to maintain the quality of
our dairy products at increased levels of production. Increased production
levels may cause American Dairy to modify its current manufacturing methods and
will necessitate the use of milk from other additional sources. A decline in
the quality of our products could damage American Dairys business, operations
and finances.

We face the potential risk of product
liability associated with food products. American
Dairy faces the risk of liability in connection with the sale and consumption
of milk products and soybean products should the consumption of such products
cause injury, illness or death. Such risks may be particularly great in a
company undergoing rapid and significant growth. American Dairy currently
maintains no product liability insurance. Any insurance which we may obtain in
the future may be insufficient to cover potential claims or the level of
insurance coverage needed may be unavailable at a reasonable cost. A partially
or completely uninsured successful claim against American Dairy would drive up
our costs to defend such claim or pay damages and could cause reputational
damage which would hurt our revenues. Either of these results would in turn
reduce our profitability.

Doing business in China involves various
risks including internal and international political risks, evolving national
economic policies as well as financial accounting standards, expropriation and
the potential for a reversal in economic conditions.
Since the late 1970s, the government of the PRC has been reforming the Chinese
economic system. These reforms have resulted in significant economic growth and
social progress. These policies and measures may from time to time be modified
or revised. Adverse changes in economic policies of the Chinese government or
in the laws and regulations, if any, could have a material adverse effect on
the overall economic growth of China, and could adversely affect our business
operations.

Extensive regulation of the food processing
and distribution industry in China could increase our expenses resulting in
reduced profits. American Dairy is subject to
extensive regulation by Chinas Agricultural Ministry, and by other county and
local authorities in jurisdictions in which its products are processed or sold,
regarding the processing, packaging, storage, distribution and labeling of our
products. Applicable laws and regulations governing our products may include
nutritional labeling and serving size requirements. Our processing facilities
and products are subject to periodic inspection by national, county and local
authorities. We believe that we are currently in substantial compliance with
all material governmental laws and regulations and maintain all material
permits and licenses relating to our operations. Nevertheless, we may fall out
of substantial compliance with current laws and regulations or may be unable to
comply with any future laws and regulations. To the extent that new regulations
are adopted, American Dairy will be required to conform its activities in order
to comply with such regulations. Our failure to comply with applicable laws and
regulations could subject American Dairy to civil remedies, including fines,
injunctions, recalls or seizures, as well as potential criminal sanctions,
which could have a material adverse effect on our business, operations and
finances.

The Chinese currency, Renminbi, is not a
freely convertible currency, which could limit our ability to obtain sufficient
foreign currency to support our business operations in the future.
We rely on the Chinese governments foreign currency conversion policies, which
may change at any time, in regard to our currency exchange needs. We receive
substantially all of our revenues in Renminbi, which is not freely convertible
into other foreign currencies. In China, the government has control over
Renminbi reserves through, among other things, direct regulation of the
conversion of Renminbi into other foreign currencies and restrictions on
foreign imports. Although foreign currencies which are required for current
account transactions can be bought freely at authorized Chinese banks, the
proper procedural requirements prescribed by Chinese law must be met. At the
same time, Chinese companies are also required to sell their foreign exchange
earnings to authorized Chinese banks and the purchase of foreign currencies for
capital account transactions still requires prior approval of the Chinese
government. This type of heavy regulation by the Chinese government of foreign
currency exchange restricts certain of our business operations and a change in
any of these government policies, or any other, could further negatively impact
our operations which could result in a loss of profits.

Fluctuations in the exchange rate between the
Chinese currency and the United States dollar could adversely affect our
operating results. The functional currency of our
operations in China is Renminbi. However, results of our operations are
translated at average exchange rates into United States dollars for purposes of
reporting results. As a result, fluctuations in exchange rates may adversely
affect our expenses and results of operations as well as the value of our
assets and liabilities. Fluctuations may adversely affect the comparability of
period-to-period results. Although we may use hedging techniques in the future
(which we currently do not use), we may not be able to eliminate the effects of
currency fluctuations. Thus, exchange rate fluctuations could cause our
profits, and therefore our stock prices, to decline.

12

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In order for
our China subsidiaries to pay dividends to American Dairy, a conversion of
Renminbi into US dollars is required which, if we were not allowed to do by the
Chinese government, would cause an interruption in our operating cash flow.
Under current Chinese law, the conversion of Renminbi into foreign currency
generally requires government consent. Government authorities may impose
restrictions that could have a negative impact in the future on the conversion
process and upon the ability of American Dairy to meet its cash needs and to
pay dividends to its shareholders. Although, our subsidiaries classification
as wholly-owned foreign enterprises (WOFEs) under Chinese law permits them to
declare dividends and repatriate their funds to American Dairy in the United
States, any change in this status or the regulations permitting such
repatriation could prevent them from doing so. Any inability to repatriate
funds to American Dairy would in turn prevent payments of dividends to our
shareholders.

Dividends paid to American Dairy, as the U.S.
parent company, would be subject to U.S. corporate income tax.
American Dairy has not accrued any tax liability associated with the possible
payment of dividends to the U.S. parent company. Such a tax would be an added
expense appearing on our balance sheet which would reduce our net income.

Lack of bank deposit insurance puts our funds
at risk of loss from bank foreclosures or insolvencies.
American Dairy maintains certain bank accounts in China that are not insured
and are not protected by FDIC insurance or other insurance. As of December 31,
2006, American Dairy held $37,126,918 in bank accounts in China. If a Chinese
bank holding our funds experienced insolvency, it may not permit us to withdraw
our funds which would result in a loss of such funds and reduction of our net
assets.

Limited and uncertain trademark protection in
China makes the ownership and use of our trademark uncertain.
American Dairy has obtained trademark registrations for the use of our
tradename Feihe, which has been registered with the Trademark Bureau of the
State Administration for Industry and Commerce with respect to our milk
products. We believe our trademark is important to the establishment of
consumer recognition of our products. However, due to uncertainties in Chinese
trademark law, the protection afforded by our trademark may be less than we
currently expect and may, in fact, be insufficient. Moreover even if it is
sufficient, in the event it is challenged or infringed, we may not have the
financial resources to defend it against any challenge or infringement and such
defense could in any event be unsuccessful. Moreover, any events or conditions
that negatively impact our trademark could have a material adverse effect on
our business, operations and finances.

Our lack of patent protection could permit
our competitors to copy our trade secrets and formulae and thus gain a
competitive advantage. American Dairy has no patents
covering our products or production processes, and we expect to rely
principally on know-how and the confidentiality of our formulae and production
processes for our products and our flavoring formulae in producing competitive
product lines. Any breach of confidentiality by our executives or employees
having access to our formulae could result in our competitors gaining access to
such formulae. The ensuing competitive disadvantage could reduce our revenues
and our profits.

FORWARD-LOOKING STATEMENTS

This Annual
Report on Form 10-K contains forward-looking statements that involve
substantial risks and uncertainties. You can identify these statements by
forward-looking words such as may, expect, plans, intends,
anticipate, believe, estimate and continue or similar words and are
intended to identify forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. You should read statements that contain these words carefully
because they discuss our future expectations, contain projections of our future
results of operations or of our financial condition or state other forward-looking
information. American Dairy believes that it is important to communicate our
future expectations to our investors. However, there may be events in the
future that American Dairy is not able to accurately predict or control. The
factors listed above in the section captioned Risk Factors, as well as any
cautionary language in this Annual Report on Form 10-K, provide examples of
risks, uncertainties and events that may cause American Dairys actual results
to differ materially from the expectations American Dairy describes in our
forward-looking statements. Before you invest in the common stock, you should
be aware that the occurrence of the events described as risk factors and
elsewhere in this Annual Report on Form 10-K could have a material adverse
effect on our business, operating results and financial condition.

13

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Item 1B. Unresolved Staff Comments.

Not applicable.

14

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Item 2. Properties

The principal
executives of American Dairy are located at C-16 Shin Chen International
Building, No. 10, Jui-shen Road. Zho Yan Chu, Beijing, The Peoples Republic of
China. The building was acquired during 2003 at a purchase price of $1,200,861.

American Dairy
presently operates milk powder processing plants and also rice, soy beans and
walnut processing facilities, and various warehouses in northern China, known
as Feihe Dairy, Sanhao Dairy and BaiQuan Dairy.

In December
2005, American completed the construction of a new walnut powder production
plant in Shenyang in northeast China and a new milk powder production facility
in Kedong County, Heilongjiang Province.

During 2005,
American Dairy also acquired from Nutricia Nutritionals Co., Ltd. of
Heilongjiang of the land use rights and buildings of its Numico milk powder
plant in Heilongjiang Province in the PRC and all of its milk powder processing
equipment located at the plant. American Dairy also acquired approximately 19
milk collection stations for the collection of raw milk to supply the
processing plant.

In January
2006, American Dairy entered into an agreement with the government of Gannan
County in Heilongjiang Province, PRC, to build a new milk processing plant. The
first phase of the plant was completed in December 2006. The plant is situated
on approximately 300,000 square meters of land. In connection with its
agreement to construct the plant, the government also agreed to subsidize local
farmers for the initial costs of acquiring up to 200,000 milk cows to increase
the local production of milk.

In 2006,
American Dairy also substantially completed phase one of its Langfang Flying
Crane construction project which is expected to be one of Chinas biggest milk
powder packaging plants. This project is also being constructed in two phases.
As planned, the facility will have an initial production rate of 35,000 tons of
milk powder in tin containers. The facilities are expected to be ready to begin
packaging operations in 2007. The facility has workshops, storehouses and
equipment which will allow for expansion. We believe that production at the
plant can grow to at least 50,000 tons following completion of phase two.

There is no
private ownership of land in the PRC; all land ownership is held by the
government of the PRC, its agencies and collectives. Land use rights are
obtained from the government for period ranging from 50 to 70 years, and are
typically renewable. Land use rights can be transferred upon approval by the
land administrative authorities of the PRC (State Land Administration Bureau)
upon payment of the required land transfer fee.

Item 3. Legal Proceedings

From time to
time, American Dairy may become involved in various claims and lawsuits
incidental to its business. There are presently no material legal proceedings
pending or threatened against American Dairy.

American Dairy
is not a party to any material litigation, and there are no material
outstanding claims against American Dairy or its assets.

15

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

American Dairy
held its 2006 annual meeting of stockholders on December 28, 2006. At this
meeting, the stockholders elected James Lewis and re-elected Leng You-Bin, Liu
Hua, Kevin Likeng Tseng, Tracy Lee/Lee Hui Lan and Kirk G. Downing to serve as
directors of the company.

Shares were
voted at the meeting as follows:

|                        |  |              |            |          |  |                |           |  |  |      | 
|----------------------- |  | ------------ | ---------- | -------- |  | -------------- | --------- |  |  | ---- | 
|                        |  | Shares Voted |            |          | 
|Directors               |  | For Director |            | Withheld |  | Percentage For |          
|                        |  |              |            |          |  |                |          
|                        |  |              |            |          |  |                |           |  |  |      | 
|Leng You-Bin            |  |              | 12,620,388 |          |  |                | 79,572    |  |  | 99.4 | 
|                        |  |              |            |          |  |                |           |  |  |      | 
|Liu Hua                 |  |              | 12,620,388 |          |  |                | 79,572    |  |  | 99.4 | 
|                        |  |              |            |          |  |                |           |  |  |      | 
|Kevin Likeng
  Tseng    |  |              | 3,636,757  |          |  |                | 9,055,453 |  |  | 28.7 | 
|                        |  |              |            |          |  |                |           |  |  |      | 
|Tracy
  Lee/Lee Hui Lan |  |              | 12,522,327 |          |  |                | 177,633   |  |  | 98.6 | 
|                        |  |              |            |          |  |                |           |  |  |      | 
|Kirk Gordon
  Downing   |  |              | 12,697,965 |          |  |                | 1,995     |  |  | 99.9 | 
|                        |  |              |            |          |  |                |           |  |  |      | 
|James Lewis             |  |              | 12,697,965 |          |  |                | 1,995     |  |  | 99.9 | 

16

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PART II

Item 5. Market for Registrants Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

General

American Dairy
is authorized to issue 50,000,000 shares of Common Stock, $.001 par value per
share. At December 31, 2006, there were 15,831,820 shares of common stock
issued and outstanding that were held by approximately 600 stockholders of
record.

Common Stock

Holders of
common stock are entitled to one vote for each share held on all matters voted
upon by stockholders, including the election of directors. The holders of
common stock have no preemptive rights to purchase or subscribe for any stock
of American Dairy now or hereafter authorized or for securities convertible
into such stock. All of the outstanding shares of common stock are fully paid
and nonassessable. Upon any liquidation of American Dairy, the holders of
common stock are entitled to share ratably in assets available for distribution
to stockholders. Holders of common stock are entitled to receive dividends out
of assets legally available therefore at such times and in such amounts as the
Board of Directors may from time to time determine.

Shareholders
are not entitled to cumulative voting rights, and accordingly, the holders of a
majority of the voting power of the shares voting for the election of directors
can elect the entire class of directors to be elected each year if they choose
to do so and, in that event, the holders of the remaining shares will not be
able to elect any person as a director of such class.

Dividend Restrictions

American Dairy
has not declared or paid any dividends on its common stock and presently does
not expect to declare or pay any such dividends in the foreseeable future.
America Dairy has not yet formulated a future dividend policy in the event
restrictions on its ability to pay dividends are created. Payment of dividends
to our shareholders would require payment of dividends by our China
subsidiaries to American Dairy. This, in turn, would require a conversion of
Renminbi into US dollars and repatriation of funds to the US. Under current
Chinese law, the conversion of Renminbi into foreign currency generally
requires government consent. Government authorities may impose restrictions
that could have a negative impact in the future on the conversion process and
upon the ability of American Dairy to meet its cash needs, and to pay dividends
to its shareholders. Although, our subsidiaries classification as wholly -
owned foreign enterprises (WOFEs) under Chinese law permits them to declare
dividends and repatriate their funds to American Dairy in the United States,
any change in this status or the regulations permitting such repatriation could
prevent them from doing so. Any inability to repatriate funds to American Dairy
would in turn prevent payments of dividends to our shareholders.

Transfer Agent and Registrar

The transfer
agent and registrar for American Dairy is Interwest Transfer Company, 1981
Murray Holladay Road, Suite 100, Salt Lake City, Utah 84117-5148; telephone
(801) 272-9294.

Market for Common Stock


The following
table sets forth the range of high and low closing bid prices per share of the
Common Stock (former trading symbol ADIY) of American Dairy until April 18,
2005 (reflecting inter-dealer prices without retail mark-up, mark-down or
commission and may not represent actual transactions), and reflects closing
sale prices of the Common Stock of American Dairy on the NYSE Archipelago
Exchange (ArcaEx) (present trading symbol ADY) from April 18, 2005 through
December 31, 2006.

17

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|                                |  |                           |       |                       |   |       | 
|------------------------------- |  | ------------------------- | ----- | --------------------- | - | ----- | 
|                                |  | High Closing
  Bid Prices |       | Low ClosingBid Prices |  
|                                |  |                           |       |                       |  
|Year Ended
  December 31, 2004: |  |                           |       |                       |   |       | 
|1st Quarter                     |  | $                         | 2.00  |                       | $ | 2.00  | 
|2nd Quarter                     |  | $                         | 3.00  |                       | $ | 2.00  | 
|3rd Quarter                     |  | $                         | 3.90  |                       | $ | 2.50  | 
|4th Quarter                     |  | $                         | 5.02  |                       | $ | 3.30  | 
|                                |  |                           |       |                       |   |       | 
|                                |  |                           |       |                       |   |       | 
|Year Ended
  December 31, 2005: |  |                           |       |                       |   |       | 
|1st Quarter                     |  | $                         | 5.00  |                       | $ | 4.35  | 
|2nd Quarter
  (1)               |  | $                         | 6.90  |                       | $ | 5.35  | 
|3rd Quarter                     |  | $                         | 8.35  |                       | $ | 6.30  | 
|4th Quarter                     |  | $                         | 8.00  |                       | $ | 5.25  | 
|                                |  |                           |       |                       |   |       | 
|                                |  |                           |       |                       |   |       | 
|Year Ended
  December 31, 2006: |  |                           |       |                       |   |       | 
|1st Quarter                     |  | $                         | 18.10 |                       | $ | 6.65  | 
|2nd Quarter                     |  | $                         | 17.03 |                       | $ | 11.11 | 
|3rd Quarter                     |  | $                         | 13.95 |                       | $ | 11.95 | 
|4th Quarter                     |  | $                         | 20.90 |                       | $ | 13.55 | 
|                                |  |                           |       |                       |   |       | 

(1) On April
18, 2005, the Common Stock of American Dairy ceased trading on the NASD Electronic
Bulletin Board over-the-counter market (OTC-BB), and trading of its Common
Stock commenced on the NYSE Archipelago Exchange (ArcaEx).

Compensation Plan.
American Dairy has a 2003 Incentive Plan that authorizes the issuance of up to
3,000,000 shares of its Common Stock for stock options, SARs and stock bonuses
to its directors, officers, employees and consultants. As of December 31, 2006,
stock option and warrant awards have been made under the Plan as follows:

Performance Graph

The following
graph compares the annual cumulative total shareholder return on an investment
on December 31, 2001 of $100 in our common stock with the annual cumulative
total return on the same investment in the Russell 2000 Index and the Nasdaq
Composite for each of the last five fiscal years.

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL
RETURN

(LINE GRAPH)

Sale of Unregistered Securities.
During the three months ended December 31, 2006, American Dairy sold shares of
its restricted Common Stock that were not registered under the Securities Act
of 1933, as described below:


18

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On February 15, 2006, the
Company issued 4,500 restricted shares of its Common Stock to each of the
directors of the Company for their services to the Company as members of the
Board of Directors, specifically to Mr. Leng You-Bin, Liu Hua, Liu Sheng-Hui,
Hui Lan-Lee, Kevin Tseng, and Kirk Downing, in reliance upon Section 4(2) under
the 1933 Act.


On February 15, 2006, the
Company issued restricted shares of its Common Stock to consultants of the
Company for their services, specifically, Charles Hung, Jr. (5,000 shares),
Trang Chung Hung (5,000 shares), Matthew Wang (2,500 shares), Sun-Kaipan (2,500
shares), Liu Gang (5,000 shares), and Joanne Marie Hung (2,000 shares), in
reliance upon Section 4(2) under the 1933 Act.


During the
three months ended December 31, 2006, warrants to purchase 888,455 shares of
common stock of American Dairy were exercised for $1,416,788, in reliance upon
Section 4(2) under the Securities Act of 1933.

19

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ITEM 6. SELECTED FINANCIAL DATA

The following
table sets forth selected consolidated financial data of American Dairy for the
years ended December 31, 2006, 2005 and 2004. The data are derived from our
audited consolidated financial statements revised to reflect the
reclassification of certain items. The table should be read in conjunction with
Managements Discussion and Analysis of Financial Condition and Results of
Operations and our consolidated financial statements, including the notes,
appearing in elsewhere in this report.

|                                              |  |                            |             |                            |   |                            |  |   |            | 
|--------------------------------------------- |  | -------------------------- | ----------- | -------------------------- | - | -------------------------- |  | - | ---------- | 
|                                              |  | Year EndedDecember 31,2006 |             | Year EndedDecember 31,2005 |   | Year EndedDecember 31,2004 | 
|                                              |  |                            |             |                            |   |                            | 
|Revenues                                      |  | $                          | 122,799,000 |                            | $ | 68,024,000                 |  | $ | 37,416,000 | 
|Cost of
  goods sold                          |  | $                          | 70,221,000  |                            | $ | 38,716,000                 |  | $ | 18,007,000 | 
|Distribution
  expenses                       |  | $                          | 29,398,000  |                            | $ | 16,743,000                 |  | $ | 13,486,000 | 
|General and
  administrative                  |  | $                          | 5,219,000   |                            | $ | 2,483,000                  |  | $ | 1,313,000  | 
|Depreciation                                  |  | $                          | 266,000     |                            | $ | 161,000                    |  | $ | 55,000     | 
|Other income                                  |  | $                          | 3,410,000   |                            | $ | 2,221,000                  |  | $ | 1,489,000  | 
|Gain on
  disposal of assets                  |  | $                          |            |                            | $ | 9,000                      |  | $ | 1,000      | 
|Interest
  expense                            |  | $                          | 1,197,000   |                            | $ | 523,000                    |  | $ | 49,000     | 
|Net income                                    |  | $                          | 19,908,000  |                            | $ | 11,630,000                 |  | $ | 6,258,000  | 
|Other
  comprehensive income                  |  | $                          | 1,111,000   |                            | $ | 605,000                    |  | $ |           | 
|Total
  comprehensive income                  |  | $                          | 21,020,000  |                            | $ | 12,235,000                 |  | $ | 6,258,000  | 
|Basic net
  income per share                  |  | $                          | 1.35        |                            | $ | .83                        |  | $ | .52        | 
|Weighted
  average basic shares outstanding   |  |                            | 14,756,000  |                            |   | 13,931,000                 |  |   | 12,077,000 | 
|Diluted net
  income per common share         |  | $                          | 1.14        |                            | $ | .74                        |  | $ | .47        | 
|Weighted
  average diluted shares outstanding |  |                            | 18,056,000  |                            |   | 16,057,000                 |  |   | 13,456,000 | 

Summarized unaudited quarterly financial data
for 2006 and 2005 are as follows:

|                               |  |                  |            |                 |   |                      |   |                     |            |                    |   |            |   |   |             |  
|------------------------------ |  | ---------------- | ---------- | --------------- | - | -------------------- | - | ------------------- | ---------- | ------------------ | - | ---------- | - | - | ----------- | -
|                               |  | March 31,
  2006 |            | June 30,
  2006 |   | September 30,
  2006 |   | December 31,
  2006 |            | Fiscal Year
  2006 |  
|                               |  |                  |            |                 |   |                      |   |                     |            |                    |  
|Total revenues                 |  | $                | 25,893,000 |                 | $ | 26,110,028           |   | $                   | 32,611,627 |                    | $ | 38,184,536 |   | $ | 122,799,191 |  
|Gross profit                   |  | $                | 11,908,000 |                 | $ | 9,997,007            |   | $                   | 15,236,726 |                    | $ | 15,456,435 |   | $ | 52,578,168  |  
|Gross Margin:                  |  |                  | 46         | %               |   | 38                   | % |                     | 47         | %                  |   | 40         | % |   | 43          | %
|Net income                     |  | $                | 4,764,000  |                 | $ | 5,261,967            |   | $                   | 5,528,239  |                    | $ | 4,354,075  |   | $ | 19,908,281  |  
|Net earnings per common share: |  |                  |            |                 |   |                      |   |                     |            |                    |   |            |   |   |             |  
|Basic                          |  | $                | 0.34       |                 | $ | 0.36                 |   | $                   | 0.37       |                    | $ | 0.28       |   | $ | 1.35        |  
|Diluted                        |  | $                | 0.29       |                 | $ | 0.31                 |   | $                   | 0.32       |                    | $ | 0.22       |   | $ | 1.14        |  

|                               |  |                  |            |                 |   |                      |   |                     |            |                    |   |            |   |   |            |  
|------------------------------ |  | ---------------- | ---------- | --------------- | - | -------------------- | - | ------------------- | ---------- | ------------------ | - | ---------- | - | - | ---------- | -
|                               |  | March 31,
  2005 |            | June 30,
  2005 |   | September 30,
  2005 |   | December 31,
  2005 |            | Fiscal Year
  2005 |  
|                               |  |                  |            |                 |   |                      |   |                     |            |                    |  
|Total revenues                 |  | $                | 13,560,731 |                 | $ | 14,589,807           |   | $                   | 14,273,618 |                    | $ | 25,599,747 |   | $ | 68,023,903 |  
|Gross profit                   |  | $                | 6,263,478  |                 | $ | 6,996,110            |   | $                   | 6,744,356  |                    | $ | 9,304,064  |   | $ | 29,308,008 |  
|Net income                     |  | $                | 2,632,757  |                 | $ | 2,823,250            |   | $                   | 2,178,699  |                    | $ | 3,994,723  |   | $ | 11,629,429 |  
|Gross Margin:                  |  |                  | 46         | %               |   | 48                   | % |                     | 47         | %                  |   | 36         | % |   | 43         | %
|                               |  |                  |            |                 |   |                      |   |                     |            |                    |   |            |   |   |            |  
|Net earnings per common share: |  |                  |            |                 |   |                      |   |                     |            |                    |   |            |   |   |            |  
|Basic                          |  | $                | 0.19       |                 | $ | 0.21                 |   | $                   | 0.16       |                    | $ | 0.27       |   | $ | 0.83       |  
|Diluted                        |  | $                | 0.17       |                 | $ | 0.18                 |   | $                   | 0.14       |                    | $ | 0.25       |   | $ | 0.74       |  

* Effective
July 1, 2005 slotting fees paid by American Dairy previously reported as
expenses have been reclassified as a reduction of revenues. The above schedule
reflects a reclassifying entry for prior periods to conform to this
presentation.

20

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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Effective May
7, 2003, American Dairy completed the acquisition of 100% of the issued and
outstanding capital stock of American Flying Crane Corporation (formerly called
American Dairy Holdings, Inc.), a Delaware corporation. As a result, AFC become
a wholly-owned subsidiary of American Dairy. For financial reporting purposes,
this transaction was treated as a recapitalization of American Flying Crane and
the historical figures prior to May 7, 2003 represent the activities of
American Flying Crane.

Overview

The discussion
and analysis of our financial condition and results of operations is based upon
our consolidated financial statements which have been prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates including the allowance for doubtful
accounts, the salability and recoverability of inventory, income taxes and
contingencies. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances, the
results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.

We must make
estimates of the collectibility of accounts receivable. We analyze historical
write-offs, changes in our internal credit policies and customer concentrations
when evaluating the adequacy of our allowance for doubtful accounts.
Differences may result in the amount and timing of expenses for any period if
we make different judgments or use difference estimates. As part of the process
of preparing our consolidated financial statements, we are required to estimate
our income taxes. This process involves estimating our current tax exposure
together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income, and, to
the extent we believe that recovery is not likely, we must establish a
valuation allowance. To the extent that we establish a valuation allowance or
increase this allowance in a period, we must include a tax provision or reduce
our tax benefit in the statements of operations. We use our judgment to
determine our provision or benefit for income taxes, deferred tax assets and
liabilities and any valuation allowance recorded against our net deferred tax
assets. We believe, based on a number of factors including historical operating
losses, that we will not realize the future benefits of a significant portion
of our net deferred tax assets and we have accordingly provided a full
valuation allowance against our deferred tax assets. However, various factors
may cause those assumptions to change in the near term.

We cannot
predict what future laws and regulations might be passed that could have a
material effect on our results of operations. We assess the impact of
significant changes in laws and regulations on a regular basis and update the
assumptions and estimates used to prepare our financial statements when we deem
it necessary.

Plan of Operation

We perceive
that the dairy industry in China is experiencing rapid growth with demand
outpacing supply. We further believe that this growth presents a window of
opportunity for American Dairy to capture as much of this growing market as
possible while it is in this growth phase. We must increase output of our milk
products to meet this demand and capture market share. We must act quickly to
secure our supply of raw milk by acquiring additional milking rights and
collection stations and expand our production and distribution capacity to
handle the additional volume. This involves the acquisition or construction of
additional processing and distribution facilities and further increases in our
marketing efforts. It is important for American Dairys future that we
concentrate our current efforts on this expansion.

Our expansion
strategy will require the continued retention and investment of our earnings
from operations as well as additional funding from private debt and equity
financing. We currently have sufficient cash to fund our

21

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operations for
the next twelve months with bank credit facilities available to cover any
unforeseen shortfall. However, in order to effect our planned expansion, we
will require additional funding in the approximate amount of $76 million. Of
this amount, we plan to use approximately $16 million for the Lang Fang
Distribution Plant and approximately $40 million for the Feihe Gannan
Processing Plant (both of which are discussed in greater detail below). On
October 3, 2006, we closed an offering of $18.2 million of 7.75% Convertible
Notes the terms of which are discussed in greater detail under Liquidity and
Capital Resources. We have not yet determined exactly how much of our existing
cash we will utilize for our expansion strategy going forward, but we will
require a significant amount of additional external funding. Of the additional
funding, we anticipate that the majority of it will come from private investors
and that we will continue to renew our bank credit facilities for short-term
needs. (See Liquidity and Capital Resources.)

We anticipate
that the Feihe Gannan Processing Plant construction project will cost
approximately $40 million. The milk processing plant constructed by the project
is to be situated on 300,000 square meters of land with facilities occupying
60,000 square meters. The project is being carried out in two phases.
Construction on the first phase was completed in December 2006 with machinery
and equipment being installed in the first quarter of 2007. The total cost for
phase one is approximately $15 million. We have spent approximately $5 million
on the project for land, construction planning, design and logistical details,
waste removal systems, etc. Other costs include piping (hardware and
controllers), refrigeration systems, facilities which monitor cowshed hygiene
as well as related building materials, equipment and labor. Phase one focuses
on the infrastructure of the facilities and is set to begin its milk processing
operations by the end of 2007. After phase one is complete, the facility is
expected to be able to process at least 300 tons of fresh milk and will be
equipped to allow for the expansion of its operations.

The second
phase is scheduled to begin in 2008, and we plan to have it completed by the
end of 2009. Phase two will focus on the improvement and expansion of the
facility in order to increase production and lower costs. This phase is
expected to cost approximately $28 million.

The production
equipment is being manufactured and provided to us by a Germany-based company,
which is one of the worlds leading process engineering and equipment
manufacturers. Thus far, we have paid this company $2 million to begin production
of the milking equipment and other equipment including fillers, product tanks,
pasteurizers, and storage. The project costs also include acquiring supplies
and licenses, etc.

As planned,
the facility will be able to process at least 300 tons of fresh milk by the end
of the first phase in 2007, and will process at least 1,000 tons of fresh milk
by 2009. To date, we have used approximately $10 million of our existing cash
to fund the Gannan Processing Plant.

We believe
that once fully developed and operating, the Langfang Flying Crane Construction
Project (LFC) will be one of Chinas biggest milk powder packaging plants. As
planned, the facility will have an annual production rate of 35,000 tons of
milk powder in tin containers. Construction on the project is substantially
completed with equipment installed. The facilities are expected to be ready to
begin packaging operations in 2007 following testing of all equipment and
processes and licensing. The facility has workshops, storehouses and equipment which
will allow for expansion. The total cost is expected to be approximately $15
million. To date, approximately $5 million has been spent on construction and
the installation of the equipment.

We have
considered various options for obtaining the necessary financing to fund our
expansion strategy, including the possibility of a Rule 144A offering, among
others and have recently completed a placement of Convertible Notes in the aggregate
    principal amount of $60,000,000 pursuant to Regulation S under the Securities
    Act of 1933, as amended. Details of this placement are set forth below under
    Subsequent Development. At present, we are considering other possible
    sources of private debt and equity placements. We intend to use the proceeds
    of this funding and any other such placement for these projects. We cannot, however, be certain
    that our fundraising efforts will be successful or how much we will actually
    raise if any. Moreover, the proceeds raised in any private offering may be
    inadequate to cover any unforeseen costs associated with the construction
    of these facilities.

In addition to
construction of new facilities, we believe that acquisition of existing
facilities is a necessary part of our strategy as well. By the acquisition of
the Numico plant in late 2005, we were able to increase our processing capacity
from 450 tons to 720 tons without waiting for a new plant to be built.
Furthermore, in the Numico acquisition, not only did we immediately increase
our processing capacity, but we added collecting stations and

22

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more
grazing/milking rights. As we identify potential acquisition targets, we will
consider how best to fund their purchase which will likely take the form of
additional private debt or equity offerings.

Results of Operations

The following
table sets forth certain operating information regarding American Dairy,
including its subsidiaries.

|                                 |  |                            |             |      |   |            |  |   |            | 
|-------------------------------- |  | -------------------------- | ----------- | ---- | - | ---------- |  | - | ---------- | 
|                                 |  | Years ended
  December 31, |            
|                                 |  | 2006                       |             | 2005 |   | 2004       | 
|                                 |  |                            |             |      |   |            |  |   |            | 
|Sales                            |  | $                          | 122,799,000 |      | $ | 68,024,000 |  | $ | 37,416,000 | 
|Cost of good
  sold              |  | $                          | 70,221,000  |      | $ | 38,716,000 |  | $ | 18,007,000 | 
|Distribution
  expense           |  | $                          | 29,398,000  |      | $ | 16,743,000 |  | $ | 13,486,000 | 
|General and
  administrative     |  | $                          | 5,219,000   |      | $ | 2,483,000  |  | $ | 1,313,000  | 
|Depreciation                     |  | $                          | 266,000     |      | $ | 161,000    |  | $ | 55,000     | 
|Other income                     |  | $                          | 3,410,000   |      | $ | 2,221,000  |  | $ | 1,489,000  | 
|Gain on
  disposal of assets     |  |                            |            |      | $ | 9,000      |  | $ | 1,000      | 
|Interest
  expense               |  | $                          | 1,197,000   |      | $ | 523,000    |  | $ | 49,000     | 
|Minority
  interest              |  |                            |            |      |   | 2,000      |  |   |           | 
|Income tax
  (provision) benefit |  |                            |            |      |   |           |  |   | 262,000    | 
|Net Income                       |  | $                          | 19,908,000  |      | $ | 11,630,000 |  | $ | 6,258,000  | 

Comparison of Years Ended December 31, 2006
and 2005

Net Income.
Net income increased by approximately $8,278,000, or 71%, from approximately
$11,629,000 for 2005 to approximately $19,908,000 for 2006. This increase in
net income is attributable primarily to a 81% increase in sales and, to a
lesser extent, a 54% increase in other income, offset in part by (i) an 76%
increase in distribution expenses, (iii) an 110% increase in general and
administrative expenses, and (iv) a 129% increase in interest expense. Gross
profit margin remained constant at 43% in 2006 and 2005.

Sales. Sales
increased by approximately $54,775,000, or 81%, from approximately $68,024,000
in 2005 to approximately $122,799,000 in 2006. This increase was due primarily
to expanding market areas and adding new value added products.

23

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One component
of the increase, sales volume, is reflected in the following table which shows
sales volume in kilograms by product for 2006 as compared to 2005:


|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|-------------------- |  | ---------------- | ---------- | ------ | - | ------------- | - | ---------------- | --- | ------ |  | ------------- |  | ---------------- | ---------- | - |  | --- | - |  | ---------- | -
|                     |  | 2006             |            | 2005   |   |               |   |                 
|                     |  |                  |            |        |   |               |   |                 
|Product name         |  | Quantity 
  (Kg) |            | Amount |   | % of 
  sales |   | Quantity 
  (Kg) |     | Amount |  | % of 
  sales |  | Variance 
  (Kg) |           
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|CPP series           |  |                  | 7,467,289  |        | $ | 37,524,523    |   |                  | 30  | %      |  | 4,503,308     |  | $                | 24,700,822 |   |  | 35  | % |  | 2,963,981  |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|Nucleotides
  series |  |                  | 3,857,615  |        |   | 34,921,188    |   |                  | 28  | %      |  | 1,094,676     |  |                  | 11,017,136 |   |  | 16  | % |  | 2,762,939  |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|Ca+Zn series         |  |                  | 9,788,881  |        |   | 27,040,611    |   |                  | 21  | %      |  | 4,722,624     |  |                  | 13,348,008 |   |  | 19  | % |  | 5,066,257  |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|Rice cereal          |  |                  | 913,927    |        |   | 3,898,860     |   |                  | 3   | %      |  | 2,664,230     |  |                  | 7,319,683  |   |  | 11  | % |  | (1,750,303 | )
|Soybean
  series     |  |                  | 2,096,727  |        |   | 3,604,251     |   |                  | 3   | %      |  | 1,781,052     |  |                  | 3,065,612  |   |  | 4   | % |  | 315,675    |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|Total                |  |                  | 24,124,439 |        |   | 106,989,433   |   |                  | 85  | %      |  | 14,765,890    |  |                  | 59,451,261 |   |  | 85  | % |  | 9,358,549  |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|Others               |  |                  | 5,000,857  |        |   | 18,546,443    |   |                  | 15  | %      |  | 2,582,741     |  |                  | 10,372,650 |   |  | 15  | % |  | 2,418,116  |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|                    
|                     |  |                  | 29,125,296 |        |   | 125,535,876   |   |                  | 100 | %      |  | 17,348,631    |  |                  | 69,823,911 |   |  | 100 | % |  | 11,776,665 |  
|Less:                |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|Slotting
  Fees      |  |                  |            |        |   | (2,736,685    | ) |                  |     |        |  |               |  |                  | (1,800,008 | ) |  |     |   |  |            |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  
|                     |  |                  | 29,125,296 |        | $ | 122,799,191   |   |                  |     |        |  | 17,348,631    |  | $                | 68,023,903 |   |  |     |   |  | 11,776,665 |  
|                     |  |                  |            |        |   |               |   |                  |     |        |  |               |  |                  |            |   |  |     |   |  |            |  

(*) Other products included
(1) butter, (2) non-fat milk powder, (3) milk powder for the middle-aged, (4)
milk powder for the elderly, (5) light milk powder, (6) walnut powder, and (7)
raw infant milk powder products produced under private labels for, and pursuant
to formulas specified by, original equipment manufacturers.


The second
component is an increase in the average sales price per kilogram as
demonstrated in the table below:

|                                  |  |      |             |      |   |            | 
|--------------------------------- |  | ---- | ----------- | ---- | - | ---------- | 
|Statistics                        |  | 2006 |             | 2005 |  
|                                  |  |      |             |      |  
|Sales
  revenues                  |  | $    | 122,799,000 |      | $ | 68,024,000 | 
|                                  |  |      |             |      |   |            | 
|Total sales
  volume (kilograms)  |  |      | 29,125,000  |      |   | 17,211,000 | 
|                                  |  |      |             |      |   |            | 
|Average
  selling prices/kilogram |  | $    | 4.22        |      | $ | 3.92       | 
|                                  |  |      |             |      |   |            | 

The increase
in average sales price per kilogram, as reflected in the table, is relatively
small and is due primarily to the shift in product mix to higher end products
rather than an increase in the sales price of individual products. Prices per
kilogram actually declined in the three most significant product lines as
demonstrated in the following table which reflects the average sales price per
kilogram by product for 2006 and 2005 and the percentage change in the sales
price per kilogram.

|                     |  |                              |      |            |   |        |  |       |    | 
|-------------------- |  | ---------------------------- | ---- | ---------- | - | ------ |  | ----- | -- | 
|                     |  | Average Price Per
  Kilogram |      | Percentage |  
|Product              |  | 2006                         |      | 2005       |   | Change | 
|                     |  |                              |      |            |   |        | 
|CPP series           |  | $                            | 5.03 |            | $ | 5.49   |  | (8.4  | )% | 
|Nucleotides
  series |  | $                            | 9.05 |            | $ | 10.06  |  | (10.0 | )% | 
|Ca+Zn series         |  | $                            | 2.76 |            | $ | 2.83   |  | (2.5  | )% | 
|Rice cereal
  series |  | $                            | 4.27 |            | $ | 2.75   |  | 55.3  | %  | 
|Soybean
  series     |  | $                            | 1.72 |            | $ | 1.72   |  | -0-   | %  | 
|Other series         |  | $                            | 3.69 |            | $ | 4.02   |  | (8.2  | )% | 

The growth in
2006 came primarily from increased sales in (i) ShanDong Province which had
sales of $14,083,913 (average selling price per kilogram was $4.70) on
2,998,766 kilograms of product (vs. sales of $6,350,035 in 2005 on 1,455,344
kilograms) and (ii) Henan Province which had sales volume of and sales revenues
generated of $13,321,747 (average selling price per kilogram was $4.34) on
3,068,328 kilograms of product vs. sales of $6,272,927 in 2005 on 1,559,791
kilograms, each of such provinces representing 11% of total sales revenues in
2006. The largest portion of sales in 2005 were in Heilongjiang Province which
represented 18% of sales in that year.

24

---



Sales
increases are attributable to the following factors:

 Increased
popularity of Feihe brand in mainland China following successful advertising
campaigns and extensive networks of principal agents in 25 provinces which
enhance distribution of our products to different provinces in North Eastern
China  the milk belt, increasing the overall popularity of Feihe branded
products but also promoting them in remote areas of China;

 demand
boosted by improved and high quality ingredients for several products such as
Ca+Zn, CPP and nucleotides series and resulting strong market acceptance of
these products;

 the dairy
milk industry scandal in China in 2003 and the resulting strict control over
dairy producers (quality and ingredient contains) drove many unscrupulous dairy
producers and their tainted dairy products out of the market and continues to
do so as consumers become more quality-conscious and reject fake milk powder
or inferior products;

 consumer
preferences for dairy products produced by such reputable dairy producers as
Feihe Dairy; and

 increase in
sales quantities of several high profit margin products as can be seen from the
table above (although averages prices per kilogram for these products
declined).

The relatively significant
increase in sales of products in the nucleotides series resulted from a strong
promotional campaign coupled with lower prices for a high quality product. The
nucleotides series saw a similar increase from 2004 to 2005. We expect this
trend to continue with this product line in the current year.


We introduced our rice
cereal product line in 2005 but considered its introduction to be in part a
test of the market. The rice cereal products during that year were lower-end
and priced accordingly. During 2006, we reformulated these products as a
higher-end line and reintroduced them. Because of the reformulation, sales
quantities were low in 2006. However, the average price increased significantly
due to the increased quality and market level, which stemmed the decline in
revenue from the line. We expect demand for this product series to continue to
increase.


Cost of Goods Sold.
Cost of goods sold increased $31,505,000, or 81%, from $38,716,000 in 2005 to
$70,221,000 in 2006 due primarily to a 65% increase in sales volume and an 87%
increase in average per-kilogram factory overhead. These increases were offset
somewhat by a 13% decrease in average direct materials cost per kilogram from
$2.00 in 2005 to $1.74 in 2006, while direct labor cost per kilogram remained
constant at $0.04. The increase in factory overhead resulted primarily from (i)
an increase in depreciation charges by $511,675, or 61%, arising from
additional plant, machinery and factory buildings as we completed and expanded
usage of our new production facilities during 2006 (with our Numico facility
becoming fully operational); (ii) a significant $3,487,803, or 937%, increase
in utility expenses; and (iii) a $2,181,352, or 370%, increase in packaging and
consumables expenses. Utilities included water, electricity, coal and fuel for
production. We do not believe that the increase resulted from any significant
inflationary pressures on these items but was partly due to additional costs in
preparing the test runs of the new milk powder and formula powder production
facilities.

Distribution Expenses.
Distribution expenses increased approximately $12,655,000, or 76%, from
approximately $16,743,000 for the year ended December 31, 2005 to approximately
$29,398,000 for the year ended December 31, 2006. The principal reasons for the
increase were substantial increases in advertising expense as well as increases
in promotional expenses, distribution salaries, and transportation expense
which were incurred to expand market areas. Distribution expenses are likely to
continue to increase as we continue to expand into other provinces farther from
our production base in Kedong County, Heilongjiang Province.

General and Administrative Expenses.
General and administrative expenses increased approximately $2,735,000, or
110%, from approximately $2,484,000 for the year ended December 31, 2005 to
approximately $5,219,000 for the year ended December 31, 2006. The increase was
mainly due to increases in depreciation expenses, education expenses, travel
and entertainment, office expenses, union expenses, transportation expenses,
bad debts, and staff salaries, as well as an increase in expense for consulting
services incurred at the parent company level.

Depreciation Expense.
Depreciation expense increased approximately $105,000, or 65%, from
approximately $161,000 for the year ended December 31, 2005 to approximately
$266,000 for the year ended December 31, 2006. This increase is due primarily
to substantial additions of buildings, plant and machinery during 2006.

Interest Expense.
Interest expense increased approximately $674,000, or 129%, from approximately
$523,000 for the year ended December 31, 2005 to approximately $1,197,000 for
the year ended December 31, 2006. This increase was due primarily to interest
accrued on additional convertible notes issued in 2006, as well as increases in
exchange loss and interest expense arising from additional short-term loans.

25

---



Comparison of Years Ended December 31, 2005
and 2004

Net
income increased by 86% from $6,258,000 in 2004 to $11,630,000 for 2005. This
increase in net income is attributable primarily to the following factors: (1)
an 82% increase in sales; (2) a 49% increase in other income, offset in part by
(i) a 17% decrease in gross profit margins from 52% in 2004 to 43% in 2005;
(ii) a 24% increase in distribution expenses, (iii) an 89% increase in general
and administrative expenses, and (iv) a 959% increase in interest expense.

Sales.
Revenues increased by $30,608,000 or 82% from $37,416,000 in 2004 to
$68,024,000 in 2005. This increase was due primarily to expanding market areas
and adding new value added products. Increase in sales is due to the following
factors:

The
primary sales component is volume. The following table sales volumes in
kilograms by product for 2005 as compared to 2004:

|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|---------------------- |  | --------------- | ---------- | ------ | - | ------------ | - | --------------- | --- | ------ |  | ---------- |  | --------------- | ---------- |  |  | --- | - |  | --------- | -
|                       |  | 2005            |            | 2004   |   |              |   |                
|                       |  |                 |            |        |   |              |   |                
|                       |  |                 |            |        |   |              |   |                
|                       |  |                 |            |        |   |              |   |                
|Product name           |  | Quantity
  (Kg) |            | Amount |   | % of
  sales |   | Quantity
  (Kg) |     | Amount |  | % f sales  |  | Variance
  (Kg) |           
|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|CPP series             |  |                 | 4,503,308  |        | $ | 24,700,822   |   |                 | 35  | %      |  | 2,398,579  |  | $               | 12,609,205 |  |  | 34  | % |  | 2,104,729 |  
|Nucleotides
  series   |  |                 | 1,094,676  |        |   | 11,017,136   |   |                 | 16  | %      |  | 219,153    |  |                 | 2,418,618  |  |  | 6   | % |  | 875,523   |  
|Ca+Zn series           |  |                 | 4,722,624  |        |   | 13,348,008   |   |                 | 19  | %      |  | 4,719,669  |  |                 | 12,682,053 |  |  | 34  | % |  | 2,955     |  
|Rice cereal            |  |                 | 2,664,230  |        |   | 7,319,683    |   |                 | 11  | %      |  |           |  |                 |           |  |  |    | % |  | 2,664,230 |  
|Low fat high
  calcium |  |                 |           |        |   |             |   |                 |    | %      |  | 368,968    |  |                 | 973,943    |  |  | 3   | % |  | (368,968  | )
|Light powder           |  |                 |           |        |   |             |   |                 |    | %      |  | 382,475    |  |                 | 684,162    |  |  | 2   | % |  | (382,475  | )
|Soybean
  series       |  |                 | 1,781,052  |        |   | 3,065,612    |   |                 | 4   | %      |  | 2,199,445  |  |                 | 5,570,911  |  |  | 15  | % |  | (418,393  | )
|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|Total                  |  |                 | 14,765,890 |        |   | 59,451,261   |   |                 | 85  | %      |  | 10,288,289 |  |                 | 34,938,892 |  |  | 94  | % |  | 4,477,601 |  
|Others*                |  |                 | 2,582,741  |        |   | 10,372,650   |   |                 | 15  | %      |  | 3,190,356  |  |                 | 2,477,331  |  |  | 6   | % |  | (607,615  | )
|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|                       |  |                 | 17,348,631 |        |   | 69,823,911   |   |                 | 100 | %      |  | 13,478,645 |  |                 | 37,416,223 |  |  | 100 | % |  | 3,869,986 |  
|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|Less:                  |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|Slotting
  Fees        |  |                 |            |        |   | (1,800,008   | ) |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  
|                       |  |                 | 17,348,631 |        | $ | 68,023,903   |   |                 |     |        |  | 13,478,645 |  | $               | 37,416,223 |  |  |     |   |  | 3,869,986 |  
|                       |  |                 |            |        |   |              |   |                 |     |        |  |            |  |                 |            |  |  |     |   |  |           |  

* Other products included
(1) butter, (2) non-fat milk powder, (3) milk powder for the middle-aged, (4)
milk powder for the elderly, (5) light milk powder, (6) walnut powder, and (7)
raw infant milk powder products produced under private labels for, and pursuant
to formulas specified by, original equipment manufacturers.


The second
component is an increase in the average sales price per kilogram as
demonstrated below:

|                                  |  |      |            |      |   |            | 
|--------------------------------- |  | ---- | ---------- | ---- | - | ---------- | 
|                                  |  | 2005 |            | 2004 |  
|                                  |  |      |            |      |   |            | 
|Sales
  revenues                  |  | $    | 68,024,000 |      | $ | 37,416,000 | 
|                                  |  |      |            |      |   |            | 
|Total sales
  volume (kilograms)  |  |      | 17,210,752 |      |   | 13,478,645 | 
|                                  |  |      |            |      |   |            | 
|Average
  selling prices/kilogram |  | $    | 3.95       |      | $ | 2.78       | 
|                                  |  |      |            |      |   |            | 

This
increase in average sales price per kilogram is due primarily to the shift in
product mix to higher end products rather than an increase in the sales price
of individual products.

The
following table reflects the average sales price by kilogram by product for
2005 and 2004 and the percentage change in the sales price per kilogram.

|                     |  |                                 |       |            |   |        |  |     |    | 
|-------------------- |  | ------------------------------- | ----- | ---------- | - | ------ |  | --- | -- | 
|                     |  | Average
  Price Per 
  Kilogram |       | Percentage |  
|Product              |  | 2005                            |       | 2004       |   | Change | 
|                     |  |                                 |       |            |   |        | 
|Ca+Zn series         |  | $                               | 2.83  |            | $ | 2.69   |  | 5   | %  | 
|CPP series           |  | $                               | 5.49  |            | $ | 5.26   |  | 4   | %  | 
|Soybean
  series     |  | $                               | 1.79  |            | $ | 2.53   |  | (32 | )% | 
|Nucleotides
  series |  | $                               | 10.06 |            | $ | 11.04  |  | (9  | )% | 
|Other series         |  | $                               | 4.24  |            | $ | 1.08   |  | 315 | %  | 

The
growth came primarily from increased sales in the Heilong Jiang Provence which
had sales of $21,400,000 in 2005 on 5,794,840 kilograms of product vs. sales of
$3,513,985 on 1,754,068 kilograms of product during 2004.

26

---



The above
sales and price increases are attributable to the following factors:

Increased
popularity of Feihe brand in mainland China following the successful
advertising campaigns in the previous year and extensive networks of Agencies
in 25 provinces;

Demand
boosted by improved and high quality ingredients for several products such as
Ca+Zn, CPP series, and nucleotides series and resulting market acceptance of
these products;

The
dairy milk industry scandal in China in 2003 and the resulting strict control
over dairy producers (quality and ingredient contains) drove many unscrupulous
Dairy producers and their tainted dairy products out of the market. Consumers
concentrated on dairy products produced by such reputable dairy producers as
Feihe Dairy.

Increase
in sales quantities of several higher priced major products as can be seen from
the table above.

Cost
of Goods Sold. Cost of goods sold increased 115% or
$20,709,000 from $18,007,000 in 2004 to $38,716,000 in 2005. This increase is
due to the following factors (1) a 28% increase in sales volumes (2) a 49%
increase in direct materials cost per kilogram from $1.35 in 2004 to $2.00 in
2005 (3) a 25% increase per kilogram in direct labor cost from $.04 in 2004 to
$.05 in 2005, and (4) a 120% increase in manufacturing overhead from $.05 per
kilogram in 2004 to $.11 per kilogram in 2005. The increase in direct materials
cost is due primarily to the increased use of nutritional supplements used
primarily in higher end products. The increase in labor and overhead cost is
attributable to the new production facilities coming on line which were not yet
operating at full capacity.

Distribution
Expenses. Distribution expenses for the year ended
December 31, 2005 were $16,743,000, an increase of $3,257,000 or 24% from the
prior years distribution expenses of $13,486,000. The principal reasons for
the increase were substantial increases in advertising expense, promotional
expenses, distribution salaries, and transportation expense which were incurred
to expand market areas.

General
and Administrative Expenses. General and
administrative expenses for the year ended December 31, 2005 were $2,483,000,
an increase of $1,170,000 or 89% from the prior years general and
administrative expenses of $1,313,000. The principal reason for the increase
was mainly due to increases in depreciation expenses, education expenses,
entertainment, office expenses, union expenses, transportation expenses, bad
debts, and staff salaries, as well as an increase in expense for consulting
services incurred at the parent company level.

Depreciation
Expense. Depreciation expense for the year ended
December 31, 2005 was $161,000 and $839,000, for general and administrative and
cost of goods sold depreciation, respectively, resulting in increases of
$106,000 and $632,000, respectively, compared to the year ended December 31,
2004, which reflected general and administrative and cost of goods sold
depreciation of $55,000 and $207,000, respectively. This increase is due
primarily to substantial additions of buildings, plant and machinery in Feihe
Dairy and Shanxi Feihe during 2005.

Interest
Expense. Interest expense for the year ended December
31, 2005 was $523,000 as compared to $49,000 for the prior year. This increase
was due primarily to interest accrued on convertible notes issued in 2005, as
well as interest expense arising from new short-term loans.

Income
Taxes. Income tax benefit decreased by $262,000 from
$262,000 of benefit in 2004 to $0 in 2005. This was due primarily to reversal
of a 2003 tax accrual for BiaQuan Dairy which was waived by the taxing
authorities in 2004.

Liquidity and Capital Resources

Operating Activities.
Net cash flows provided by operating activities for the year ended December 31,
2006 was approximately $8,842,000 compared with net cash flows provided by
operating activities of approximately $7,927,000 for the year ended December
31, 2005. This increase of approximately 12% was attributable primarily to an
increase in depreciation and compensation expense from the issuance of stock
and warrants.

27

---



In addition,
while our overall inventories increased approximately $4,291,000, or 45% from
$9,622,000 at December 31, 2005 to $13,914,000 at December 31, 2006, our
inventories of raw materials increased by approximately 92% during that period.
Our raw materials consist of demineralized whey powder (DWP) and raw milk. The
increase was primarily due to increased production capacity as compared to the
prior year-end and the addition of the rice cereal series product line during
2006. In addition, whey powder is imported from Europe and its prices have
continued to rise, and domestically, raw milk prices also continue to rise.

Sale of
Stock/Securities - During the fiscal year ended
December 31, 2006, American Dairy realized $2,006,855 from the sale of common
stock for cash, $3,195,000 from the conversion of an outstanding convertible
note into common stock and issued shares for services valued at $1,262,625.


On October 3, 2006, we closed an offering of
$18.2 million of 7.75% Convertible Notes together with warrants to purchase
approximately 251,000 shares of our common stock that bear interest at 7.75% per
annum for a term of three years, payable at maturity in shares of common stock.
Under the terms of the financing, the notes are convertible, and the warrants
exercisable, into the Companys common shares at $14.50 per share, subject to
certain conditions. We anticipate that we have adequate working capital for the
next twelve months. However, we may wish to borrow additional amounts or sell
our common stock to realize additional funds in order to expand and grow our
operations.

Pursuant to the terms of a
Investor Registration Rights Agreement, dated as of October 3, 2006, executed
in connection with the issuance of the 7.75% Convertible Notes, we are required
to file with the Securities and Exchange Commission a registration statement
    registering the resale of the shares of common stock underlying these notes.
    The original deadline for filing such registration statement was January
    2, 2007, and, under the terms of the agreement, we are subject to a penalty
    of 2% of the then outstanding principal on the notes for each month of such
    delinquency. We received waivers with respect to such deadline from these
    investors through May 2, 2007 and thus did not accrue any of such penalty through
    that date. However, for any subsequent delinquency, the investors could enforce
    this penalty against us.


Based upon our
short term liabilities, we believe our cash and cash equivalents are adequate
to satisfy our working capital needs and sustain our ongoing operations for the
next twelve months. In the event of an unanticipated shortfall, we have access
to a line of credit with the Construction Bank of China to fund our operations.
This line of credit was renewed in June 2006.

Our expansion
strategy outlined above under Plan of Operation will necessitate additional
funding most likely through debt or equity financing. In general, the
commitment of funds to the acquisition of plant and equipment tends to impair
liquidity. However, we believe that because of the upward trend in our revenues
in recent years, even if this upward trend levels off, our income from
operations coupled with such additional financing should provide sufficient
liquidity to meet our needs. As discussed above under Plan of Operation, we
are considering several possible sources of private funding in the form of one
or more debt or equity placements. We have received loans from our Chief
Executive Officer in the past in order to satisfy cash flow needs. However, we
do not view this as a necessary or meaningful source of liquidity going
forward.

Working Capital
- At December 31, 2006, the Company had working capital of approximately
$28,805,000.

Contractual Obligations
- As of December 31, 2006, the Company had the following contractual
obligations:

|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 
|------------------------------------------------ |  | ---------------------- | ---------- | ------------------ | - | ----------- |  | ----------- | ---------- | ------------------- | - | ------- |  | - | ------- | 
|                                                 |  | Payments due by period |           
|                                                 |  |                        |           
|Contractual
  obligations                        |  | Total                  |            | Less than
  1 year |   | 1-3
  years |  | 3-5
  years |            | More than
  5 years |  
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |  
|Long-term debt obligations                       |  | $                      | 23,755,722 |                    | $ | 5,103,197   |  | $           | 18,390,538 |                     | $ | 190,538 |  | $ | 71,449  | 
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 
|Purchase obligation for building
  acquisition   |  |                        |           |                    |   |            |  |             |           |                     |   |        |  |   |        | 
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 
|Purchase obligations for land use rights         |  | $                      | 276,802    |                    | $ | 6,251       |  | $           | 12,502     |                     | $ | 12,502  |  | $ | 245,547 | 
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 
|Purchase obligations for advertising
  contracts |  | $                      | 1,582,844  |                    | $ | 1,582,844   |  |             |           |                     |   |        |  |   |        | 
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 
|Total                                            |  | $                      | 25,561,368 |                    | $ | 6,638,292   |  | $           | 18,403,040 |                     | $ | 203,040 |  | $ | 316,996 | 
|                                                 |  |                        |            |                    |   |             |  |             |            |                     |   |         |  |   |         | 

28

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American Dairy
has credit facilities in place with an aggregate limit of which are provided by
three branches of the China Construction Bank and details of which are as
follows:


|                |                                              
|--------------- | ---------------------------------------------
|Lender:         | Qi Qihaer
  Branch of China Construction Bank
|Credit
  Limit: | Approximately
  $3 million (¥ 25 million RMB)

|                 |                                                                                                               
|---------------- | --------------------------------------------------------------------------------------------------------------
|Interest
  Rate: | 5.3625%
  monthly                                                                                             
|Conditions:      | The rate
  holds the line before the release of the first loan.                                               
|Maturity
  Date: | July 5, 2007                                                                                                  
|                 |                                                                                                               
|Lender:          | Qi Qihaer
  Branch of China Construction Bank                                                                 
|                 |                                                                                                               
|                 |                                                                                                               
|Credit
  Limit:  | Approximately
  $2 million (¥ 15 million RMB)                                                                 
|Interest
  Rate: | 5.115%
  monthly                                                                                              
|Conditions:      | The rate
  holds the line before the release of the first loan.                                               
|Maturity
  Date: | August 25,
  2007                                                                                             
|                 |                                                                                                               
|                 |                                                                                                               
|Lender:          | Keshang
  Branch of China Construction Bank (Kedong County Branch of Agricultural
  Development Bank of China)
|                 |                                                                                                               
|Credit
  Limit:  | Approximately
  $4 million (¥ 30 million RMB)                                                                 
|Interest
  Rate: | 5.85%
  annually                                                                                              
|Conditions:      | The starting
  date of actual loan term is counted from the date of borrowers first time
  drawing funds.    
|Maturity
  Date: | July 26,
  2007                                                                                               

The latter two loans each
contain covenants requiring American Dairy to seek the consent of the lender
prior to taking certain actions or engaging in certain transactions such as
financings or guaranties of other loans, restructuring, significant asset sales
or investments and related party transactions. These agreements also provide
for payment in full of all amounts due on the loans in the event of certain
adverse circumstances affecting American Dairy such as production stoppages,
events that have an adverse affect on our business and bankruptcy.


We currently have an
aggregate outstanding balance on these credit facilities in excess of ¥ 15
million RMB (approximately $1,894,000 USD). All principal amounts are due on
maturity, and no payment schedules apply. Although the second of these loans
matured on February 28, 2007, we have agreed with the bank to renew it until
August 25, 2007 on the same terms and conditions. We have not executed any new
written agreement with respect to such renewal.

Subsequent Development

On June 1, 2007, we entered into an amended and restated Notes
    Purchase Agreement, (the Purchase Agreement) for the sale of our 1% Guaranteed Senior
  Secured Convertible Notes (the Notes) in an aggregate principal amount of up
  to US $80,000,000 (the Purchase Amount) to Citadel Equity Fund Ltd.
  (Citadel) and completed the first closing pursuant to the Purchase Agreement,
  resulting in gross proceeds to our company of US $60,000,000 (the First
  Closing).

The Notes are to be issued under an Indenture, dated as of June 1,
2007, (the Indenture) between American Dairy, our wholly-owned subsidiary,
American Flying Crane Corporation, as Guarantor, and The Bank of New York as
Trustee (the Trustee). The Notes will be offered and sold pursuant to
Regulation S under the Securities Act of 1933, as amended (the Act) to non-US
persons.

Certain existing holders of our securities are entitled, pursuant to a
right of first refusal, to purchase, in the aggregate, up to US $20,000,000 of
the Purchase Amount. The notes (the Other Notes) to be issued to these
existing investors who exercise such right of first refusal will be issued
pursuant to Regulation D under the Act to accredited investors in the United
States. The Other Notes will have terms and conditions that are substantially
identical to those of the Notes, except for transfer restrictions and other
provisions required for compliance with the Act.

We anticipate that the issuance and sale of the Other Notes will be
made on or about June 14, 2007. In the event that the Existing Investors do not
purchase the entire US $20,000,000 in aggregate principal of the Other Notes,
Citadel is entitled to a further issuance of the Notes in an aggregate
principal amount equal to US$20,000,000 less the aggregate principal amount of
the Other Notes on the date of the issuance and sale of the Other Notes.

The Notes have been issued in denominations of US $100,000 each. The
Notes mature on June 1, 2012 (the Maturity Date), at which time we will be
required to redeem the Notes at a redemption price equal to $228,775.78 for
every $100,000 of Notes


29

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then outstanding. In addition, we may be required to make additional
payments of up to 5.0% of the then outstanding principal amount of the Notes if
certain conditions set forth in the Indenture are not met (the Additional
Payments).


The Notes will be convertible into shares of our common stock at the
option of the holders of the Notes at an initial conversion price of $24.00,
subject to adjustment (but no lower than $12.00 in case of adjustment based on
market price of our common Stock).

The Notes bear interest at the rate of 1% per annum, payable
semi-annually, subject to adjustment (the Interest Rate). The Interest Rate
may increase by 5.0% if certain conditions set forth in the Indenture are not
met (the Interest Rate Adjustments).

The payment and performance of our obligations to the holders of the
Notes and Trustee will be guaranteed by the following direct and our indirect
subsidiaries: Heilongjiang Feihe Dairy Co., Limited; BaiQuan Feihe Dairy Co.,
Limited, Beijing Feihe Biotechnology Scientific and Commercial Co., Limited, LangFang
Feihe Dairy Company Limited, GanHan Feihe Dairy Company Limited, Shanxi
Feihesantai Biotechnology Scientific and Commercial Co., Limited (collectively,
the PRC Subsidiaries) and American Flying Crane Corporation, a Delaware
corporation (AFC). The guarantee by the PRC Subsidiaries is subject to the
laws of the Peoples Republic of China.

In addition, the Notes and Guarantees will be secured by (i) a
perfected first-priority lien on all of our equity interests in AFC and, to the
extent permitted under the PRC law, the PRC Subsidiaries and (ii) a pledge of
2,664,340 shares of our common stock held by Mr. Leng You-Bin, our Chief
Executive Officer.

Pursuant to the Purchase Agreement, we have agreed to use our best
efforts to complete a public offering of our common stock by December 1, 2008.
Our failure to complete a public offering by December 1, 2008 can result in
Interest Rate Adjustments and certain Additional Payments.

In connection with the Purchase Agreement, we also entered into a
registration rights agreement (the Registration Rights Agreement) and an
investor rights agreement (the Investor Rights Agreement). The Registration
Rights Agreement provides for the filing of a registration statement (the
Registration Statement) with the SEC for the registration of the shares of
common stock issuable upon conversion of the Notes. We are obligated to file
the Registration Statement 90 days after the latter of (x) the Closing Date and
(y) the date on which we become eligible to file the Registration Statement
(the Eligibility Date). In addition, we are obligated to use reasonable
efforts to cause the Registration Statement to become effective within 180 days
after the Eligibility Date. The Investor Rights Agreement, among other rights,
grants Citadel a right of first refusal on future securities offerings by us
prior to the Maturity Date.

In connection with the Purchase Agreement, we also entered into
Non-Compete Agreements with its Chief Executive Officer, Leng You-Bin, and its
Chief Financial Officer, Liu Hua.

We are in violation of
certain loan covenants which require insurance coverage. Under the provisions
of the covenants, we are considered to be in default of these covenants, and
all debt under the relevant financing agreements may be due upon demand. As of
December 31, 2006, our long-term debt obligations were $16,936,654 in the
aggregate (net of current portion). We have not had any discussions with our
lenders regarding this technical default and have not received any demand for
payment. Any such demand would require that we utilize funds which are
currently earmarked for our expansion and acquisition program, including
bringing our new facilities into full operation, in order to pay any amounts so
demanded.


Critical Accounting Policies

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 and our disclosure of
contingent assets and liabilities at the date of our financial statements. We
routinely evaluate these estimates, utilizing historical experience, consulting
with experts and other methods we consider reasonable in the particular
circumstances. Nevertheless, actual results may differ significantly from our
estimates. Any effects on our business, financial position or results of
operations resulting from revisions to these estimates are recorded in the
period in which the facts that give rise to the revision become known.

In preparing
our consolidated financial statements and related disclosures, we must use
estimates in determining the economic useful lives of our assets, the fair
values used to determine possible asset impairment charges, provisions for
uncollectible

30

---



accounts
receivable, exposures under contractual indemnifications and various other
recorded or disclosed amounts. However, we believe that certain accounting
policies are of more significance in our consolidated financial statement
preparation process than others, which policies are discussed below. See also
Note 3 to the consolidated financial statements for a summary of our
significant accounting policies.

Estimates of
Allowances for Bad Debts - We must periodically review its trade and other
receivables to determine if all are collectible or whether an allowance is
required for possible uncollectible balances.

Estimate of
the useful lives of property and equipment - We must estimate the useful lives
and proper salvage values of property and equipment. We must also review it
property and equipment for possible impairment or obsolescence.

Inventory - We
must determine whether it has any obsolete or impaired inventory. Please refer
to the Notes to the financial statements included elsewhere in this filing for
a more complete listing of all of our critical accounting policies.


New Accounting Pronouncements

In April 2003,
the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities (SFAS 149). SFAS 149 amends and clarifies
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS 133. SFAS 149 is effective for certain contracts entered
into or modified by the Company after June 30, 2003. The adoption of SFAS 149
had no impact on the Companys financial position, results of operations, or
cash flows.

In May 2003,
the FASB issued SFAS No. 150, Accounting for Instruments with Characteristics
of Both Debt and Equity (SFAS 150). SFAS 150 requires liability classification
for three types of instruments: 1) Mandatory redeemable shares that obligate
the company to deliver cash or other assets to shareholders on fixed or
determinable dates; 2) Freestanding written put options and forward purchase
contracts on a companys own shares that obligate the company to deliver cash
or other assets, and 3) Contracts that obligate a company to issue its own
shares in amounts that are unrelated to, or inversely related to, the value of
the shares. The adoption of SFAS 150 had no impact on the Companys financial
position, results of operations, or cash flows.

In November
2004, the FASB issued SFAS No. 151 Inventory Costs - an amendment of ARB No.
43, Chapter 4 (SFAS 151). SFAS 151 requires that certain abnormal costs
associated with the manufacturing, freight, and handling costs associated with
inventory be charged to current operations in the period in which they are
incurred. The adoption of SFAS 151 had no impact on the Companys financial
position, results of operations, or cash flows.

In December
2004, the FASB issued a revision of SFAS No. 123 Share-Based Payment (SFAS
123). SFAS 123 establishes standards for the accounting for transactions in
which an entity exchanges its equity investments for goods and services. It
also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entitys equity
instruments or that may be settled by the issuance of those equity instruments.
The statement does not change the accounting guidance for share-based payments
with parties other than employees. The statement requires a public entity to
measure the cost of employee service received in exchange for an award of
equity instruments based on the grant-date fair value of the award (with
limited exception). That cost will be recognized over the period during which
an employee is required to provide service in exchange for the award (usually
the vesting period). A public entity will initially measure the cost of
employee services received in exchange for an award of liability instrument
based on its current fair value; the fair value of that award will be
remeasured subsequently at each reporting date through the settlement date.
Changes in fair value during the requisite service period will be recognized as
compensation over that period.

The grant-date
for fair value of employee share options and similar instruments will be
estimated using option- pricing models adjusted for the unique characteristics
of these instruments.

The statement
was effective for the quarter beginning January 1, 2006. The Company adopted
SFAS 123R on January 1, 2006 using the modified prospective method. The Company
has no outstanding stock options or unvested stock compensation and SFAS 123R
had no effect on the consolidated financial statements.

SFAS No. 152
Accounting for Real Estate Time-Sharing Transactions - an amendment of FASB
Statements No. 66 and 67, SFAS No. 155 Accounting for Certain Hybrid
Financial Instruments - an amendment of FASB Statements No. 133 and No. 140,
SFAS No. 156 Accounting for Servicing of Financial Assets - an amendment of
FASB Statement No. 140, SFAS No. 157 Fair Value Measurement, SFAS 158
Employers Accounting for Defined Benefit and Other Postretirement Plans, and
FASB Statement No. 159 The Fair Value Option for Financial Assets and
Financial Liabilities were recently issued. SFAS No. 152, 155, 156, and 158
have no current applicability to the Company and have no significant effect on
the consolidated financial statements.

Management is
currently assessing the effect, if any, that the adoption of SFAS 157 and SFAS
159 will have on the reporting of future operations.

31

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In June of
2006, the Financial Accounting Standards Board issued FASB Interpretation No.
48 Accounting for Uncertainty in Income Taxes. This interpretation clarifies
the accounting and reporting of uncertainty in income taxes recognized in an
enterprises financial statements. This Interpretation will be effective for
fiscal years beginning after December 15, 2006. The Company is currently
assessing the effect this Interpretation will have on the reporting of future
operations.

In September
2006, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 108 (SAB No. 108). SAB No. 108 addresses how the effects of prior year
uncorrected misstatements should be considered when quantifying misstatements
in current year financial statements. SAB No. 108 requires companies to
quantify misstatements using a balance sheet and income statement approach and
to evaluate whether either approach results in quantifying an error that is
material in light of relevant quantitative and qualitative factors. When the
effect of initial adoption is material, companies will record the effect as a
cumulative effect adjustment to beginning of year retained earnings and
disclose the nature and amount of each individual error being corrected in the
cumulative adjustment. SAB No. 108 is effective beginning January 1, 2007 and
it is anticipated that the initial adoption of SAB No. 108 will not have a
material impact on the Companys financial position, results of operations, or
cash flows.

In February
2007, the FASB issued Statement No. 159 The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS 159). This statement permits companies
to choose to measure many financial assets and liabilities at fair value.
Unrealized gains and losses on items for which the fair value option has been
elected are reported in earnings. SFAS 159 is effective for fiscal years
beginning after November 15, 2007. The Company is currently assessing the
impact of SFAS 159 on its consolidated financial statements.

Item 7A. Quantitative and Qualitative
Disclosures About Market Risk.

All of the
operations of American Dairy are conducted in The Peoples Republic of China
(the PRC), and the Renminbi is the national currency in which its operations
are conducted. American Dairy has not utilized any derivative financial
instruments or any other financial instruments, nor does it utilize any
derivative commodity instruments in its operations, nor any similar market
sensitive instruments.

The exchange
rate between the Renminbi and the U.S. dollar is subject to the PRC foreign
currency conversion policies which may change at any time. The exchange rate at
December 31, 2006, was approximately 7.8 Renminbi to 1 U.S. dollar, and the
exchange rate is currently permitted to float within a very limited range. See
Item 1A - Risks of Doing Business in China.

Item 8. Financial Statements and
Supplementary Data

Please see the
accompanying Financial Statements attached hereto beginning on page F-1.

32

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Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure

There have
been no disagreements regarding accounting and financial disclosure matters
with the independent certified public accountants of American Dairy.

Item 9A. Controls and Procedures

Evaluation of
Disclosure Controls and Procedures. The Companys
Chief Executive Officer and the Companys Principal financial officer, after
evaluating the effectiveness of the Companys disclosure controls and procedures
(as defined in the Securities Exchange Act of 1943, Rule 13a-15(e) and
15d-15(e)) as of December 31, 2006, have concluded that the Companys
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in reports that it files or submits
under the Securities Exchange Act of 1934, as amended, is recorded, processed
and summarized and reported on a timely basis and is accumulated and
communicated to the Companys management, including its principal executive
officers as appropriate, to allow timely decisions regarding required
disclosure.

Changes in Internal
Controls. In connection with their evaluation, the
certifying officers identified no changes in the Companys internal control
over financial reporting during the Companys fiscal quarter ended December 31,
2006 that materially affected or are reasonably likely to materially affect,
the Companys internal control over financial reporting.

Item 9B. Other Information

33

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PART III

Item 10. Directors and Executive Officers of
the Registrant

The following
table sets forth certain information regarding the executive officers and
directors of American Dairy. All officers serve at the pleasure of the Board of
Directors. Directors serve until the election and qualification of their
successors.

|                       |  |    |     |                                                              |          | 
|---------------------- |  | -- | --- | ------------------------------------------------------------ | -------- | 
|Name                   |  |    | Age |                                                              | Position | 
|                       |  |    |     |                                                              |          | 
|Leng You-Bin           |  | 37 |     | Chairman,
  Chief Executive Officer and President           
|Liu Hua                |  | 34 |     | Chief
  Financial Officer, Secretary, Treasurer and Director
|Liu Sheng-Hui          |  | 36 |     | Director                                                    
|Hui-Lan Lee            |  | 57 |     | Director                                                    
|Kirk G.
  Downing      |  | 53 |     | Director                                                    
|James C.
  Lewis, Esq. |  | 54 |     | Director                                                    

Leng You-Bin
has been the Chairman, Chief Executive Officer, President, and General Manager
of American Dairy since May 7, 2003. From January 2002 to May 2003, he was the
Chief Executive Officer and President of American Flying Crane. He is
responsible for the overall strategic planning, management and business
development of Feihe Dairy. Mr. Leng has been in the dairy industry for more
than 13 years. He obtained his Bachelor of Science degree in Food Engineering
from Northeast Agriculture University, China. From 1989 to 1997, Mr. Leng acted
as technician, deputy director and director of ZhaoGuang Dairy Plants, the
predecessor of Feihe Dairy. From 1997 to 2002, Mr. Leng was the General Manager
of Feihe Dairy. He became the Chairman and General Manager in 2000. He has
researched and patented the liver protection milk powder (GanBao Milk
Powder).

Liu Hua has
been the Chief Financial Officer, Secretary, Treasurer and a director of
American Dairy since May 7, 2003, and was the Financial Officer of Feihe Dairy
from November 2000 to May 2003. From June 1998 to November 2000, he was the
Chief Executive Officer of Shenzhen Cima Limited, a financial consulting
company. From January 1996 to June 1998, he was Chief Executive Officer of
Shensheng Jiajing Inc., a trading company. From September 1993 to January 1996,
he was the Chief Executive Officer of Zhengzhou Huacheng Limited, also a
trading company. Mr. Liu received a degree in finance and economics from Xian
Traffic University in 1993 and from Shenzhen University in 1997.

Liu Sheng-Hui
has been a director of American Dairy since May 7, 2003. He also serves as
Chief Financial Officer of Feihe Dairy where he is responsible for the overall
financial planning and management of Feihe Dairy. He joined Feihe Dairy in
1992. He was Chief Financial Officer and a director of American Flying Crane
from January 2000 to May 2003, and previously of Feihe Dairy from September
1998 to January 2000. He graduated from Northeast Agriculture University with a
Bachelor of Agriculture in 1992 and received another Bachelor of Agriculture
from Agriculture University in 1994.

Hui-Lan Lee
(also known as Tracy Lee) has been a director of American Dairy since June
2003. She served as Vice President and Director of Income Tax Compliance of
Countrywide Home Loans, Inc. from April 2003 to April 2006 and, since April
2006, as its Vice President of Financial Reporting. She was the Tax Manager of
Watson Pharmaceuticals, Inc. from October 26, 1996 to March 2003. From 1979 to
1996, Ms. Lee was employed by major Fortune 500 companies including The Flying
Tiger Line Inc. (a Tiger International Company), Quotron Systems, Inc. (a
subsidiary of the Citigroup, Inc.) and Lear Siegler, Inc. in various management
positions. Ms. Lee holds a Master of Science degree in Taxation from Golden
Gate University, and a Master of Business Administration degree from Indiana
University.

Mr. Downing
became a director of American Dairy on February 21, 2005. From December 1980 to
the present, he has been practicing law in Los Angeles, California. From
January 1989 to June 1997, Mr. Downing also engaged in ranching, farming,
logging and property development. Mr. Downing received his B.A. degree in
liberal arts from Portland State University in 1976. He received his Juris
Doctorate degree in 1980 from Loyola Law School.

34

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Mr. Lewis was
elected to our board of directors in December 2006. He is an attorney and has
been practicing law in the state of Utah since 1979. Mr. Lewis is currently a
partner in the firm of Lewis, Hansen, Waldo & Pleshe, Salt Lake City, Utah.
From 2000 to 2002, he was a member of the firm of Jones, Waldo, Holbrook &
McDonough, Salt Lake City, Utah. From 1997 to 2000, he was a partner in the
firm of Lewis Law Offices, where he concentrated his practice in the areas of
litigation, corporate, commercial and real estate law. Mr. Lewis was a partner
in the firm of Diumenti & Lewis from 1993-1997. From 1987 to 1992, he was a
partner in the firm of Lewis & Lehman. From 1979 to 1985, he was an
attorney with Kruse, Landa & Maycock, where he concentrated his practice in
corporate and transactional law. During the past few years, Mr. Lewis has been
involved in the private development of a number of real estate projects and
other development stage ventures. Mr. Lewis graduated from the University of
Utah in 1976 with an undergraduate degree in psychology, and from the
University of San Diego in 1979 with a juris doctorate degree. He is currently
a principal owner of 3Star Technology, Inc., a closely-held technology venture.
Mr. Lewis serves on the board of two non-profit corporations, Odyssey House,
and the Summit County Chapter of Habitat for Humanity.

Director Independence

The Board of
Directors has determined that Hui-lan Lee, Kirk Downing and James C. Lewis, are
each an independent director under the general guidelines for determining
director independence of the NYSE Arca and the rules of the SEC.

Indemnification

Pursuant to
the Certificate of Incorporation, as amended, and By-laws of American Dairy,
the officers and directors of American Dairy will be indemnified to the fullest
extent allowed under Utah law for claims brought against them in their capacities
as officers or directors. American Dairy is in the process of obtaining
directors and officers liability insurance. Indemnification will not be
provided if the officer or director does not act in good faith and in a manner
reasonably believed to be in the best interests of American Dairy, or, with
respect to any criminal proceedings, if the officer or director had no
reasonable cause to believe his conduct was lawful. Accordingly,
indemnification may be sought for liabilities arising under the Securities Act
of 1933. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted for directors, officers and controlling
persons, American Dairy has been advised that in the opinion of the Securities
and Exchange Commission, such indemnification is against public policy as
expressed in the Securities Act and may, therefore, be unenforceable.

Board Committees

Audit Committee

The boards
audit committee consists of Kirk G. Downing, James C. Lewis and Hui-Lan Lee.

The Audit Committee operates under a written charter adopted by the Audit
Committee and the Board of Directors. A copy of the Audit Committee Charter may
be accessed at our website at http://www.americandairyinc.com. The Audit
Committee reviews the scope and results of the annual audits, receives reports
from our independent public accountants, and reports the committees findings
to the Board of Directors. As more fully described in the Audit Committee
Charter, the Audit Committee is responsible for assisting the Board of
Directors with oversight of:

| |   |                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the
  integrity of the Companys financial statements;                                                                                                                                                            
| |   |                                                                                                                                                                                                                   
| |  | the
  Companys systems of disclosure and internal control regarding finance,
  accounting, legal compliance and ethics that management and the Board have
  established;                                         
| |   |                                                                                                                                                                                                                   
| |  | the
  Companys compliance with legal and regulatory requirements;                                                                                                                                                
| |   |                                                                                                                                                                                                                   
| |  | the
  qualifications and independence of the independent accountants retained by
  the Company for the purpose of preparing or issuing an audit report or performing
  other audit, review or attest services; and
| |   |                                                                                                                                                                                                                   
| |  | the
  performance of the auditors and of the Companys internal audit function;                                                                                                                                   

35

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The Audit
Committee has the direct authority and responsibility to select, evaluate and,
where appropriate, replace the independent auditors.

Compensation and Executive Personnel Committee

The
Compensation and Executive Personnel Committee consists of Leng You-Bin, James
C. Lewis and Hui-Lan Lee. The Charter of our Compensation Committee is
available on our website at http://www.americandairyinc.com. The purpose of the
Compensation and Executive Committee is:

| |   |                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to discharge
  the Boards responsibilities relating to compensation of those officers of
  the Company whose salaries are required by the Company Bylaws to be fixed by
  the Board;
| |   |                                                                                                                                                                                      
| |  | to produce a
  report on executive compensation annually for inclusion in the Companys
  proxy statement in accordance with applicable rules and regulations, and                   
| |   |                                                                                                                                                                                      
| |  | to perform
  the other duties specified in this Charter.                                                                                                                             

The
Compensation and Executive Personnel Committee also administers our 2003
Incentive Stock Plan.

Nominating/Corporate Governance Committee

The
Nominating/Corporate Governance Committee consists of Liu Hua, Hui-Lan Lee and
Leng You-Bin. The primary purposes of the Nominating/Corporate Governance
Committee are:

| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | to identify
  and recommend to the Board individuals qualified to serve as directors of the
  Company;                  
| |   |                                                                                                                         
| |  | to advise
  the Board with respect to Board composition and procedures;                                                 
| |   |                                                                                                                         
| |  | to develop
  and recommend to the Board on an ongoing basis Corporate Governance
  Guidelines applicable to the Company;
| |   |                                                                                                                         
| |  | to advise
  the Board with respect to corporate governance matters;                                                     
| |   |                                                                                                                         
| |  | and to
  oversee the evaluation of the Board.                                                                           

The
Nominating/Corporate Governance Committee has adopted a charter and a copy is
available on our website at http://www.americandairyinc.com. Our Board has
determined that all of its members are not independent under the general
guidelines for determining director independence of the NYSE Arca listing
standards. NYSE Arca rules do not require that all of the members of the
Nominating/Corporate Governance Committee be independent because we are a
listed domestic issuer of which more than 50% of the voting power is held by an
individual.

The committee
has not established any specific minimum qualifications that must be met for
recommendation for a position on the Board of Directors. Instead, in
considering candidates for director, the nominating committee will generally
consider candidates from all sources, including shareholders. In evaluating
potential candidates from all sources, the committee considers all relevant
factors, including among others the candidates applicable expertise and
demonstrated excellence in his or her field, the usefulness of such expertise
to American Dairy, the availability of the candidate to devote sufficient time
and attention to the affairs of American Dairy, the candidates reputation for
personal integrity and ethics and the candidates ability to exercise sound
business judgment. Other relevant factors, including diversity, age and skills,
will also be considered. Candidates for director are reviewed in the context of
the existing membership of the Board (including the qualities and skills of the
existing directors), the operating requirements of the Company and the
long-term interests of its shareholders.

36

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Executive Committee

The Executive
Committee consists of Liu Sheng-Hui, Liu Hua and Leng You-Bin. The primary
duties and responsibilities of the Executive Committee are:

| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The approval
  of any action for which the Utah General Corporation Law also requires
  shareholders approval or approval of the outstanding shares;
| |   |                                                                                                                                                      
| |  | The filling
  of vacancies on the Board or in any committee;                                                                                         
| |   |                                                                                                                                                      
| |  | The fixing
  of compensation of the directors for serving on the Board or on any
  committee;                                                        
| |   |                                                                                                                                                      
| |  | The
  amendment or repeal of Bylaws or the adoption of new Bylaws;                                                                                   
| |   |                                                                                                                                                      
| |  | The
  amendment or repeal of any resolution of the Board which by its express terms
  is not so amendable or repealable;                             
| |   |                                                                                                                                                      
| |  | A
  distribution to the shareholders of the Company except at a rate or in a
  periodic amount or within a price range determined by the Board; and  
| |   |                                                                                                                                                      
| |  | The
  appointment of other committees of the Board or the members thereof.                                                                           

The Finance Committee

The Finance
Committee consists of Liu Hua, Hui-Lan Lee and James C. Lewis. The Committee
has the following duties and responsibilities:

| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | Review the
  financial planning process of the Company and the subsidiaries of the
  Company;                            
| |   |                                                                                                                          
| |  | Review at
  least annually the financial structure of the Company and the subsidiaries of
  the Company;                 
| |   |                                                                                                                          
| |  | Review at
  least annually the investment outlook for the Company and the subsidiaries of
  the Company; and             
| |   |                                                                                                                          
| |  | Perform such
  additional functions as are necessary or prudent to fulfill the Committees
  duties and responsibilities.

Item 11. Executive Compensation

The officers
and directors of American Dairy received compensation during the three fiscal
years ended December 31, 2006, as follows:

Summary Compensation Table




|                               |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 
|------------------------------ |  | -------------- | ---- | ------ | - | --------------- |  | ---------------- | ------ | -------------------------------------------- |  | ------------------------------------------------------------------------------------ |  | ------------------------- |  | ----- |  |  |  |  |  |  | - | ------ | 
|Name and Principal 
  Position |  | Fiscal 
  Year |      | Salary |   | Stock 
  Awards |  | Option 
  Awards |        | Non-equity 
  Incentive Plan 
  Compensation |  | Change inPension Value 
  and
  Nonqualified 
  Deferred 
  Compensation 
  Earnings |  | All Other 
  Compensation |  | Total | 
|                               |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       | 
|Leng You-Bin                   |  |                | 2004 |        | $ | 6,884           |  | $                | 45,000 |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  | $ | 51,884 | 
|Director,
  Chief              |  |                | 2005 |        | $ | 9,000           |  | $                | 27,405 |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  | $ | 36,405 | 
|Executive Officer              |  |                | 2006 |        | $ | 9,000           |  | $                | 90,730 |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  | $ | 99,730 | 
|and
  President                |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 
|                               |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 
|Roger Liu                      |  |                | 2004 |        |   |                |  | $                | 21,000 |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  | $ | 21,000 | 
|Chief
  Financial              |  |                | 2005 |        |   |                |  | $                | 89,840 |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  | $ | 89,840 | 
|Officer,
  Principal           |  |                | 2006 |        |   |                |  | $                | 90,730 |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  | $ | 90,730 | 
|Accounting
  and               |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 
|Financial
  Officer,           |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 
|Secretary
  and                |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 
|Treasurer                      |  |                |      |        |   |                 |  |                  |        |                                              |  |                                                                                      |  |                           |  |       |  |  |  |  |  |  |   |        | 




37

---



No other
executive officer received compensation in excess of $100,000 during the
specified periods.

Compensation Discussion and Analysis

Our executive compensation to date has been a simple combination primarily of
stock and, to a lesser extent, cash. The amounts of such compensation have been
based upon American Dairys early stage of development and its need to conserve
working capital balanced with the economic needs of our management. These
considerations continue to drive the analysis of the appropriate amount and
type of compensation we pay our executives. However, as we grow, we continually
evaluate and compare our compensation to other companies in our industry, such
as American Oriental Bioengineering Inc. and Lifeway Foods Inc. as well as
companies of similar size and scale of operations. In so doing, we have
determined that in order to attract and retain talented individuals to our
management team, an increase in the amount of our executive compensation and a
shift to a more cash-based approach is appropriate. We also believe that
additional forms of compensation may enable us to attract members to our
management team with different compensation needs.

Our Compensation Committees
goals in regards to executive compensation are primarily to recruit, hire,
retain, motivate and reward the most talented executives possible by providing
annual, short-term, and long-term compensation incentives to achieve our
specified performance objectives, and to create long-term value for our
shareholders. We intend to align the interests of key executives with our
shareholders by implementing compensation plans that tie a substantial portion
of executives overall compensation to key strategic, operational and financial
goals such as achievement of budgeted levels of revenues and EBITDA, and other
non-financial goals that the board of directors may deem important.

We plan to adopt a more
comprehensive approach to evaluating our compensation annually. Our board of
directors and the Compensation Committee will evaluate individual executive
performance with a goal of setting compensation at levels which will be based
on their general business and industry knowledge and experience and comparable
with executives in other companies of similar size and stage of development,
while taking into account our relative performance and our own strategic goals.
We plan to conduct an annual review of the aggregate level of our executive
compensation as part of the annual budget review and annual performance review
processes, which include determining the operating metrics and non-financial
elements used to measure our performance and to compensate our executive
officers. This review will be based on our knowledge of how other similarly
situated companies measure their executive performance and on the key operating
metrics that are critical in our effort to increase the value of our company.

So far, executive
compensation has consisted, and for the coming year will likely continue to
consist, of the following:

Our board of directors has
approved a cash compensation package for each of our Chief Executive Officer
and Chief Financial Officer of $200,000 for services rendered in 2007.
Previously, our Chief Financial Officer has not received cash compensation but
only stock. We have brought his cash compensation component into line with that
of our Chief Executive Officer in recognition of the time and effort he has put
into our business over the past several months which we anticipate will
continue into 2007.

Incentives/Equity: Stocks,
options and other incentive compensation will be determined after we evaluate
our stock available for issuance and our market capitalization . We also plan
to consider 401(k) plans, time off allocation, bonuses, and other compensation
along with the above.

The stock awards listed in the table represent
shares of our common stock which were issued to the named officers. None of the
shares issued as stock awards were or are subject to vesting or other risk of
forfeiture and were valued by reference to the closing price on the date of
grant. The amounts of the awards in each year are based upon managements
assessment of the amount of time and effort devoted to our business by each
officer and the amount of equity available for issuance given our near-term
funding and compensation plans.

We are in the process of
reexamining the structure of our management compensation program. We are
looking to the compensation programs of similarly situated companies and
considering other factors such as performance, length of service, peer
evaluations, subjective and objective reviews, and examination of other
similarly situated companies. Historically, our compensation structure was
based upon prevailing norms in China where it is somewhat unusual for executive
officers to make significantly more than middle management or executives of
subsidiaries. We are now in a position to compensate our executives in cash
amounts that better reflect their efforts on behalf of American Dairy and the
progress our company has made in terms of revenue growth. Nevertheless, we
believe that the $200,000 we intend to pay each of our Chief Executive Officer
and Chief Financial Officer is significantly lower than that paid to executives
in the United States at companies of similar size and with similar revenues.
This reflects managements concern over the fairness to our employees in China
and avoiding substantial discrepancies between executive pay versus that of
middle management and employees.

38

---



Our management and Compensation Committee have received guidance from various
advisors and consultants and have made an effort to determine the best way to
allocate total compensation between cash and equity based on benchmarking to
our peer group, while considering the balance between short and long-term
incentives (we are still in the process of developing our peer group, which is
expected to consist primarily of US-based dairy companies and other public
companies with similar revenues. We expect to have the peer group analysis
completed in time to set our executive compensation for our next fiscal year).
Our Compensation Committee expects to compensate our executive officers in a
range of between the 50 th
and the 75 th
percentile of the compensation amounts provided to executives at comparable
companies in an effort to maintain such a balance. We have considered retaining
one or more compensation consultants to assist us with information regarding
market data for executive compensation in similar industries and situations.
However, upon further consideration, we have determined that this would not be
a worthwhile use of our available funds at this point.

GRANT OF PLAN-BASED AWARDS

|                                                                        |  |            |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |   |                                                                          |       |                                                                              |   |                                                 |   |                                                            |   |        | 
|----------------------------------------------------------------------- |  | ---------- |  | ----------------------------------------------------------------- |  | ---------------------------------------- | - | ------- | - | --------- | - | ------ | - | ------- | - | ------------------------------------------------------------------------ | ----- | ---------------------------------------------------------------------------- | - | ----------------------------------------------- | - | ---------------------------------------------------------- | - | ------ | 
|                                                                        |  |            |  | Estimated Future Payouts Under
  Non-Equity Incentive Plan Awards |  | Non-equity
  Incentive Plan Compensation |   |         |   |           |   |        |   |         |  
|                                                                        |  |            |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |  
|Name and
  Principal Position                                           |  | Grant Date |  | Threshold                                                         |  | Target                                   |   | Maximum |   | Threshold |   | Target |   | Maximum |   | All
  other
  Stock
  Awards:
  Number
  of Shares
  of Stock
  or Units |       | All Other
  Option
  Awards:
  Number of
  Securities
  Underlying
  Options |   | Exercise
  or Base
  Price of
  Option
  Awards |   | Grant
  Date Fair
  Value of
  Stock and
  Option
  Awards |  
|                                                                        |  |            |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |   |                                                                          |       |                                                                              |   |                                                 |   |                                                            |  
|Leng You-Bin Director, Chief                                            |  | 2/15/2006  |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |   |                                                                          | 4,500 |                                                                              |   |                                                 |   |                                                            | $ | 51,210 | 
|Executive Officer and
  President                                       |  | 6/08/2006  |  |                                                                  |  |                                          |  |         |  |           |  |        |  |         |  |                                                                          | 3,250 |                                                                              |  |                                                 |  |                                                            | $ | 39,520 | 
|                                                                        |  |            |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |   |                                                                          |       |                                                                              |   |                                                 |   |                                                            |   |        | 
|Roger Liu
  Chief Financial Officer, Principal Accounting and Financial |  | 2/15/2006  |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |   |                                                                          | 4,500 |                                                                              |   |                                                 |   |                                                            | $ | 51,210 | 
|Officer, Secretary and
  Treasurer                                      |  | 6/08/2006  |  |                                                                  |  |                                          |  |         |  |           |  |        |  |         |  |                                                                          | 3,250 |                                                                              |  |                                                 |  |                                                            | $ | 39,520 | 
|                                                                        |  |            |  |                                                                   |  |                                          |   |         |   |           |   |        |   |         |   |                                                                          |       |                                                                              |   |                                                 |   |                                                            |   |        | 




Employment Agreements

American Dairy presently has no written employment agreements with its officers
or key employees, but plans to enter into such agreements in the future.

Board Compensation

American Dairy
plans to provide its non-management directors, if any, a competitive directors
compensation package comparable to programs offered by the similarly situated
corporations which are listed under Compensation Discussion and Analysis
above. This compensation will likely include equity compensation.

The following
table lists the shares awarded our outside directors for their service as
directors during 2006:

|
|

|                |  |                             |  |             |        |              |   |                            |   |                                                                    |   |                       |   |       |   |        | 
|--------------- |  | --------------------------- |  | ----------- | ------ | ------------ | - | -------------------------- | - | ------------------------------------------------------------------ | - | --------------------- | - | ----- | - | ------ | 
|Name            |  | Fees
  Earnedor Paidin Cash |  | StockAwards |        | OptionAwards |   | Non-EquityPlanCompensation |   | Change inPension Valueand NonqualifiedDeferredCompensationEarnings |   | All OtherCompensation |   | Total |  
|                |  |                             |  |             |        |              |   |                            |   |                                                                    |   |                       |   |       |  
|Kirk Downing    |  |                            |  | $           | 93,948 |              |  |                            |  |                                                                    |  |                       |  |       | $ | 93,948 | 
|Liu
  Sheng-Hui |  |                            |  | $           | 93,948 |              |  |                            |  |                                                                    |  |                       |  |       | $ | 93,948 | 
|Hui-Lan Lee     |  |                            |  | $           | 93,948 |              |  |                            |  |                                                                    |  |                       |  |       | $ | 93,948 | 




39

---



None of the
shares issued as stock awards were or are subject to vesting or other risk of
forfeiture and were valued by reference to the closing price on the date of
grant.

Benefit Plans

American Dairy
does not have any profit sharing plan or similar plans for the benefit of its
officers, directors or employees. However, American Dairy reserves the right to
establish any such plans in the future. Certain employees of our subsidiaries
have pension and healthcare benefits through plans offered by such
subsidiaries.

Incentive Stock Plan

Effective
April 1, 2003, American Dairy adopted and approved its 2003 Incentive Stock Plan
which reserves 3,000,000 shares of common stock for issuance under the plan.
The plan allows us to issue awards of incentive or non-qualified stock options,
stock appreciation rights, and stock bonuses which may be subject to
restrictions. During 2006, we granted to employees, consultants and management
a total of 103,370 shares of common stock under the plan. Mr. Leng You-Bin and
Mr. Liu Hua are the members of the Committee that administers the Plan.

Mr. Leng
You-Bin and Mr. Liu Hua are the members of the Committee that administers the
Plan.

Compliance with Section 16(a) of the
Securities Exchange Act

Section 16(a)
of the Exchange Act requires American Dairys executive officers and directors,
and persons who beneficially own more than ten percent (10%) of its equity
securities, to file reports of ownership and changes in ownership with the U.S.
Securities and Exchange Commission. Officers, directors and greater than ten
percent shareholders are required by SEC regulation to furnish American Dairy with
copies of all Section 16(a) forms they file.

Based on its
review of the copies of such forms received by it, American Dairy believes that
during the year ended December 31, 2006, all such filing requirements
applicable to its officers, directors and 10% owners of its Common Stock were
complied with.

Limited Liability and Indemnification

Section
16-10a-840 of the Utah Revised Business Corporation Act (the URBC) requires
directors and officers to perform their duties in good faith and with the care
that an ordinary person would exercise under similar circumstances in a manner
reasonably believed to be in the best interest of the corporation. A director
or officer of a corporation is not liable to the corporation, its shareholders
or others for any action taken or any failure to act as an officer or director
unless he has breached or failed or failed to perform his duties as described
above and the breach or failure to perform constitutes gross negligence, wilful
misconduct, or intentional infliction of harm on the corporation or its
shareholders.

Section
16-10a-841 of the URBC provides that the articles of incorporation of a Utah
corporation may eliminate or limit the liability of a director to the
corporation or its shareholders for monetary damages, except for (I) a
financial benefit to which is not entitled; (ii) an intentional infliction of
harm; (iii) unlawful distributions of the corporation constituting a violation
of Section 16-10a-842 of the URBC; or (iv) an intentional violation of criminal
law.

Section
16-10a-902 of the URBC permits a Utah corporation to indemnify directors made a
party to a proceeding because he is or was a director if (i) his conduct was
in, or not opposed to, the corporations best interest; and (ii) he reasonably
believed his conduct was in, or not opposed to, the corporations best
interests; and (iii) in the case of a criminal proceeding, he had no reasonable
cause to believe his conduct was unlawful. However, a Utah corporation may not
indemnify a director if he was adjudged liable to the corporation, or if he was
adjudged liable on the basis that he derived an improper personal benefit; and
such indemnification in any action brought by the corporation is limited to
reasonable expenses incurred in connection with the proceedings.

Article VI of
the Articles of Incorporation and Article VIII of the By-Laws of American Dairy
provide for the indemnification of directors and officers of American Dairy.
Indemnification is mandatory regarding reasonable expenses incurred in connection
with proceedings or claims with respect to which he has been successful.
Officers, employees, fiduciaries and agents of a Utah corporation may be
entitled to indemnification to a greater extent that directors, if not
inconsistent with public policy, if provided for in the Articles of
Incorporation, By-Laws, the general or specific action of its board of
directors or contract.

40

---



Consultants

American Dairy
intends to retain consultants to the extent necessary and appropriate. American
Dairy will not delegate its authority and responsibility to make management
decisions to consultants or any other persons, nor shall any consultant have
any discretionary authority or the authority to bind American Dairy in any
material respect.

41

---



Item 12. Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters

The following
table sets forth certain information concerning the beneficial ownership of
American Dairys shares of common stock by directors and officers of American Dairy,
and by each person known to American Dairy to be a beneficial owner of five
percent (5%) or more of its outstanding common stock as of December 31, 2006.

|                                                                                                          |  |                                                   |     |                                             |   | 
|--------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------- | --- | ------------------------------------------- | - | 
|Name and Address                                                                                          |  | Amount and
  Nature of 
  Beneficial 
  Ownership |     | Percent of
  
  Outstanding 
  Common Stock |  
|                                                                                                          |  |                                                   |     |                                             |  
|Leng You-Bin(1)                                                                                           |  | 8,881,135                                         |     | 62.8                                        | % | 
|Liu Hua(1)                                                                                                |  | 19,000                                            |     | *                                           |   | 
|Hui-Lan Lee(1)                                                                                            |  | 23,000                                            |     | *                                           |   | 
|Liu Sheng-Hui(1)                                                                                          |  | 269,576                                           |     | 1.8                                         |   | 
|James C. Lewis(1)                                                                                         |  | 27,000                                            | (2) | *                                           |   | 
|Kirk Downing(1)                                                                                           |  | 4,900                                             |     | *                                           |   | 
|Pike Capital Partners LP/ Pike Capital
  Partners (QP) LP 275 Madison Avenue Suite 418 New York, NY 10016 |  | 2,331,519                                         | (3) | 16.7                                        | % | 
|Charles Hung (4)                                                                                          |  | 182,165                                           |     | 1.7                                         | % | 
|American Eastern Group, Inc.(4)                                                                           |  | 400,000                                           | (5) | 6.1                                         | % | 
|American Eastern Securities, Inc.(4)                                                                      |  | 157,947                                           | (5) | 5.8                                         | % | 
|All executive officers and directors as a
  group (6 persons)                                             |  | 9,224,611                                         |     | 67.5                                        | % | 

|  |                
|- | ---------------
|* | Less than
  1%.

(1) The
address for this beneficial owner is c/o American Dairy, Inc., C-16 ShinChen
International Bldg., No. 10, Jiu-shen Road, Zho Yan Chu, Beijing, The Peoples Republic
of China.

(2) Mr. Lewis
holds such shares jointly with his spouse.

(3) Includes
250,000 shares underlying warrants and 575,000 shares receivable on conversion
of principal and interest on notes. 12.19% of these shares are held in the name
of Pike Capital Partners (QP) LP, and 87.81% are held in the name of Pike
Capital Partners LP. Dan Pike is a principal of both Pike Capital Partners LP
and Pike Capital Partners (QP) LP and has voting and dispositive power over the
listed shares for both entities.

(4) The
address for each of Mr. Hung and these two entities is 865 S. Figueroa Street,
#3340, Los Angeles CA 90017. Mr. Hung is a principal of both American Eastern
Group, Inc. and American Eastern Securities, Inc. and has voting and
dispositive power over all of the listed shares in addition to those held in
his name.

(5) Includes
warrants to purchase 323,982 shares of the common stock of American Dairy.

42

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Item 13. Certain Relationships and Related
Transactions, and Director Independence

Pike Capital
Partners LP together with its affiliate Pike Capital Partners (QP) LP
beneficially own in excess of 5% of our issued and outstanding common stock. We
have entered into the following transactions with Pike Capital Partners LP
and/or Pike Capital Partners (QP) LP:

Effective
April 27, 2005, the Company issued to Pike Capital Partners LP a Series A
Convertible Note in the principal amount of $3,000,000 that bears interest at 6
1/2% per annum for a term of one year, which is convertible into the common
stock of the Company at $8.00 per share at any time during the term of the
note. The sale was made to one accredited institutional investor, as defined by
Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as
amended. The offering was made in reliance upon an exemption from registration
under Section 4(2) of the Act. During 2006, this note was converted in
accordance with its terms into 399,375 shares of the Companys common stock
which were allocated between Pike Capital Partners LP and Pike Capital Partners
(QP) LP.

Effective June
30, 2005, the Company issued to Pike Capital Partners LP two of its Series B
Convertible Notes in the total principal amount of $5,000,000 that bear
interest at 7 1/2% per annum for a term of two years, which are convertible
into the common stock of the Company at $10.00 per share at any time during the
two-year term of the note. The sale was made to one accredited institutional
investor, as defined by Rule 501(a) of Regulation D promulgated under the
Securities Act of 1933, as amended. The offering was made in reliance upon an
exemption from registration under Section 4(2) of the Act. The entire principal
amount plus accrued interest on these notes remain outstanding.

Pike Capital
Partners LP and Pike Capital Partners (QP) LP also hold warrants to purchase
575,000 shares of our common stock in the aggregate.

Review, Approval or Ratification of
Transactions with Related Persons

Although
American Dairy has not adopted formal procedures for the review, approval or ratification
of transactions with related persons, we adhere to a general policy that such
transactions should only be entered into if they are on terms that, on the
whole, are no more favorable, or no less favorable, than those available from
unaffiliated third parties and their approval is in accordance with applicable
law. Such transactions require the approval of our board of directors.

Corporate Governance

The Board of
Directors has determined that Hui-Lan Lee, Kirk Downing and James C. Lewis, are
each an independent director under the general guidelines for determining
director independence of the NYSE Arca and the rules of the SEC.

Item 14. Principal Accountant Fees and
Services

Fees paid to
principal accountants are as follows:

|                                                            |  |            |         |                        |   |          |  |                  |        |  |   |     | 
|----------------------------------------------------------- |  | ---------- | ------- | ---------------------- | - | -------- |  | ---------------- | ------ |  | - | --- | 
|                                                            |  |            |         |                        |   |          |  |                  |       
|Name                                                        |  | Audit Fees |         | Audit
  Related
  Fees |   | Tax Fees |  | All Other
  Fees |       
|                                                            |  |            |         |                        |   |          |  |                  |       
|Weinberg
  & Company, P.A for fiscal year ended             |  |            |         |                        |   |          |  |                  |        |  |   |     | 
|December 31,
  2004                                         |  | $          | 8,044   |                        | $ | -0-      |  | $                | -0-    |  | $ | -0- | 
|December 31,
  2005                                         |  | $          | -0-     |                        | $ | -0-      |  | $                | -0-    |  | $ | -0- | 
|December 31,
  2006                                         |  | $          | -0-     |                        | $ | -0-      |  | $                | -0-    |  | $ | -0- | 
|                                                            |  |            |         |                        |   |          |  |                  |        |  |   |     | 
|Murrell,
  Hall, McIntosh & Co., PLLP for fiscal year ended |  |            |         |                        |   |          |  |                  |        |  |   |     | 
|December 31,
  2004                                         |  | $          | 19,000  |                        | $ | 1,250    |  | $                | 5,000  |  | $ | -0- | 
|December 31,
  2005                                         |  | $          | 42,500  |                        | $ | 8,900    |  | $                | 5,500  |  | $ | -0- | 
|December 31,
  2006                                         |  | $          | 167,466 |                        | $ | 60,000   |  | $                | 12,824 |  | $ | -0- | 
|                                                            |  |            |         |                        |   |          |  |                  |        |  |   |     | 

43

---



The Audit
Committee of the Board of Directors evaluated the scope and cost of the audit
for its fiscal year ended December 31, 2006 before our auditor rendered its
audit and non-audit services.

Item 15. Exhibits

(a) Reports on
Form 8-K None

(b) Exhibits

44

---



SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.

|              |     |                                     
|------------- | --- | ------------------------------------
|June 13, 2007 |     | AMERICAN DAIRY, INC.                
|              |     |                                     
|              | By: | /s/ Leng You-Bin                    
|              |     |                                     
|              |     | Leng
  You-Bin, Chief Executive     
|              |     | Officer, and
  President            
|              |     |                                     
|              | By: | /s/ Liu Hua                         
|              |     |                                     
|              |     | Liu Hua,
  Chief Financial Officer, 
|              |     | Principal
  Accounting and Financial
|              |     | Officer and
  Treasurer             

In accordance
with the Exchange Act, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.

|                                             |  |              
|-------------------------------------------- |  | -------------
|/s/ Leng You-Bin                             |  | June 13, 2007
|                                             |  |              
|Leng
  You-Bin, Director, Chief              |  |              
|Executive
  Officer and President            |  |              
|                                            
|/s/ Liu Hua                                  |  |              
|                                             |  | June 13, 2007
|Liu Hua,
  Director, Chief Financial         |  |              
|Officer,
  Principal Accounting and          |  |              
|Financial
  Officer, Secretary and Treasurer |  |              
|                                             |  |              
|/s/ Liu Sheng-Hui                            |  |              
|                                             |  | June 13, 2007
|Liu
  Sheng-Hui, Director                    |  |              
|                                             |  |              
|                                             |  | June 13, 2007
|Hui-Lan Lee,
  Director                      |  |              
|                                             |  |              
|                                             |  | June 13, 2007
|Kirk Downing, Director                       |  |              
|                                             |  |              
|                                             |  | June 13, 2007
|James Lewis, Director                        |  |              

45

---



REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS 
AMERICAN DAIRY, INC.

We have
audited the accompanying consolidated balance sheets of American Dairy, Inc.
and subsidiaries (the Company) as of December 31, 2006 and 2005 and the
related consolidated statements of operations, stockholders equity and cash
flows for each of the three years in the period ended December 31, 2006. These
consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted
our audits in accordance with standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required, nor
have we been engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Companys internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of American Dairy,
Inc. and subsidiaries as of December 31, 2006 and 2005 and the results of their
operations and cash flows for each of the three years in the period ended
December 31, 2006, in conformity with accounting principles generally accepted
in the United States of America.

/s/ Murrell,
Hall, McIntosh & Co., PLLP

Oklahoma City,
Oklahoma
March 28, 2007

F-1

---



AMERICAN DAIRY, INC.
CONSOLIDATED BALANCE SHEETS 
AS OF DECEMBER 31, 2006 AND 2005

ASSETS

|                                                                              |  |      |             |      |   |            | 
|----------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ---------- | 
|                                                                              |  | 2006 |             | 2005 |  
|                                                                              |  |      |             |      |  
|Current assets:                                                               |  |      |             |      |   |            | 
|Cash                                                                          |  | $    | 39,473,910  |      | $ | 12,958,435 | 
|Accounts receivable                                                           |  |      |             |      |   |            | 
|Trade-net of allowance for bad debts of
  $322,520 and $309,461, respectively |  |      | 5,459,760   |      |   | 4,132,931  | 
|Employees                                                                     |  |      | 433,121     |      |   | 488,413    | 
|Other                                                                         |  |      | 452,728     |      |   | 1,516,105  | 
|Notes receivable                                                              |  |      | 230,179     |      |   |           | 
|Inventories                                                                   |  |      | 13,913,766  |      |   | 9,622,347  | 
|Prepaid expenses                                                              |  |      | 664,530     |      |   | 875,031    | 
|Advances to suppliers                                                         |  |      | 1,301,935   |      |   | 1,216,172  | 
|Other tax refundable                                                          |  |      | 1,365,214   |      |   | 500,892    | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      |             |      |   |            | 
|Total current assets                                                          |  |      | 63,295,143  |      |   | 31,310,326 | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      |             |      |   |            | 
|Property and equipment:                                                       |  |      |             |      |   |            | 
|Fixed assets, net of accumulated
  depreciation                               |  |      | 36,981,569  |      |   | 34,685,898 | 
|Construction in progress                                                      |  |      | 9,433,148   |      |   | 3,373,833  | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      | 46,414,717  |      |   | 38,059,731 | 
|                                                                              |  |      |             |      |   |            | 
|Other assets:                                                                 |  |      |             |      |   |            | 
|Goodwill                                                                      |  |      | 1,460,695   |      |   |           | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      | 1,460,695   |      |   |           | 
|                                                                              |  |      |             |      |   |            | 
|                                                                              |  |      |             |      |   |            | 
|Total assets                                                                  |  | $    | 111,170,555 |      | $ | 69,370,057 | 
|                                                                              |  |      |             |      |   |            | 

See accompanying summary of accounting
policies and notes to financial statements.

F-2

---



AMERICAN DAIRY, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2006 AND 2005

LIABILITIES AND STOCKHOLDERS EQUITY

|                                                                                                                                                                     |  |      |             |      |   |            | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ---------- | 
|                                                                                                                                                                     |  | 2006 |             | 2005 |  
|                                                                                                                                                                     |  |      |             |      |  
|Current liabilities:                                                                                                                                                 |  |      |             |      |   |            | 
|Accounts payable and accrued expenses                                                                                                                                |  | $    | 13,263,315  |      | $ | 11,855,430 | 
|Current portion of long term debt                                                                                                                                    |  |      | 5,103,197   |      |   | 102,466    | 
|Advances from related parties                                                                                                                                        |  |      | 119,911     |      |   | 932,942    | 
|Advances from employees                                                                                                                                              |  |      | 735,294     |      |   | 947,596    | 
|Deferred income                                                                                                                                                      |  |      | 2,145,325   |      |   | 12,073,781 | 
|Short-term notes and loans payable                                                                                                                                   |  |      | 13,122,868  |      |   | 7,323,801  | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|Total current liabilities                                                                                                                                            |  |      | 34,489,910  |      |   | 33,236,016 | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|Long term debt, net of current portion
  shown above, net of discount of $1,715,871 as of December 31, 2006                                                          |  |      | 16,936,654  |      |   | 5,543,517  | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|Minority interest                                                                                                                                                    |  |      |            |      |   | 493,500    | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|Stockholders equity:                                                                                                                                                |  |      |             |      |   |            | 
|Common stock, $.001 par value; 50,000,000
  shares authorized; 15,831,820 and 14,132,824 shares issued and outstanding at
  December 31, 2006 and 2005, respectively |  |      | 15,832      |      |   | 14,133     | 
|Additional paid-in capital                                                                                                                                           |  |      | 17,834,429  |      |   | 9,208,837  | 
|Retained earnings                                                                                                                                                    |  |      | 40,177,074  |      |   | 20,268,793 | 
|Accumulated other comprehensive income                                                                                                                               |  |      | 1,716,656   |      |   | 605,261    | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|Total stockholders equity                                                                                                                                           |  |      | 59,743,991  |      |   | 30,097,024 | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|                                                                                                                                                                     |  |      |             |      |   |            | 
|Total liabilities and stockholders
equity                                                                                                                           |  | $    | 111,170,555 |      | $ | 69,370,057 | 
|                                                                                                                                                                     |  |      |             |      |   |            | 

See accompanying summary of accounting
policies and notes to financial statements.

F-3

---



AMERICAN DAIRY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

|                                            |  |      |             |      |   |            |   |   |            |  
|------------------------------------------- |  | ---- | ----------- | ---- | - | ---------- | - | - | ---------- | -
|                                            |  | 2006 |             | 2005 |   | 2004       |  
|                                            |  |      |             |      |   |            |  
|SALES                                       |  | $    | 122,799,191 |      | $ | 68,023,903 |   | $ | 37,416,223 |  
|COST OF GOODS SOLD                          |  |      | 70,221,023  |      |   | 38,715,895 |   |   | 18,006,918 |  
|                                            |  |      |             |      |   |            |   |   |            |  
|Gross Profit                                |  |      | 52,578,168  |      |   | 29,308,008 |   |   | 19,409,305 |  
|                                            |  |      |             |      |   |            |   |   |            |  
|OPERATING AND ADMINISTRATIVE EXPENSES:      |  |      |             |      |   |            |   |   |            |  
|Distribution expenses                       |  |      | 29,397,910  |      |   | 16,742,578 |   |   | 13,486,232 |  
|General and administrative
expenses         |  |      | 5,218,526   |      |   | 2,484,039  |   |   | 1,313,358  |  
|Depreciation                                |  |      | 266,154     |      |   | 161,450    |   |   | 54,419     |  
|                                            |  |      |             |      |   |            |   |   |            |  
|                                            |  |      | 34,882,590  |      |   | 19,388,067 |   |   | 14,854,009 |  
|                                            |  |      |             |      |   |            |   |   |            |  
|Income from operations                      |  |      | 17,695,578  |      |   | 9,919,941  |   |   | 4,555,296  |  
|                                            |  |      |             |      |   |            |   |   |            |  
|OTHER INCOME (EXPENSE):                     |  |      |             |      |   |            |   |   |            |  
|Refunds of VAT taxes                        |  |      | 3,344,635   |      |   | 1,502,127  |   |   | 1,144,060  |  
|Other income (expenses)                     |  |      | 64,909      |      |   | 718,624    |   |   | 345,707    |  
|Gain on disposal of assets                  |  |      | (147        | )    |   | 9,125      |   |   | 693        |  
|Interest and finance costs                  |  |      | (1,196,694  | )    |   | (522,812   | ) |   | (49,353    | )
|                                            |  |      |             |      |   |            |   |   |            |  
|                                            |  |      | 2,212,703   |      |   | 1,707,064  |   |   | 1,441,107  |  
|                                            |  |      |             |      |   |            |   |   |            |  
|MINORITY INTEREST                           |  |      |            |      |   | 2,424      |   |   | 356        |  
|                                            |  |      |             |      |   |            |   |   |            |  
|INCOME BEFORE INCOME TAXES                  |  |      | 19,908,281  |      |   | 11,629,429 |   |   | 5,996,759  |  
|(PROVISION FOR) BENEFIT FROM                |  |      |             |      |   |            |   |   |            |  
|INCOME TAXES                                |  |      |            |      |   |           |   |   | 261,621    |  
|                                            |  |      |             |      |   |            |   |   |            |  
|NET INCOME                                  |  |      | 19,908,281  |      |   | 11,629,429 |   |   | 6,258,380  |  
|Other comprehensive income:                 |  |      |             |      |   |            |   |   |            |  
|Foreign currency translation
adjustment     |  |      | 1,111,395   |      |   | 605,261    |   |   |           |  
|                                            |  |      |             |      |   |            |   |   |            |  
|TOTAL COMPREHENSIVE INCOME                  |  | $    | 21,019,676  |      | $ | 12,234,690 |   | $ | 6,258,380  |  
|                                            |  |      |             |      |   |            |   |   |            |  
|BASIC NET INCOME PER COMMON SHARE           |  | $    | 1.35        |      | $ | 0.83       |   | $ | 0.52       |  
|                                            |  |      |             |      |   |            |   |   |            |  
|WEIGHTED AVERAGE BASIC SHARES OUTSTANDING   |  |      | 14,755,576  |      |   | 13,931,006 |   |   | 12,077,085 |  
|                                            |  |      |             |      |   |            |   |   |            |  
|DILUTED NET INCOME PER COMMON SHARE         |  | $    | 1.14        |      | $ | 0.74       |   | $ | 0.47       |  
|                                            |  |      |             |      |   |            |   |   |            |  
|WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING |  |      | 18,056,143  |      |   | 16,057,073 |   |   | 13,455,700 |  
|                                            |  |      |             |      |   |            |   |   |            |  

See accompanying summary of accounting
policies and notes to financial statements.

F-4

---





AMERICAN DAIRY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY 
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

|                                         |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|---------------------------------------- |  | -------------------- |  | -------------- | ------ | ------------------------ | ------ | -------------------------------------------- | - | - | ---------- |  | - | --------- |  | - | ---------- | -
|                                         |  | Common Stock         |  |                |        |                          |        |                                              |   |   |           
|                                         |  |                      |  |                |        |                          |        | Accumulated
  Other
  Comprehensive
  Income |   |   |           
|                                         |  | Number
  of
  Shares |  | $0.001parValue |        | AdditionalPaid-InCapital |        | RetainedEarnings                             |   |   |            | 
|                                         |  |                      |  |                |        |                          |        |                                             
|                                         |  |                      |  |                |        |                          | Totals |                                             
|                                         |  |                      |  |                |        |                          |        |                                              |   |   |            |  |  
|Balance, December 31, 2003               |  | 11,750,970           |  |                | 11,751 |                          |        | 3,228,298                                    |   |   | 2,380,984  |  |   |          |  |   | 5,621,033  |  
|Shares issued for services               |  | 46,000               |  |                | 46     |                          |        | 96,554                                       |   |   |           |  |   |          |  |   | 96,600     |  
|Stock issued for cash                    |  | 1,759,384            |  |                | 1,759  |                          |        | 4,671,147                                    |   |   |           |  |   |          |  |   | 4,672,906  |  
|Less offering costs                      |  |                     |  |                |       |                          |        | (476,825                                     | ) |   |           |  |   |          |  |   | (476,825   | )
|Net income for the year ended            |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|December 31, 2004                        |  |                     |  |                |       |                          |        |                                             |   |   | 6,258,380  |  |   |          |  |   | 6,258,380  |  
|                                         |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|Balance, December 31, 2004               |  | 13,556,354           |  | $              | 13,556 |                          | $      | 7,519,174                                    |   | $ | 8,639,364  |  | $ |          |  | $ | 16,172,094 |  
|Stock issued for cash                    |  | 428,570              |  |                | 429    |                          |        | 749,571                                      |   |   |           |  |   |          |  |   | 750,000    |  
|Stock issued for services                |  | 147,900              |  |                | 148    |                          |        | 940,092                                      |   |   |           |  |   |          |  |   | 940,240    |  
|COMPREHENSIVE INCOME:                    |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|Foreign currency translation adjustments |  |                     |  |                |       |                          |        |                                             |   |   |           |  |   | 605,261   |  |   | 605,261    |  
|Net income for the year ended            |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|December 31, 2005                        |  |                     |  |                |       |                          |        |                                             |   |   | 11,629,429 |  |   |          |  |   | 11,629,429 |  
|                                         |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|Balance, December 31, 2005               |  | 14,132,824           |  | $              | 14,133 |                          | $      | 9,208,837                                    |   | $ | 20,268,793 |  | $ | 605,261   |  | $ | 30,097,024 |  
|Stock issued for cash                    |  | 1,196,251            |  |                | 1,197  |                          |        | 2,005,658                                    |   |   |           |  |   |          |  |   | 2,006,855  |  
|Stock issued for services                |  | 103,370              |  |                | 103    |                          |        | 1,262,522                                    |   |   |           |  |   |          |  |   | 1,262,625  |  
|Stock issued for note conversion         |  | 399,375              |  |                | 399    |                          |        | 3,194,601                                    |   |   |           |  |   |          |  |   | 3,195,000  |  
|Paid in capital for warrant extension    |  |                     |  |                |       |                          |        | 290,952                                      |   |   |           |  |   |          |  |   | 290,952    |  
|Warrants issued with convertible notes   |  |                     |  |                |       |                          |        | 1,871,859                                    |   |   |           |  |   |          |  |   | 1,871,859  |  
|COMPREHENSIVE INCOME:                    |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|Foreign currency translation adjustments |  |                     |  |                |       |                          |        |                                             |   |   |           |  |   | 1,111,395 |  |   | 1,111,395  |  
|Net income for the year ended            |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|December 31, 2006                        |  |                     |  |                |       |                          |        |                                             |   |   | 19,908,281 |  |   |          |  |   | 19,908,281 |  
|                                         |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  
|Balance, December 31, 2006               |  | 15,831,820           |  | $              | 15,832 |                          | $      | 17,834,429                                   |   | $ | 40,177,074 |  | $ | 1,716,656 |  | $ | 59,743,991 |  
|                                         |  |                      |  |                |        |                          |        |                                              |   |   |            |  |   |           |  |   |            |  

See accompanying summary of accounting
policies and notes to financial statements.

F-5

---



AMERICAN DAIRY, INC. 
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

|                                                                |  |      |             |      |   |             |   |   |             |  
|--------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | - | - | ----------- | -
|                                                                |  | 2006 |             | 2005 |   | 2004        |  
|                                                                |  |      |             |      |   |             |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                           |  |      |             |      |   |             |   |   |             |  
|Net income                                                      |  | $    | 19,908,281  |      | $ | 11,629,429  |   | $ | 6,258,380   |  
|Adjustments to reconcile net income to
  operating activities - |  |      |             |      |   |             |   |   |             |  
|Depreciation                                                    |  |      | 1,814,064   |      |   | 1,000,596   |   |   | 261,294     |  
|Provision for doubtful
accounts                                 |  |      | 13,059      |      |   | 309,461     |   |   | 83,677      |  
|Compensation expense for stock
issued                           |  |      | 1,262,624   |      |   | 940,240     |   |   | 96,600      |  
|Compensation expense for warrant
extension                      |  |      | 290,952     |      |   |            |   |   |            |  
|Interest expense from amortization of
loan
  discount           |  |      | 155,988     |      |   |            |   |   |            |  
|Gain on disposal of assets                                      |  |      | (146        | )    |   | (9,125      | ) |   | (693        | )
|Changes in assets and liabilities:                              |  |      |             |      |   |             |   |   |             |  
|(Increase) decrease in -                                        |  |      |             |      |   |             |   |   |             |  
|Accounts and notes receivable                                   |  |      | (221,219    | )    |   | (5,176,111  | ) |   | 537,762     |  
|Inventories                                                     |  |      | (4,291,419  | )    |   | (4,579,949  | ) |   | 32,073      |  
|Prepaid expenses                                                |  |      | 210,501     |      |   | (309,962    | ) |   | 672,711     |  
|Advances to suppliers                                           |  |      | (85,763     | )    |   | (908,505    | ) |   | 322,559     |  
|Other tax refundable                                            |  |      | (864,322    | )    |   | (463,511    | ) |   | 522,563     |  
|Increase (decrease) in -                                        |  |      |             |      |   |             |   |   |             |  
|Accounts payable and accrued
expenses                           |  |      | 1,602,885   |      |   | 3,115,205   |   |   | 2,533,031   |  
|Advances from related parties                                   |  |      | (813,031    | )    |   |            |   |   |            |  
|Advances from employees                                         |  |      | (212,302    | )    |   |            |   |   |            |  
|Deferred income                                                 |  |      | (9,928,456  | )    |   | 2,379,258   |   |   | 4,826,778   |  
|Tax payable                                                     |  |      |            |      |   |            |   |   | 211,761     |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|Net cash provided by operating activities                       |  |      | 8,841,696   |      |   | 7,927,026   |   |   | 16,358,496  |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                           |  |      |             |      |   |             |   |   |             |  
|Purchase of fixed assets                                        |  |      | (10,324,891 | )    |   | (15,326,899 | ) |   | (5,241,177  | )
|Payments received (loans made) on note
  receivable             |  |      | (230,179    | )    |   | 217,391     |   |   |            |  
|Disposal of assets                                              |  |      |            |      |   | 23,834      |   |   | 33,816      |  
|Deposit on land, building and
equipment                         |  |      |            |      |   |            |   |   | 417,678     |  
|Acquisition of minority
interest                                |  |      | (1,954,195  | )    |   |            |   |   |            |  
|Contributions by (repayments of)
minority
  interest            |  |      | (493,500    | )    |   | 313,042     |   |   | 180,458     |  
|Construction in progress                                        |  |      |            |      |   |            |   |   | (12,685,851 | )
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|Net cash used in investing activities                           |  |      | (12,509,265 | )    |   | (14,772,632 | ) |   | (17,295,076 | )
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                           |  |      |             |      |   |             |   |   |             |  
|Proceeds from short-term debt                                   |  |      | 13,376,572  |      |   | 8,548,705   |   |   | 1,660,194   |  
|Proceeds from long-term debt                                    |  |      | 19,310,651  |      |   | 5,000,000   |   |   |            |  
|Repayments of short-term debt                                   |  |      | (4,939,564  | )    |   | (1,466,450  | ) |   | (1,185,726  | )
|Repayments of long-term debt                                    |  |      | (2,554,724  | )    |   | (70,033     | ) |   |            |  
|(Repayment of) advance from
shareholder                         |  |      |            |      |   | (208,639    | ) |   | 232,946     |  
|Sale of common stock and capital
  contribution                 |  |      | 3,878,714   |      |   | 750,000     |   |   | 4,672,906   |  
|Payment of offering costs                                       |  |      |            |      |   |            |   |   | (476,825    | )
|Purchase obligation
(repayment)                                 |  |      |            |      |   |            |   |   | (362,318    | )
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|Net cash provided by financing activities                       |  |      | 29,071,649  |      |   | 12,553,583  |   |   | 4,541,177   |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|Effect of exchange rate change on cash and
  cash equivalents   |  |      | 1,111,395   |      |   | 605,261     |   |   |            |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|NET INCREASE IN CASH AND EQUIVALENTS                            |  |      | 25,404,080  |      |   | 5,707,977   |   |   | 3,604,597   |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|CASH AND CASH EQUIVALENTS, BEGINNING OF
  PERIOD                |  |      | 12,958,435  |      |   | 6,645,197   |   |   | 3,040,600   |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|                                                                |  |      |             |      |   |             |   |   |             |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                        |  | $    | 39,473,910  |      | $ | 12,958,435  |   | $ | 6,645,197   |  
|                                                                |  |      |             |      |   |             |   |   |             |  

See accompanying summary of accounting
policies and notes to financial statements.

F-6

---



AMERICAN DAIRY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004 
(Continued)

|                                                     |  |      |         |      |   |         |  |   |        | 
|---------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | - | ------ | 
|                                                     |  | 2006 |         | 2005 |   | 2004    | 
|                                                     |  |      |         |      |   |         | 
|SUPPLEMENTAL
  DISCLOSURES OF CASH FLOW INFORMATION: |  |      |         |      |   |         |  |   |        | 
|Interest paid, net of capitalized amounts            |  | $    | 409,321 |      | $ | 139,985 |  | $ | 37,076 | 
|                                                     |  |      |         |      |   |         |  |   |        | 
|                                                     |  |      |         |      |   |         |  |   |        | 
|Income taxes paid                                    |  | $    |        |      | $ |        |  | $ |       | 
|                                                     |  |      |         |      |   |         |  |   |        | 

SUPPLEMENTAL
DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

During the
years ended December 31, 2006, 2005, and 2004, the Company issued for services
rendered 103,370, 147,900, and 46,000 common shares, valued at $1,262,624,
$940,240, and $96,600, respectively.

During 2006
and 2005, construction costs of $2,565,515 and $11,347,000, respectively, were
transferred from construction in progress to fixed assets.

During the
year ended December 31, 2004, the Company issued 523,305 warrants to
underwriters as additional consideration for funds raised in private placements
during the year. The exercise price on these warrants ranged from $1.50 per
share to $2.70 per share and all had a three year life. The fair market value
at the date of issuance of these warrants totaled $862,245. The effect of the
issuance is to increase additional paid in capital by the fair value of the
warrants issued with an offset to additional paid in capital in the same
amount, since offering costs are treated as reductions in additional paid in
capital.

During 2004,
the net assets of Sanhao Dairy were transferred to Feihe Dairy by way of distribution
to members effective July 1, 2004.

During April
2006, holders of $3,000,000 in convertible debt elected to convert their notes
plus accrued interest into 399,375 shares of the Companys common stock. The
conversion price was $8.00 per share.

During August
2006, the Company modified the terms of certain warrants issued which extended
the expiration date and allowed for a cashless exercise. In connection with
this transaction, the Company valued these modifications at $290,952 and
recognized compensation expense in that amount.

During October
2006, the Company closed an unregistered offering of convertible notes in the
aggregate principal amount of $18.2 million, also issuing to debenture holders
warrants to purchase approximately 251,000 shares of the Companys common stock
at an exercise price of $14.50 per share. In connection with this transaction,
loan discount of $1,871,859 has been recognized, with amortization for 2006 of
$155,988.

See accompanying summary of accounting
policies and notes to financial statements.

F-7

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

1. DESCRIPTION
OF BUSINESS

ORGANIZATIONAL STRUCTURE

American
Dairy, Inc. (American Dairy or the Company) was incorporated in the State
of Utah on December 31, 1985, originally with the name of Gaslight, Inc. It was
inactive until March 30, 1988 when it changed its corporate name to Lazarus
Industries, Inc. and engaged in the business of manufacturing and marketing
medical devices. This line of business was discontinued in 1991, and it became
a non-operating public company shell. During 2003, the Company changed its name
to American Dairy, Inc.

Effective May
7, 2003, American Dairy completed the acquisition of 100% of the issued and
outstanding capital stock of American Flying Crane Corporation (AFC), a
Delaware corporation. As a result, AFC became a wholly owned subsidiary of
American Dairy.

AFC was
incorporated on January 15, 2002 in Delaware, with 50,000,000 authorized shares
of common stock at a par value of $0.0001 per share and 10,000 of which
authorized shares are currently issued and outstanding. AFC owns 100% of the
registered capital of Heilongjiang Feihe Dairy Co., Limited (Feihe Dairy) and
Feihe Dairy in turn owns 100% of the registered shares of BaiQuan Feihe Dairy
Co. Limited (BaiQuan Dairy) and Heilongjiang Sanhao Dairy Co., Limited (Sanhao
Dairy) which was liquidated into BaiQuan Dairy during 2004, and 95% of Beijing
Feihe Biotechnology Scientific and Commercial Co., Limited (Beijing Feihe) with
the other 5% being held in trust for the Company. AFC also owns 97% of the
registered capital of Shanxi Feihesantai Biotechnology Scientific and
Commercial Co., Limited (Shanxi) formed to develop and operating a walnut
processing plant.

Currently, the
principal core activity of AFC is investment holdings, while the principal core
activities of Feihe Dairy, Sanhao Dairy and BiaQuan Dairy are manufacturing and
distribution of dairy products under the Feihe trademarks. The principal core
activity of Shanxi is the production and distribution of walnut powder. Shanxi
commenced operations in October 2005. The subsidiaries principal country of
operations is the Peoples Republic of China (PRC).

Included in
the consolidated financial statements are the following subsidiaries:

|  |                                                                          
|- | -------------------------------------------------------------------------
|o | American
  Flying Crane Corporation                                      
|  |                                                                          
|o | Langfang
  Flying Crane Dairy Products Co., Limited                      
|  |                                                                          
|o | GanNan
  Flying Crane Dairy Products Co., Limited                        
|  |                                                                          
|o | Heilongjiang
  Feihe Dairy Co., Limited                                  
|  |                                                                          
|o | BaiQuan Feihe
  Dairy Co., Limited                                       
|  |                                                                          
|o | Beijing
  Feihe Biotechnology Scientific and Commercial Co., Limited     
|  |                                                                          
|o | Shanxi
  Feihesantai Biotechnology Scientific and Commercial Co., Limited

2. BASIS OF
PREPARATION OF FINANCIAL STATEMENTS

The Companys
consolidated financial statements include the accounts of American Dairy, Inc.,
its wholly-owned subsidiaries, AFC, Feihe Dairy, Beijing Feihe, and BaiQuan
Feihe and its 97% owned subsidiary, Shanxi Feihe. The consolidated financial
statements are prepared in accordance with accounting principles generally
accepted in the United States of America.

On May 7,
2003, American Dairy, Inc. acquired all of the outstanding common stock of
American Flying Crane Corporation. For accounting purposes, the acquisition has
been treated as a recapitalization of American Flying Crane Corporation with
American Flying Crane Corporation as the acquirer. The historical financial
statements presented both before and after May 7, 2003 are those of American
Flying Crane Corporation.

F-8

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

On December
31, 2002, American Dairy, Inc. (formerly Lazarus Industries Inc.(Lazarus))
had 7,485,147 shares issued and outstanding. In preparation for the acquisition
of AFC, Lazarus did a 19 to 1 stock split which reduced the shares outstanding
by 7,090,994 shares. This was followed by the repurchase of an additional
258,623 shares by Lazarus for $20,000 leaving 135,530 shares outstanding. On
May 7, 2003, Lazarus issued 9,650,000 shares of its common stock for the
acquisition of 100% of the outstanding stock of AFC.

In accordance
with the requirements of SEC Accounting and Disclosure Rules and Practices
Appendix B, the May 7, 2003 transaction was treated as a recapitalization of
AFC as it was deemed to be the accounting acquirer. Furthermore, in accordance
with the requirements of Current Issue and Rulemaking Projects (CIRP)
T.VI.G-11-98, the historical financial statements prior to the acquisition are
those of the accounting acquirer, although (in absence of a name change) they
are labeled as those of the issuer. Therefore, for financial reporting
purposes, the recapitalized financial statements of AFC were rolled back. As of
December 31, 2002, the common shares outstanding include the 9,650,000 shares
issued to the AFC shareholders plus the 135,530 shares still owned by the
original Lazarus shareholders for a total of 9,785,530 shares.

3. SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES

The following
is a summary of significant accounting policies:

CONSOLIDATION
POLICY - All significant inter-company transactions and balances within the
Company are eliminated on consolidation.

CASH AND
EQUIVALENTS - The Company considers all highly liquid debt instruments
purchased with maturity period of three months or less to be cash equivalents.
The carrying amounts reported in the accompanying consolidated balance sheet
for cash and cash equivalents approximate their fair value.

ACCOUNTS
RECEIVABLE - Provision is made against accounts receivable to the extent which
they are considered to be doubtful. Accounts receivable in the balance sheet is
stated net of such provision.

INVENTORIES -
Inventories comprise raw materials, consumables and goods held for resale and
are stated at the lower of cost or market value. Cost is calculated using the
weighted average method and includes any overhead costs incurred in bringing
the inventories to their present location and condition. Overhead costs
included in finished goods inventory include direct labor cost and other costs
directly applicable to the manufacturing process, including utilities,
supplies, repairs and maintenances, and depreciation expense.

Market value
represents the estimated selling price in the ordinary course of business less
the estimated costs necessary to complete the sale.

CONSTRUCTION-IN-PROGRESS
- All facilities purchased for installation, self-made or subcontracted are
accounted for as construction-in-progress. Construction-in-progress is recorded
at acquisition cost, including cost of facilities, installation expenses and
the interest capitalized during the course of construction for the purpose of
financing the project. Upon completion and readiness for use of the project,
the cost of construction-in-progress is to be transferred to fixed assets.

PROPERTY AND
EQUIPMENT - Property and equipment are recorded at cost. Expenditures for major
additions and improvements are capitalized, and minor replacements,
maintenance, and repairs are charged to expense as incurred. When property and
equipment are retired or otherwise disposed of, the cost and accumulated
depreciation are removed from the accounts and any resulting gain or loss is
included in the results of operations for the respective period. Depreciation
is provided over the estimated useful lives of the related assets using the
straight-line method less anticipated salvage values of 10% for financial

F-9

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

statement
purposes. Land use rights are being amortized on a straight-line basis over the
term of the use agreement. The estimated useful lives for significant property
and equipment categories are as follows:

|                          |  |         
|------------------------- |  | --------
|Buildings                 |  | 33 years
|Plant and
  machinery     |  | 20 years
|Motor
  vehicles          |  | 9 years 
|Computers
  and equipment |  | 5 years 

The Company
reviews the carrying value of property, plant, and equipment for impairment
whenever events and circumstances indicate that the carrying value of an asset
may not be recoverable from the estimated future cash flows expected to result
from its use and eventual disposition. In cases where undiscounted expected
future cash flows are less than the carrying value, an impairment loss is
recognized equal to an amount by which the carrying value exceeds the fair
value of assets. The factors considered by management in performing this
assessment include current operating results, trends and prospects, the manner
in which the property is used, and the effects of obsolescence, demand,
competition, and other economic factors. There were no impairments recorded at
December 31, 2006 or during the three years then ended.

DEFERRED
REVENUES - Revenue from the sale of goods or services is recognized when goods
are delivered or services are rendered. Receipts in advance for goods to be
delivered or services to be rendered in the subsequent year are carried forward
as deferred revenue.

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 delivered to customers and the title has passed. During 2005, one
customer represented 15% of sales. No customer represented over 10% of sales in
2006 and 2004.

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

Other income
includes compensation received from the State Bureau as incentive to relocate
from the previous factory premises, value added tax rebates, profit from the
sales of raw materials to third parties and write back of long outstanding
trade payables.

FOREIGN
CURRENCIES - The Companys principal country of operations is in The Peoples
Republic of China. The financial position and results of operations of the
Company are determined using the local currency (Renminbi or Yuan) as the
functional currency. The results of operations denominated in foreign currency
are translated at the average rate of exchange during the reporting period.
Assets and liabilities denominated in foreign currencies at the balance sheet
date are translated at the market rate of exchange ruling at that date. The
registered equity capital denominated in the functional currency is translated
at the historical rate of exchange at the time of capital contribution. All
translation adjustments resulting from the translation of the financial
statements into the reporting currency (US Dollars) are dealt with as an
exchange fluctuation reserve in shareholders equity.

Historically
the local currencys exchange rate had been tied to the US Dollar at a rate of
approximately 8.28 Yuan per US Dollar. Effective July 21, 2005 the Yuan was
revalued to an effective exchange rate of approximately 8.11 Yuan per US
Dollar. Subsequent to the revaluation the Yuan has been allowed to float within
a specified range. As of December 31, 2006 and 2005, the exchange rate was 7.82
and 8.11 Yuan per US Dollar, respectively.

TAXATION - In
accordance with the requirements of Statement of Financial accounting Standards
No. 109 Accounting Form Income Taxes, deferred tax assets and liabilities are
recognized for the future tax

F-10

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets, including tax loss and credit carryforwards, and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in the
deferred tax assets and deferred tax liabilities. The components of the
deferred tax assets and liabilities are individually classified as current and
non-current based on their characteristics. Deferred tax assets are reduced by
a valuation allowance when, in the opinion of management, it is more likely
that not that some portion or all of the deferred tax assets will not be
realized. For the years ended December 31, 2006, 2005, and 2004, Feihe Dairy
enjoyed a 100% tax holiday from enterprise income taxes. Therefore the only
timing differences giving rise to deferred income taxes during these periods
was the tax effect of the net operating loss carryforward at the parent company
level, which was subject to a 100% valuation allowance.

A provision
has not been made at December 31, 2006 for U.S. or additional foreign
withholding taxes on approximately $25,224,000 of undistributed earnings of
foreign subsidiaries because it is the present intention of management to
reinvest the undistributed earnings indefinitely in foreign operations.
Generally, such earnings become subject to U.S. tax upon the remittance of
dividends and under certain other circumstances. It is not practicable to
estimate the amount of deferred tax liability on such undistributed earnings.

Enterprise
income tax (EIT) is provided on the basis of the statutory profit for
financial reporting purposes, adjusted for income and expense items, which are
not assessable or deductible for income tax purposes. Under the Business
Promotion Policy Concerning Income Tax on Foreign Enterprises promulgated by
the QiQiHaEr City Municipal Government, foreign owned enterprises registered in
QiQiHaEr City are entitled to a tax holiday of seven years for full EIT
exemption as though the EIT has been paid during the tax holiday periods. The
preferential tax treatment commenced in 2003 and will expire in 2009.

Value added
tax

Value added
tax payable in the PRC is charged on an aggregated basis at a rate of 13% or
17% (depending on the type of goods involved) on the full price collected for
the goods sold or, in the case of taxable services provided, at a rate of 17%
on the charges for the taxable services provided, but excluding, in respect of
both goods and services, any amount paid in respect of value added tax included
in the price or charges, and less any deductible value added tax already paid
by the taxpayer on purchases of goods and services in the same financial year.

During 2004,
2005, and 2006, the Kendong County Government had a policy of refunding amounts
equal to 50% of the value added tax paid as an economic incentive to support
the local economy through the employment the Company provides at its production
facilities. These refunds which amounted to $3,344,635, $1,502,127 and
$1,144,060 for the fiscal years ended December 31, 2006, 2005, and 2004
respectively are reflected in other income on the financial statements.

PRODUCT
DISPLAY FEES - The Company has entered into a number of agreements with the
resellers of its products, whereby the Company pays the reseller an agreed upon
amount to display its products. As prescribed by the Emerging Issues Task Force
Issue 01-09: Accounting for Consideration Given by a Vendor to a Customer, the
Company has reduced sales by the amounts paid under these agreements. For the
years ended December 31, 2006, 2005, and 2004 these totaled $2,736,685,
$1,800,008 and $1,922,186 respectively.

ADVERTISING
COSTS - Advertising costs are charged to operations when incurred. Advertising
expense totaled $12,399,138, $3,380,218, and $2,742,257 during the years ended
December 31, 2006, 2005, and 2004, respectively.

F-11

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

SHIPPING AND
HANDLING COSTS - The Companys shipping and handling costs are included in cost
of sales for all periods presented.

RETIREMENT
BENEFIT COST - According to the Peoples Republic of China regulations on
pension, a company contributes to a defined contribution retirement plan
organized by municipal government in the province in which the Company was
registered and all qualified employees are eligible to participate in the plan.
Contributions to the plan are calculated at 20% of the employees salaries
above a fixed threshold amount and the employees contribute 4% while the
Company contributes the balance contribution of 16%. Wholly owned foreign
enterprises are exempted from contribution to the retirement plan.

FAIR VALUE OF
FINANCIAL STATEMENTS - The carrying amounts of certain financial instruments,
including cash, accounts receivable, note receivable, other receivables,
accounts payable, accrued expenses, advances from staff, notes payable and
other payables approximate their fair values as of December 31, 2006 because of
the relatively short-term maturity of these instruments.

USE OF
ESTIMATES - The preparation of financial statements in accordance with
generally accepted accounting principles require management to make estimates
and assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

RECLASSIFICATIONS
- Certain reclassifications have been made to the prior years financial
statements to conform to the current year presentation. These reclassifications
had no effect on previously reported results of operations or retained
earnings.

NEW ACCOUNTING
PRONOUNCEMENTS - In February 2006, the FASB issued Statement No. 155, Accounting
for Certain Hybrid Financial Instruments (SFAS No. 155), which amends FASB
Statements No. 133 and 140. This Statement permits fair value remeasurement for
any hybrid financial instrument containing an embedded derivative that would
otherwise require bifurcation, and broadens a Qualified Special Purpose Entitys
(QSPE) permitted holdings to include passive derivative financial instruments
that pertain to other derivative financial instruments. This Statement is
effective for all financial instruments acquired, issued or subject to a
remeasurement event occurring after the beginning of an entitys first fiscal
year beginning after September 15, 2006. This Statement has no current
applicability to the Companys financial statements. Management plans to adopt
this Statement on January 1, 2007 and it is anticipated that the initial
adoption of this Statement will not have a material impact on the Companys
financial position, results of operations, or cash flows.

In March 2006,
the FASB issued Statement No. 156, Accounting for Servicing of Financial
Assets - an amendment of FASB Statement No. 140 (SFAS No. 156). This
Statement is effective for fiscal years beginning after September 15, 2006.
This Statement requires that all separately recognized servicing assets and
servicing liabilities be initially measured at fair value, if practicable. This
Statement has no current applicability to the Companys financial statements.
Management plans to adopt this Statement on January 1, 2007 and it is
anticipated that the initial adoption of this Statement will not have a
material impact on the Companys financial position, results of operations, or
cash flows.

In June 2006,
the FASB issued Interpretation 48, Accounting for Uncertainty in Income Taxes
(FIN 48), an interpretation of FASB Statement No. 109, Accounting for Income
Taxes. FIN 48 clarifies the accounting and reporting for income taxes where
interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model
for the financial statement recognition, measurement, presentation and
disclosure of income tax uncertainties with respect to positions taken or
expected to be taken in income tax returns. FIN 48 is effective for fiscal
years beginning after December 15, 2006. This Statement has no current
applicability to the Companys financial statements. Management plans to adopt
this Statement on January 1, 2007 and it is anticipated that the initial adoption
of FIN 48 will not have a material impact on the Companys financial position,
results of operations, or cash flows.

F-12

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

In September
2006, the FASB issued Statement No. 157, Fair Value Measurements (SFAS No.
157). SFAS No. 157 addresses how companies should measure fair value when they
are required to use a fair value measure for recognition or disclosure purposes
under GAAP. SFAS No. 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
with earlier adoption permitted. Management is assessing the impact of the
adoption of this Statement.

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

In September
2006, the Securities Exchange Commission issued Staff Accounting Bulletin No.
108 (SAB No. 108). SAB No. 108 addresses how the effects of prior year
uncorrected misstatements should be considered when quantifying misstatements
in current year financial statements. SAB No. 108 requires companies to
quantify misstatements using a balance sheet and income statement approach and
to evaluate whether either approach results in quantifying an error that is
material in light of relevant quantitative and qualitative factors. When the
effect of initial adoption is material, companies will record the effect as a
cumulative effect adjustment to beginning of year retained earnings and
disclose the nature and amount of each individual error being corrected in the
cumulative adjustment. SAB No. 108 will be effective beginning January 1, 2007
and it is anticipated that the initial adoption of SAB No. 108 will not have a
material impact on the Companys financial position, results of operations, or
cash flows.

In February
2007, the FASB issued Statement No. 159 The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS 159). This statement permits companies
to choose to measure many financial assets and liabilities at fair value.
Unrealized gains and losses on items for which the fair value option has been
elected are reported in earnings. SFAS 159 is effective for fiscal years
beginning after November 15, 2007. The Company is currently assessing the
impact of SFAS 159 on its consolidated financial statements.

4.
CONCENTRATIONS OF BUSINESS AND CREDIT RISK

The Company maintains certain
bank accounts in the PRC which are not protected by FDIC insurance or other
insurance. As of December 31, 2006 the Company held $2,346,992 of cash balances
within the United States of which $2,136,992 was in excess of FDIC insurance
limits.

Geographic Concentration;
Fluctuations in Regional Economic Conditions. Nearly all of American Dairys
sales are concentrated in China. Accordingly, American Dairy is susceptible to
fluctuations in its business caused by adverse economic conditions in this
country. American Dairys products are priced higher than non-premium quality
dairy products. Although American Dairy believes that the quality, freshness,
flavor and absence of artificial ingredients in its products compensate for
this price differential, there can be no assurance that consumers will be
willing to pay more for such products in unfavorable economic conditions, or at
all. Difficult economic conditions in other geographic areas into which
American Dairy may expand may also adversely affect its business, operations
and finances.

F-13

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

The Company
provides credit in the normal course of business. Substantially all customers
are located in The Peoples Republic of China. The Company performs ongoing credit
evaluations of its customers and maintains allowances for doubtful accounts
based on factors surrounding the credit risk of specific customers, historical
trends, and other information.

Substantially
all of the Companys fixed assets and operations are located in the Peoples
Republic of China.

The Company is
self-insured for all risks and carries no liability or property insurance
coverage of any kind.

Substantially
all of the Companys profits are generated from operations in mainland China.

Payments of
dividends may be subject to some restrictions; therefore in accordance with
Rule 504/4.08 (e) (3) of Regulation S-X, the following are condensed parent
company only financial statements for the three years ended December 31, 2006.

AMERICAN DAIRY, INC. AND AMERICAN FLYING
CRANE
CONDENSED PARENT COMPANY ONLY BALANCE SHEETS
AS OF DECEMBER 31, 2006, 2005, AND 2004

|                                                        |  |      |            |      |   |            |  |   |            | 
|------------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- |  | - | ---------- | 
|                                                        |  | 2006 |            | 2005 |   | 2004       | 
|                                                        |  |      |            |      |   |            | 
|Current assets:                                         |  |      |            |      |   |            |  |   |            | 
|Cash                                                    |  | $    | 2,346,992  |      | $ | 216,684    |  | $ | 209,347    | 
|Accounts receivable, other                              |  |      | 1,567      |      |   | 1,567      |  |   | 1,567      | 
|Prepaid expenses                                        |  |      | 20,250     |      |   | 22,500     |  |   |           | 
|                                                        |  |      |            |      |   |            |  |   |            | 
|Total current assets                                    |  |      | 2,368,809  |      |   | 240,751    |  |   | 210,914    | 
|                                                        |  |      |            |      |   |            |  |   |            | 
|Investment in subsidiaries, reported on
  equity method |  |      | 82,678,838 |      |   | 40,047,899 |  |   | 18,118,753 | 
|                                                        |  |      |            |      |   |            |  |   |            | 
|Total assets                                            |  | $    | 85,047,647 |      | $ | 40,288,650 |  | $ | 18,329,667 | 

|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- |  | - | ---------- | 
|                                                                                                                                                                                                    |  | 2006 |            | 2005 |   | 2004       | 
|                                                                                                                                                                                                    |  |      |            |      |   |            | 
|Current liabilities:                                                                                                                                                                                |  |      |            |      |   |            |  |   |            | 
|Accounts payable and accrued expenses                                                                                                                                                               |  | $    | 930,260    |      | $ | 362,153    |  | $ | 138,153    | 
|Advances from directors                                                                                                                                                                             |  |      |           |      |   | 1,829,527  |  |   | 1,091,364  | 
|Advances from subsidiaries                                                                                                                                                                          |  |      | 2,889,267  |      |   |           |  |   | 928,420    | 
|Short-term notes and loans payable                                                                                                                                                                  |  |      | 5,000,000  |      |   | 3,000,000  |  |   |            | 
|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|Total current liabilities                                                                                                                                                                           |  |      | 8,819,527  |      |   | 5,191,680  |  |   | 2,157,937  | 
|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|Long term debt, net of current portion shown
  above and discount of $1,715,871 as of December 31, 2006                                                                                             |  |      | 16,484,129 |      |   | 5,000,000  |  |   |           | 
|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|Stockholders equity:                                                                                                                                                                               |  |      |            |      |   |            |  |   |            | 
|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|Common stock, $.001 par value; 50,000,000
  shares authorized; 15,831,820, 14,132,824, and 13,556,354 shares issued and
  outstanding at December 31, 2006, 2005 2006, 2005, and 2004, respectively |  |      | 15,832     |      |   | 14,134     |  |   | 13,558     | 
|Additional paid-in capital                                                                                                                                                                          |  |      | 17,834,429 |      |   | 9,208,836  |  |   | 7,519,172  | 
|Retained earnings                                                                                                                                                                                   |  |      | 40,177,074 |      |   | 20,269,000 |  |   | 8,639,000  | 
|Accumulated other comprehensive income                                                                                                                                                              |  |      | 1,716,656  |      |   | 605,000    |  |   |           | 
|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|Total stockholders equity                                                                                                                                                                          |  |      | 59,743,991 |      |   | 30,096,970 |  |   | 16,171,730 | 
|                                                                                                                                                                                                    |  |      |            |      |   |            |  |   |            | 
|Total liabilities and stockholders equity                                                                                                                                                          |  | $    | 85,047,647 |      | $ | 40,288,650 |  | $ | 18,329,667 | 

F-14

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

AMERICAN DAIRY, INC. AND AMERICAN FLYING
CRANE
CONDENSED PARENT COMPANY ONLY INCOME STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

|                                                    |  |      |            |      |   |            |   |   |           |  
|--------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | - | - | --------- | -
|                                                    |  | 2006 |            | 2005 |   | 2004       |  
|                                                    |  |      |            |      |   |            |  
|SALES                                               |  | $    |           |      | $ |           |   | $ |          |  
|OPERATING AND ADMINISTRATIVE EXPENSES:              |  |      |            |      |   |            |   |   |           |  
|General and administrative expenses                 |  |      | 2,487,182  |      |   | 1,448,656  |   |   | 515,149   |  
|Other                                               |  |      | 182,986    |      |   | 69,734     |   |   | 34,990    |  
|                                                    |  |      | 2,670,168  |      |   | 1,518,390  |   |   | 550,139   |  
|Income from operations                              |  |      | (2,670,168 | )    |   | (1,518,390 | ) |   | (550,139  | )
|                                                    |  |      |            |      |   |            |   |   |           |  
|OTHER INCOME (EXPENSE):                             |  |      |            |      |   |            |   |   |           |  
|Equity in earnings of unconsolidated
  subsidiaries |  |      | 23,551,342 |      |   | 13,434,145 |   |   | 6,877,949 |  
|Other income (expenses)                             |  |      | 32,099     |      |   | 13,516     |   |   | (65,871   | )
|Interest and finance costs                          |  |      | (1,004,992 | )    |   | (299,271   | ) |   | (3,939    | )
|                                                    |  |      | 22,578,449 |      |   | 13,148,390 |   |   | 6,808,139 |  
|INCOME BEFORE INCOME TAXES                          |  |      | 19,908,281 |      |   | 11,630,000 |   |   | 6,258,000 |  
|(PROVISION FOR) BENEFIT FROM INCOME TAXES           |  |      |           |      |   |           |   |   |          |  
|NET INCOME                                          |  | $    | 19,908,281 |      | $ | 11,630,000 |   | $ | 6,258,000 |  

F-15

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

AMERICAN DAIRY, INC. AND AMERICAN FLYING
CRANE
CONDENSED PARENT COMPANY ONLY STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

|                                                                 |  |      |             |      |   |             |   |   |            |  
|---------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | - | - | ---------- | -
|                                                                 |  | 2006 |             | 2005 |   | 2004        |  
|                                                                 |  |      |             |      |   |             |  
|CASH FLOWS
  FROM OPERATING ACTIVITIES:                          |  |      |             |      |   |             |   |   |            |  
|Net income                                                       |  | $    | 19,908,281  |      | $ | 11,630,000  |   | $ | 6,258,000  |  
|Adjustments
  to reconcile net income to operating activities -  |  |      |             |      |   |             |   |   |            |  
|Less :
  Equity in earnings of unconsolidated subsidiaries       |  |      | (23,551,342 | )    |   | (13,434,144 | ) |   | (6,877,949 | )
|Compensation
  expense for stock issued                          |  |      | 1,262,624   |      |   | 940,240     |   |   | 96,600     |  
|Compensation
  expense for warrant extension                     |  |      | 290,952     |      |   |             |   |   |            |  
|Interest
  expense from amortization of loan discount            |  |      | 155,988     |      |   |             |   |   |            |  
|Changes in
  assets and liabilites:                              |  |      |             |      |   |             |   |   |            |  
|(Increase)
  decrease in - Accounts and notes receivable         |  |      |            |      |   |            |   |   | (1,567     | )
|Prepaid
  expenses                                               |  |      | 2,250       |      |   | (22,500     | ) |   | 113,989    |  
|Increase
  (decrease) in - Accounts payable and accrued expenses |  |      | 809,418     |      |   | 224,000     |   |   | 126,153    |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|Net cash
  (used in) operating activities                        |  |      | (1,121,829  | )    |   | (662,404    | ) |   | (284,774   | )
|                                                                 |  |      |             |      |   |             |   |   |            |  
|CASH FLOWS
  FROM INVESTING ACTIVITIES:                          |  |      |             |      |   |             |   |   |            |  
|Investment
  in subsidiary                                       |  |      | (17,968,159 | )    |   | (7,890,000  | ) |   | (5,112,376 | )
|Long-term
  investment                                           |  |      |            |      |   |            |   |   | (241,890   | )
|                                                                 |  |      |             |      |   |             |   |   |            |  
|Net cash
  (used in) investing activities                        |  |      | (17,968,159 | )    |   | (7,890,000  | ) |   | (5,354,266 | )
|                                                                 |  |      |             |      |   |             |   |   |            |  
|CASH FLOWS
  FROM FINANCING ACTIVITIES:                          |  |      |             |      |   |             |   |   |            |  
|Advances
  from director                                         |  |      | (858,418    | )    |   | 738,162     |   |   | 232,946    |  
|Advances
  from subsidiary                                       |  |      |            |      |   | (928,422    | ) |   | 714,269    |  
|Loan
  proceeds                                                  |  |      | 20,300,000  |      |   | 8,000,000   |   |   |           |  
|Loan
  payments                                                  |  |      | (2,100,000  | )    |   |             |   |   |            |  
|Proceeds
  from issuance of common stock                         |  |      | 3,878,714   |      |   | 750,000     |   |   | 4,196,082  |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|Net cash
  provided by financing activities                      |  |      | 21,220,296  |      |   | 8,559,740   |   |   | 5,143,297  |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|NET INCREASE
  (DECREASE) IN CASH AND EQUIVALENTS                |  |      | 2,130,308   |      |   | 7,336       |   |   | (495,743   | )
|                                                                 |  |      |             |      |   |             |   |   |            |  
|CASH AND
  CASH EQUIVALENTS, BEGINNING OF PERIOD                 |  |      | 216,684     |      |   | 209,348     |   |   | 705,091    |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|CASH AND
  CASH EQUIVALENTS, END OF PERIOD                       |  | $    | 2,346,992   |      | $ | 216,684     |   | $ | 209,348    |  
|                                                                 |  |      |             |      |   |             |   |   |            |  
|SUPPLEMENTAL
  DISCLOSURES OF CASH FLOW INFORMATION:             |  |      |             |      |   |             |   |   |            |  
|Interest
  paid, net of capitalized amounts                      |  | $    | 61,521      |      | $ | 299,271     |   | $ | 3,939      |  
|Income taxes
  paid                                              |  | $    |            |      | $ |            |   | $ |           |  

F-16

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

American Dairy, Inc. and American Flying
Crane 
Notes to Condensed Parent Company Only Financial Statements

Note 1 - These
condensed parent company only financial statements should be read in connection
with the American Dairy consolidated financial statements and notes thereto.

Note 2 -
Convertible Debt

As of December
31, 2006 the Company had the convertible debt outstanding as described below:

Series B
Convertible notes in the amount of $5,000,000, bearing interest at 7.5% per
annum, $2,500,000 due on June 30, 2007 and $2,500,000 due on August 14, 2007.
These notes are convertible to common stock at a conversion price of $10 per
share. The Series B Notes are reflected in current liabilities as of December
31, 2006.

Convertible
notes in the amount of $18,200,000, bearing interest at 7.75% per annum, due on
October 3, 2009, and convertible at $14.50 per share. Warrants to purchase
251,000 shares of common stock at $14.50 per share were issued to the debt
holders. The value of these warrants of $1,871,859 was recorded as a discount
to the value of the notes and will be amortized to interest expense over the
term of the notes.

As of December
31, 2006 principal payment due by year for the next five years and thereafter
on convertible debt is as follows:

|                              |  |        |            | 
|----------------------------- |  | ------ | ---------- | 
|Fiscal year ended December 31 |  | Amount |           
|                              |  |        |           
|2007                          |  | $      | 5,000,000  | 
|2008                          |  |        |           | 
|2009                          |  |        | 18,200,000 | 
|2010                          |  |        |           | 
|2011                          |  |        |           | 
|Thereafter                    |  |        |           | 
|                              |  |        |            | 
|                              |  | $      | 23,200,000 | 
|                              |  |        |            | 

5. INVENTORIES

Inventories
consist of the following as of December 31, 2006 and 2005:

|                                        |  |      |            |      |   |           | 
|--------------------------------------- |  | ---- | ---------- | ---- | - | --------- | 
|                                        |  | 2006 |            | 2005 |  
|                                        |  |      |            |      |  
|Raw and
  partially processed materials |  | $    | 4,405,270  |      | $ | 3,215,000 | 
|Work in
  progress                      |  |      | 329,867    |      |   |          | 
|Finished
  goods                        |  |      | 9,178,629  |      |   | 6,407,000 | 
|                                        |  |      |            |      |   |           | 
|                                        |  | $    | 13,913,766 |      | $ | 9,622,000 | 
|                                        |  |      |            |      |   |           | 

F-17

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

6. TAX
REFUNDABLE

Tax refundable
represents valued added tax refundable from the local governments in The
Peoples Republic of China.

7.
TRANSACTIONS WITH RELATED PARTIES

As of December
31, 2006 and 2005 the Company had the following balances due to its officers
and directors:

|                               |  |      |         |      |   |         | 
|------------------------------ |  | ---- | ------- | ---- | - | ------- | 
|Name                           |  | 2006 |         | 2005 |  
|                               |  |      |         |      |  
|Leng You-bin                   |  | $    |        |      | $ | 858,000 | 
|Other officers
  and directors |  |      | 119,911 |      |   | 75,000  | 
|                               |  |      |         |      |   |         | 
|                               |  | $    | 119,911 |      | $ | 933,000 | 
|                               |  |      |         |      |   |         | 

These balances
are non-interest bearing and due on demand.

8. FIXED
ASSETS

During 2005,
the Company completed the acquisition of the assets of Nutricia Nutritionals
Co., Limited for a total consideration of $7,430,000, of which $130,000 was
allocated to inventory and the balance of $7,300,000 was allocated to buildings
and equipment. This acquisition consisted of a production plant and milk
collection centers located in Yushutun and Angangxi Districts.

Fixed assets
consist of the following as of December 31, 2006 and 2005:

|                                 |  |      |            |      |   |            |  
|-------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                 |  | 2006 |            | 2005 |  
|                                 |  |      |            |      |  
|Buildings                        |  | $    | 21,869,643 |      | $ | 19,352,000 |  
|Plant and
  machineries          |  |      | 16,736,439 |      |   | 15,513,000 |  
|Motor
  vehicles                 |  |      | 784,823    |      |   | 787,000    |  
|Computers
  and equipment        |  |      | 722,302    |      |   | 392,000    |  
|                                 |  |      |            |      |   |            |  
|                                 |  |      | 40,113,207 |      |   | 36,044,000 |  
|Less:
  Accumulated depreciation |  |      | (3,131,638 | )    |   | (1,358,000 | )
|                                 |  |      |            |      |   |            |  
|                                 |  | $    | 36,981,569 |      | $ | 34,686,000 |  
|                                 |  |      |            |      |   |            |  

Depreciation
expense totaled $1,814,064, $1,001,000, and $261,000, respectively, for the
years ended December 31, 2006, 2005, and 2004 of which $1,547,910, $839,146,
and $206,875, were included as a component of cost of goods in the respective
periods.

F-18

---



AMERICAN DAIRY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

9.
CONSTRUCTION-IN-PROGRESS

The Company
had two major construction projects under construction at December 31, 2006 and
2005 as detailed below:

|                                         |  |      |           |      |   |           | 
|---------------------------------------- |  | ---- | --------- | ---- | - | --------- | 
|                                         |  | 2006 |           | 2005 |  
|                                         |  |      |           |      |  
|Feihe Dairy
  processing facilities      |  | $    | 808,318   |      | $ | 2,868,000 | 
|Langfang
  production factory facilities |  |      | 5,045,811 |      |   |          | 
|GanNan
  production factory facilities   |  |      | 3,579,019 |      |   |          | 
|Shanxi
  walnut processing facility      |  |      |          |      |   | 506,000   | 
|                                         |  | $    | 9,433,148 |      | $ | 3,374,000 | 
|                                         |  |      |           |      |   |           | 

10. ADVANCES
FROM EMPLOYEES

Advances from
employees represented temporary funding by employees to finance a temporary
working capital shortfall experienced by the Company. The advances were
unsecured, interest free and repayable within one year.

11. DEFERRED
INCOME

Receipts in advance
represent advances from customers and for which goods have not been delivered
as of the balance sheet date. Receipts in advance for goods to be delivered or
services to be rendered in the subsequent year are carried forward as deferred
revenue.

12. NOTES
PAYABLE

Short term
notes and loans payable consist of the following as of December 31, 2006 and
2005:

|                                                                                                                                                               |  |      |            |      |   |           | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | --------- | 
|                                                                                                                                                               |  | 2006 |            | 2005 |  
|                                                                                                                                                               |  |      |            |      |  
|Note payable to a bank, bearing interest at
  6.696% per annum, secured by plant and machinery, payable in monthly installments                                |  | $    |           |      | $ | 3,082,000 | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Series A convertible note, bearing interest
  at 6.5% per annum, due on April 26, 2006, convertible to common stock at a
  conversion price of $8.00 per share |  |      |           |      |   | 3,000,000 | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Unsecured, non-interest bearing obligation
  to an unrelated company, repayable upon demand                                                                    |  |      | 1,031,461  |      |   | 995,000   | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Note payable to a bank, bearing interest at
  5.85% per annum, secured by a loan guarantee, payable with interest upon
  maturity                              |  |      | 3,836,317  |      |   |          | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Note payable to a bank, bearing interest at
  5.36% per annum, secured by loan guarantees, payable with interest upon
  maturity                               |  |      | 3,196,931  |      |   |          | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Note payable to a bank, bearing interest at
  0.51% per month, secured by a loan guarantee, payable with interest upon
  maturity                              |  |      | 1,918,159  |      |   |           | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Note payable to a related party, bearing
  interest at 5.85% per annum, unsecured, payable with interest upon maturity                                         |  |      | 358,056    |      |   |          | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Notes payable to raw materials suppliers
  for settlement of purchases                                                                                         |  |      | 2,141,944  |      |   |          | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|Unsecured, non-interest bearing obligation
  to county finance department, with no fixed repayment terms                                                       |  |      | 640,000    |      |   | 247,000   | 
|                                                                                                                                                               |  |      |            |      |   |           | 
|                                                                                                                                                               |  | $    | 13,122,868 |      | $ | 7,324,000 | 
|                                                                                                                                                               |  |      |            |      |   |           | 

F-19

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

13. LONG-TERM
DEBT

The Company is
in violation of certain loan covenants which require insurance coverage. Under
the provisions of the covenants, the Company is considered in default of these
covenants, and all debt may be due upon demand. This debt consists of the
following as of December 31, 2006 and 2005:

|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | --------- | -
|                                                                                                                                                                                                          |  | 2006 |            | 2005 |  
|                                                                                                                                                                                                          |  |      |            |      |  
|Series B convertible notes, bearing
  interest at 7.5% per annum, payments $2,500,000 due on June 30, 2007 and
  August 14, 2007, convertible to common stock at a conversion price of $10.00
  per share |  | $    | 5,000,000  |      | $ | 5,000,000 |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|Convertible notes, bearing interest at
  7.75% per annum due on October 3, 2009, convertible to common stock at a
  convertible at $14.50 per share, net of discount of $1,715,871 at December
  31, 2006 |  |      | 16,484,129 |      |   |           |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|Note payable to a bank, bearing interest at
  0.51% per month, secured by plant and machinery, payable in 96 monthly
  installments                                                                       |  |      | 547,794    |      |   | 635,000   |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|Note payable to a finance company, secured
  by a vehicle payable in 60 monthly installments                                                                                                              |  |      | 7,928      |      |   | 10,000    |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|                                                                                                                                                                                                          |  |      | 22,039,851 |      |   | 5,645,000 |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|Less: current portion of long-term
debt                                                                                                                                                                   |  |      | (5,103,197 | )    |   | (102,000  | )
|                                                                                                                                                                                                          |  |      |            |      |   |           |  
|                                                                                                                                                                                                          |  | $    | 16,936,654 |      | $ | 5,543,000 |  
|                                                                                                                                                                                                          |  |      |            |      |   |           |  

On October 3,
2006, convertible notes in the amount of $18,200,000 including warrants to
purchase 251,000 shares of common stock at $14.50 per share were issued. The
value of the warrants of $1,871,859 was recorded as a discount to the value of
the notes and will be amortized to interest expense over the term of the notes.

Pursuant to the terms of an
Investor Registration Rights Agreement, dated as of October 3, 2006, executed
in connection with the issuance of convertible notes in the amount of
$18,200,000, the Company is required to file with the Securities and Exchange
Commission a registration statement. The original deadline for filing such
registration statement was January 2, 2007, and, under the terms of the
agreement, the Company is subject to a penalty of 2% of the outstanding
principal on the notes for each month of such delinquency. The Company has
received waivers with respect to such deadline from these note holders to date
and accordingly has not accrued any of such penalties.

Principal
payments due by year for the next five years and thereafter on these notes are
as follows:

|                                 |  |        |            |  
|-------------------------------- |  | ------ | ---------- | -
|Fiscal
  year ended December 31, |  | Amount |           
|                                 |  |        |           
|2007                             |  | $      | 5,103,197  |  
|2008                             |  |        | 95,269     |  
|2009                             |  |        | 18,295,269 |  
|2010                             |  |        | 95,269     |  
|2011                             |  |        | 95,269     |  
|Thereafter                       |  |        | 71,449     |  
|                                 |  |        |            |  
|                                 |  |        | 23,755,722 |  
|Less
  discount                  |  |        | (1,715,871 | )
|                                 |  |        |            |  
|                                 |  | $      | 22,039,851 |  
|                                 |  |        |            |  

F-20

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

14. MINORITY
INTEREST

At December 31, 2005, the
minority interest represents the proportionate share (40%) of equity of Shanxi
Feihesantai Biotechnology Scientific and Commercial Co., Limited Shanxi) owned
by Licheng Santai Technology Enterprises Co., Limited. At December 31, 2005,
the Company owned 60% of Shanxis registered capital stock. In 2006, the
Company made additional capital contributions to the funded registered capital,
which increased its ownership to 97%. The Company subsequently acquired the
remaining 3% minority interest for a total cash consideration of $1,918,841.
The purchase price for the acquired minority interest in the assets and
liabilities of Shanxi was allocated as follows:

|                                                              |  |   |           |  
|------------------------------------------------------------- |  | - | --------- | -
|Purchase price                                                |  | $ | 1,918,841 |  
|Repayment of minority
  interest advance                      |  |   | (259,396  | )
|                                                              |  |   |           |  
|Net purchase price                                            |  |   | 1,659,445 |  
|                                                              |  |   |           |  
|Current assets                                                |  |   | 46,054    |  
|Fixed assets, net                                             |  |   | 190,856   |  
|                                                              |  |   |           |  
|                                                              |  |   | 236,910   |  
|                                                              |  |   |           |  
|Accounts payable and
  accrued expenses                       |  |   | 18,722    |  
|Short-term loans - secured                                    |  |   | 19,438    |  
|                                                              |  |   |           |  
|                                                              |  |   | 38,160    |  
|                                                              |  |   |           |  
|Net assets acquired                                           |  |   | 198,750   |  
|                                                              |  |   |           |  
|                                                              |  |   |           |  
|Excess of purchase price
  over fair value of assets acquired |  | $ | 1,460,695 |  
|                                                              |  |   |           |  

The amounts paid in excess
of the fair value of the net assets acquired has been recorded as goodwill as
of December 31, 2006.

15. CAPITAL
STOCK

The Company
has 50,000,000 shares of authorized Common Stock with a par value of $.001 per
share.

During 2004,
the Company had stock transactions detailed below:

The Company
issued 46,000 shares of its restricted common stock valued at $97,000 for
consulting services.

In connection
with two private placements, the Company issued 1,759,384 shares of restricted
common stock purchased for total cash consideration of $4,673,000. Offering and
syndication costs totaling $477,000 were treated as reductions in additional
paid-in capital for financial reporting purposes. The Company also issued
1,825,546 warrants in connection with the private placements, 1,302,241 of
which went to the purchasers and 523,305 went to the underwriters as additional
consideration for funds raised in the private placements. The exercise price of
these warrants ranged from $1.50 to $3.80 and the warrants expire in three
years. The 523,305 warrants issued to underwriters had a market value at the
issuance date of $862,000. The effect of the issuance is to increase additional
paid-in capital by the fair value of the warrants issued with an offset to
additional paid in capital in the same amount, since offering costs are treated
as reductions in additional paid-in capital. No warrants were exercised during the
year ended December 31, 2004.

During 2005,
the Company had stock transactions detailed below:

The Company
issued 98,900 shares of unrestricted common stock valued at $643,000 to Chinese
employees of Feihe Dairy for bonuses, issued pursuant to a Form S-8
registration statement.

The Company
issued 428,570 shares of its common stock pursuant to the exercise of warrants
at $1.75 each for a total consideration paid of $750,000.

The Company
issued 47,000 shares of restricted common stock valued at $286,000 for bonuses
to directors and to others for consulting services.

F-21

---



The Company
issued 2,000 share of unrestricted common stock valued at $11,000 for
consulting services, issued pursuant to a Form S-8 registration statement.

During 2006, the Company had
stock transactions detailed below:

F-22

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 
DECEMBER 31, 2006

The Company
issued 103,370 shares of restricted common stock valued at $1,262,625 for
bonuses to directors and to others for consulting services.

The Company
issued 1,196,251 shares of its common stock pursuant to the exercise of
warrants at various exercise prices for a total consideration paid of
$2,006,855.

The Company
issued 399,375 shares of its common stock pursuant to the conversion of
$3,000,000 of Series A convertible notes with accrued interest of $195,000, at
a conversion price of $8.00 per share.

16. INCOME TAX

A
reconciliation of tax at the statutory rates to the Companys effective rate is
as follows:

|                                                                                                                                                                    |  |                         |            |      |   |            |   |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ---------- | ---- | - | ---------- | - | - | ---------- | -
|                                                                                                                                                                    |  | Year Ended December 31, |           
|                                                                                                                                                                    |  | 2006                    |            | 2005 |   | 2004       |  
|                                                                                                                                                                    |  |                         |            |      |   |            |  
|Computed
  expected tax expense at Federal tax rate                                                                                                                 |  | $                       | 6,769,000  |      | $ | 3,954,000  |   | $ | 2,039,000  |  
|Computed
  state income taxes                                                                                                                                       |  |                         | 896,000    |      |   | 523,000    |   |   | 270,000    |  
|Increases
  (reductions) in taxes result from:                                                                                                                      |  |                         |            |      |   |            |   |   |            |  
|Add back
  effect of U.S. losses                                                                                                                                    |  |                         | 1,291,000  |      |   | 686,000    |   |   | 245,000    |  
|Foreign
  income subject to foreign income tax but not expected to be subject to U.S.
  tax in foreseeable future - Adjustment due to change in effective tax rates |  |                         | (1,977,000 | )    |   | (1,140,000 | ) |   | (564,000   | )
|BaiQuan
  Dairy 2003 tax liability waived by province                                                                                                               |  |                         |           |      |   |           |   |   | (262,000   | )
|Foreign
  income subject to foreign tax holiday but not expected to be subject to U.S.
  tax in foreseeable future                                                  |  |                         | (6,979,000 | )    |   | (4,023,000 | ) |   | (1,990,000 | )
|                                                                                                                                                                    |  |                         |            |      |   |            |   |   |            |  
|Actual
  income tax expense (benefit)                                                                                                                               |  | $                       |           |      | $ |           |   | $ | (262,000   | )
|                                                                                                                                                                    |  |                         |            |      |   |            |   |   |            |  

Under the
Provisional Regulation of the PRC, income tax is payable by enterprises at a
rate of 33% of their taxable income. Feihe Dairy has been granted a tax holiday
of seven years for full enterprise income paid during that period. This tax
holiday will expire in April of 2009. The enterprise taxes paid during 2004
were accrued (waived) by Sanhao Dairy and BaiQuan Dairy totaled $262,000:

|              |  |                           |   |      |   |      |  |   |          |  
|------------- |  | ------------------------- | - | ---- | - | ---- |  | - | -------- | -
|              |  | Year Ended
  December 31, |  
|              |  |                           |  
|              |  | 2006                      |   | 2005 |   | 2004 | 
|              |  |                           |   |      |   |      | 
|Sanhao Dairy  |  | $                         |  |      |   |     |  | $ |         |  
|BaiQuan Dairy |  |                           |  |      |   |      |  |   | (262,000 | )
|              |  |                           |   |      |   |      |  |   |          |  
|Total         |  | $                         |  |      | $ |     |  | $ | (262,000 | )
|              |  |                           |   |      |   |      |  |   |          |  

F-23

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

The tax
holiday resulted in tax savings as follows:

|                          |  |                         |           |      |   |           |  |   |           | 
|------------------------- |  | ----------------------- | --------- | ---- | - | --------- |  | - | --------- | 
|                          |  | Year Ended December 31, |          
|                          |  |                         |          
|                          |  | 2006                    |           | 2005 |   | 2004      | 
|                          |  |                         |           |      |   |           | 
|Approximate
  tax savings |  | $                       | 6,979,000 |      | $ | 4,023,000 |  | $ | 1,990,000 | 
|Benefit per
  share       |  |                         |           |      |   |           |  |   |           | 
|Basic                     |  | $                       | 0.47      |      | $ | 0.29      |  | $ | 0.160     | 
|Diluted                   |  | $                       | 0.39      |      | $ | 0.25      |  | $ | 0.15      | 

The Company
has a U.S net operating loss carryforward of approximately $6,695,000 which
will begin expiring in 2023. For financial reporting purposes the deferred tax
asset of $2,578,000 associated with this loss carryforward is fully reserved as
of December 31, 2006.

Although it is
not anticipated in the foreseeable future, should the Parent company receive
dividends from its foreign subsidiaries, these dividends would be fully
taxable, subject to an offset for foreign taxes paid on these earnings. The
Company has not provided any accrual for any tax liabilities that might be
incurred for the receipt of dividends from its foreign subsidiaries.

17. EARNINGS
PER SHARE

Statement of
Financial Accounting Standards No. 128, Earnings Per Share, requires
presentation of basic and diluted earnings per share (EPS), as defined, on the
face of the statements of operations for all entities with complex capital
structures. SFAS No. 128 requires a reconciliation of the numerator and
denominator of the basic and diluted earnings per shares (EPS) computations:

|                                                      |  |                      |            |                        |  |                    |  |   |      | 
|----------------------------------------------------- |  | -------------------- | ---------- | ---------------------- |  | ------------------ |  | - | ---- | 
|                                                      |  | Income
  (Numerator) |            | Shares
  (Denominator) |  | Per Share
  Amount | 
|                                                      |  |                      |            |                        |  |                    | 
|For the year
  ended December 31, 2006                |  |                      |            |                        |  |                    |  |   |      | 
|Basic EPS
  income available to Common shareholders   |  | $                    | 19,908,281 |                        |  | 14,755,576         |  | $ | 1.35 | 
|Effect of
  dilutive securities:                      |  |                      |            |                        |  |                    |  |   |      | 
|Convertible
  notes                                   |  |                      | 723,707    |                        |  | 1,833,285          |  | $ | .11  | 
|Warrants
  issued                                     |  |                      |            |                        |  | 1,467,282          |  | $ | .10  | 
|Diluted EPS
  income available to Common shareholders |  | $                    | 20,631,988 |                        |  | 18,056,143         |  | $ | 1.14 | 
|For the year
  ended December 31, 2005                |  |                      |            |                        |  |                    |  |   |      | 
|Basic EPS
  income available to Common shareholders   |  | $                    | 11,629,000 |                        |  | 13,931,006         |  | $ | .83  | 
|Effect of
  dilutive securities:                      |  |                      |            |                        |  |                    |  |   |      | 
|Warrants
  issued                                     |  |                      |           |                        |  | 1,643,533          |  | $ | .08  | 
|Convertible
  notes                                   |  |                      | 304,000    |                        |  | 482,534            |  | $ | .01  | 
|Diluted EPS
  income available to Common shareholders |  | $                    | 11,933,000 |                        |  | 16,057,073         |  | $ | .74  | 
|                                                      |  |                      |            |                        |  |                    |  |   |      | 
|For the year
  ended December 31, 2004                |  |                      |            |                        |  |                    |  |   |      | 
|Basic EPS
  income available to Common shareholders   |  | $                    | 6,258,000  |                        |  | 12,077,085         |  | $ | .52  | 
|Effect of
  dilutive securities:                      |  |                      |            |                        |  |                    |  |   |      | 
|Warrants
  issued                                     |  |                      |            |                        |  | 1,378,615          |  | $ | .05  | 
|Diluted EPS
  income available to Common shareholders |  | $                    | 6,258,000  |                        |  | 13,455,700         |  | $ | .47  | 

F-24

---



AMERICAN DAIRY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

During the
year ended December 31, 2006, the Company issued convertible notes, to which
holders of the notes were issued common stock purchase warrants (See Note 13).
These notes allow the holder to convert each note to common stock at any time
through the maturity date.

During the
year ended December 31, 2005, the Company issued Series A and Series B
Convertible Notes (See Notes 12 and 13). These notes allow the holder to
convert each note to common stock of the Company at any time during the term of
the note.

18. STOCK
OPTIONS AND WARRANTS

Effective May
7, 2003, the Company adopted and approved its 2003 Incentive Stock Plan (the
Plan) which reserved 3,000,000 shares of Common Stock for issuance under the
Plan. The 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. The Company applies APB 25 and related interpretations in
accounting for its plan. Compensation for services that a corporation receives
under APB 25 through stock-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. Compensation expense of
$1,262,624, $940,240 and $96,600 was recorded during the years ended December
31, 2006, 2005, and 2004, respectively, related to the Plan.

As of December
31, 2006, the Company had 2,125,941 warrants outstanding at an average exercise
price of $4.29 per warrant for one share each of the Companys common stock.
The warrants will expire at various dates, with 330,000 expiring in 2008,
1,544,941 expiring in 2009, and the balance of 251,000 expiring in 2012. During
the years ended December 31, 2006 and 2005, 1,260,655 and 428,570 warrants,
respectively, were exercised at various exercise prices, resulting in proceeds
of $2,006,855 and $750,000, respectively, to the Company.

Information
with respect to outstanding warrants to service providers is as follows:

|                                            |  |        |            |                            |   |      | 
|------------------------------------------- |  | ------ | ---------- | -------------------------- | - | ---- | 
|                                            |  | Shares |            | Average
  Exercise
  Price |  
|                                            |  |        |            |                            |   |      | 
|Outstanding
  warrants at beginning of year |  |        | 2,555,596  |                            | $ | 2.23 | 
|Warrants granted                            |  |        | 831,000    |                            |   | 7.68 | 
|Exercised                                   |  |        | (1,260,655 | )                          |   | 1.75 | 
|Expired                                     |  |        |           |                            |   |     | 
|                                            |  |        |            |                            |   |      | 
|Outstanding
  warrants at the end of year   |  |        | 2,125,941  |                            | $ | 4.29 | 
|                                            |  |        |            |                            |   |      | 

F-25

---



AMERICAN DAIRY, INC. 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006

|                                        |  |                                 |     |                         |                        |                                       |  |                         |           |  |   |      | 
|--------------------------------------- |  | ------------------------------- | --- | ----------------------- | ---------------------- | ------------------------------------- |  | ----------------------- | --------- |  | - | ---- | 
|Warrants
  Outstanding                  |  |                                 |     |                         | Warrants
  Exercisable |                                      
|                                        |  |                                 |     |                         |                        |                                      
|                                        |  |                                 |     |                         |                        |                                       |  |                         |           |  |   |      | 
|Shares
  Outstanding
  December 31,2006 |  | Average
  RemainingLife (Years) |     | Average
  ExercisePrice |                        | Shares
  OutstandingDecember 31, 2006 |  | Average
  ExercisePrice |          
|                                        |  |                                 |     |                         |                        |                                       |  |                         |           |  |   |      | 
|2,125,941                               |  |                                 | 3.0 |                         | $                      | 4.29                                  |  |                         | 2,125,941 |  | $ | 4.29 | 
|                                        |  |                                 |     |                         |                        |                                       |  |                         |           |  |   |      | 

19. COMMITMENTS

As of December 31, 2006, the
Company has future commitments to acquire land use rights totaling $276,802,
and to pay future advertising costs totaling $1,528,844.

As of December 31, 2006,
there were no minimum future rental payments under non-cancelable operating
leases having remaining terms in excess of one year.

Rent expense incurred during
the years ended December 31, 2006, 2005, and 2004 totaled $84,426, $63,000 and
$23,000, respectively.

In accordance with the terms
and conditions of a Sale and Purchase Agreement dated February 23, 2005 between
Feihe Dairy and a vendor for the sale and purchase of a land use right in
Beijing, in the Peoples Republic of China, Feihe Dairy agreed to acquire the
commercial property for consideration of $1,009,000, of which all consideration
was paid by December 31, 2006.

In accordance with the terms
and conditions of a Sale and Purchase Agreement dated July 25, 2003, the Company
has agreed to acquire land use rights and a factory in Kedong County for a
total consideration of $401,000. At the Companys option the liability could be
settled through payment of cash consideration or through the issuance of
200,000 shares of its common stock. This option had not expired as of December
31, 2005. The Company accrued the liability during the year ended December 31,
2004. As of December 31, 2006 the Company had not settled the commitment.

20. QUARTERLY FINANCIAL DATA
(UNAUDITED)

Summarized unaudited
quarterly financial data for 2006 and 2005 are as follows:

|                                 |  |                       |            |                        |   |                 |  |                  |            |  |   |            | 
|-------------------------------- |  | --------------------- | ---------- | ---------------------- | - | --------------- |  | ---------------- | ---------- |  | - | ---------- | 
|                                 |  | Quarters
  Ended      |           
|                                 |  |                       |           
|                                 |  | December
  31,
  2006 |            | September
  30,
  2006 |   | June 30,
  2006 |  | March 31,
  2006 |           
|                                 |  |                       |            |                        |   |                 |  |                  |            |  |   |            | 
|Total revenues                   |  | $                     | 38,184,536 |                        | $ | 32,611,627      |  | $                | 26,110,028 |  | $ | 25,893,000 | 
|Gross profit                     |  |                       | 15,456,435 |                        |   | 15,236,726      |  |                  | 9,997,007  |  |   | 11,908,000 | 
|Net income                       |  |                       | 4,354,075  |                        |   | 5,528,239       |  |                  | 5,261,967  |  |   | 4,764,000  | 
|Net earnings per common
  share: |  |                       |            |                        |   |                 |  |                  |            |  |   |            | 
|Basic                            |  | $                     | 0.28       |                        | $ | 0.37            |  | $                | 0.36       |  | $ | 0.34       | 
|Diluted                          |  | $                     | 0.22       |                        | $ | 0.32            |  | $                | 0.31       |  | $ | 0.29       | 

F-26

---



|                                 |  |                       |            |                        |   |                 |  |                  |            |  |   |            | 
|-------------------------------- |  | --------------------- | ---------- | ---------------------- | - | --------------- |  | ---------------- | ---------- |  | - | ---------- | 
|                                 |  | Quarters
  Ended      |           
|                                 |  |                       |           
|                                 |  | December
  31,
  2005 |            | September
  30,
  2005 |   | June 30,
  2005 |  | March 31,
  2005 |           
|                                 |  |                       |            |                        |   |                 |  |                  |            |  |   |            | 
|Total Revenues                   |  | $                     | 25,599,747 |                        | $ | 14,273,618      |  | $                | 14,589,807 |  | $ | 13,560,731 | 
|Gross profit                     |  |                       | 9,304,064  |                        |   | 6,744,356       |  |                  | 6,996,110  |  |   | 6,263,478  | 
|Net income                       |  |                       | 3,994,723  |                        |   | 2,178,699       |  |                  | 2,823,250  |  |   | 2,632,757  | 
|Net earnings per common
  share: |  |                       |            |                        |   |                 |  |                  |            |  |   |            | 
|Basic                            |  | $                     | 0.27       |                        | $ | 0.16            |  | $                | 0.21       |  | $ | 0.19       | 
|Diluted                          |  | $                     | 0.25       |                        | $ | 0.14            |  | $                | 0.18       |  | $ | 0.17       | 

F-27

---