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EX-10.2 - EXHIBIT 10.2 - Yayi International Inca6829661ex10-2.htm
EX-10.1 - EXHIBIT 10.1 - Yayi International Inca6829661ex10-1.htm
EX-32.1 - EXHIBIT 32.1 - Yayi International Inca6829661ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - Yayi International Inca6829661ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - Yayi International Inca6829661ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - Yayi International Inca6829661ex31-2.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10−Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2011

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
 
Commission File Number: 000-23806

YAYI INTERNATIONAL INC.
 (Exact Name of Registrant as Specified in Its Charter)
 
Delaware
87-0046720
   (State or other jurisdiction of
(I.R.S. Empl. Ident. No.)
    incorporation or organization)
 
 
No. 9 Xingguang Road,
Northern Industrial Park of Zhongbei Town,
Xiqing District, Tianjin 300384, China
(Address of principal executive offices, Zip Code)
(86) 22-27984033
Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes__   No __

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

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

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

The number of shares outstanding of each of the issuer’s classes of common equity, as of August 12, 2011 is as follows:
 
Class of Securities
Shares Outstanding
Common Stock, $0.001 par value
26,454,558
 
 
 

 
 
TABLE OF CONTENTS

 
PART I - FINANCIAL INFORMATION
Page
     
Item 1.
Financial Statements
1
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 4.
Controls and Procedures
35
     
 
PART II – OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
37
Item 1A.
Risk Factors
37
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
37
Item 3.
Defaults Upon Senior Securities
37
Item 4.
[Removed and Reserved]
37
Item 5.
Other Information
37
Item 6.
Exhibits
37

 
 
 

 
 
PART I FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES
FOR THE THREE MONTHS ENDED JUNE 30, 2011 AND 2010
INDEX TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
Page
Condensed Consolidated Balance Sheets (Unaudited)
2
Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)
4
Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)
5
Condensed Consolidated Statements of Cash Flows (Unaudited)
6
Notes to Condensed Consolidated Financial Statements (Unaudited)
8
 
1

 
 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

   
June 30
   
March 31
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 14,310,028     $ 13,360,392  
Restricted cash
    919,009       1,412,404  
Accounts receivable, net of allowances of $96,261 and $72,036
    6,744,936       4,776,780  
Other receivable, net of allowances of $72,710 and $43,230
    479,769       574,383  
Inventories
    4,120,022       3,885,481  
Prepaid expenses
    105,051       309,894  
Land use rights - current portion
    19,932       19,611  
Advances
    606,950       900,033  
Deferred tax asset
    157,885       374,124  
Deferred financing cost
    204,712       159,496  
Total current assets
    27,668,294       25,772,598  
                 
Property, plant and equipment, net
    9,202,432       8,063,507  
Livestock, net
    570,416       563,402  
Goodwill
    294,397       289,643  
Land use rights
    953,433       942,939  
Deposits on property, plant and equipment
    19,431,895       19,063,439  
Deferred tax asset
    58,684       31,225  
Deferred financing cost
    795,953       867,552  
Total assets
  $ 58,975,504     $ 55,594,305  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
               
Short term loans
  $ 10,856,358     $ 10,654,328  
Accounts payable
    2,084,958       884,407  
Other payable, bills payable and accrued expenses
    3,633,758       3,172,782  
Advance from customers
    122,784       90,232  
Income and other tax payable
    1,349,364       1,214,494  
Long term loans – current portion
    7,194       17,697  
Total current liabilities
    18,054,416       16,033,940  
                 
Long-term liabilities:
               
Due to shareholders
    5,508,208       5,450,233  
Derivative liabilities
    1,361,369       1,776,400  
Convertible notes, net of discount of $3,606,709 and $3,858,839
    5,313,291       5,061,161  
Registration penalties and make good provision payable
    606,756       473,283  
      12,789,624       12,761,077  
                 
Total liabilities
    30,844,040       28,795,017  
                 
Commitments and contingencies (Note 16)
    -       -  
 
 
2

 
 
PREFERRED STOCK, par value $0.001, 10,000,000 shares authorized, Series A 10% non-cumulative redeemable convertible preferred stock, redemption $9.80 per share plus 25% interest from date of issuance to date of redemption, 1,530,612 shares issued and outstanding
    17,371,544       15,745,165  
                 
                 
STOCKHOLDERS' EQUITY
               
Common stock, par value $0.001, 100,000,000 shares authorized, 26,454,558 and 26,454,558 shares issued and outstanding, respectively
    26,454       26,454  
Additional paid-in capital
    5,873,178       5,840,290  
Statutory surplus reserve fund
    1,142,397       1,142,397  
Retained earning
    1,631,304       2,529,601  
Accumulated other comprehensive income
    2,086,587       1,515,381  
Total stockholders’ equity
    10,759,920       11,054,123  
Total liabilities and stockholders' equity
  $ 58,975,504     $ 55,594,305  
                 
The accompanying notes are an integral part of these condensed consolidated financial statements

 
3

 

YAYI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
 
   
Three months ended
 
   
June 30,
 
   
2011
   
2010
 
             
Net sales
  $ 8,343,694     $ 6,219,693  
Cost of goods sold
    3,124,247       2,680,237  
                 
Gross profit
    5,219,447       3,539,456  
                 
Operating expenses:
               
Sales and marketing expenses
    2,778,562       3,559,166  
General and administrative expenses
    816,598       1,031,526  
                 
Total operating expenses
    3,595,160       4,590,692  
                 
Income (loss) from operations
    1,624,287       (1,051,236 )
                 
Other income (expenses):
               
Interest income
    18,071       2,923  
Interest expenses, including accretion of preferred stocks
    (1,859,823 )     (146,996 )
Amortization of deferred financing costs and debt discount
    (479,213 )     -  
Change in fair value of derivative liabilities
    415,031       -  
Expense on make good provision
    (12,621 )     -  
Registration penalties
    (120,852 )     -  
Other (expenses) income
    (23,695 )     (26,189 )
                 
Loss before income tax
    (438,815 )     (1,221,498 )
                 
Income tax (expense)/benefits
    (459,482 )     211,466  
                 
Net loss from operations
    (898,297 )     (1,010,032 )
Foreign currency translation adjustment
    571,206       109,257  
                 
Comprehensive loss
  $ (327,091 )   $ (900,775 )
                 
(Loss) per share of common stock
               
- Basic
  $ (0.03 )   $ (0.04 )
- Diluted
  $ (0.03 )   $ (0.04 )
                 
Weighted average shares of common stock outstanding
               
- Basic
    26,454,558       26,409,719  
- Diluted
    26,454,558       26,409,719  

The accompanying notes are an integral part of these condensed consolidated financial statements

 
4

 
 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
 
   
Common stock
    Additional     
Statutory 
Surplus
          Accumulated Other       Total    
   
Number of shares
    Amount    
 paid-in
capital
   
 Reserve
 Fund
    Retained Earnings     Comprehensive Income     Stockholders’ Equity  
                                           
Balance at March 31, 2011
    26,454,558       26,454       5,840,290       1,142,397       2,529,601       1,515,381       11,054,123  
                                                         
Employee stock-based compensation
    -       -       32,888       -       -       -       32,888  
                                                         
Net loss for the period ended June 30, 2011
    -       -       -       -       (898,297 )     -       (898,297 )
                                                         
Foreign currency translation
    -       -       -       -       -       571,206       571,206  
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance at June 30, 2011
  $ 26,454,558     $ 26,454     $ 5,873,178     $ 1,142,397     $ 1,631,304     $ 2,086,587     $ 10,759,920  
                                                         

The accompanying notes are an integral part of these condensed consolidated financial statements

 
5

 

YAYI INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Three Months Ended
 
   
June 30,
 
   
2011
   
2010
 
             
Cash flow from operating activities
           
Net loss
  $ (898,297 )   $ (1,010,032 )
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization of livestock
    260,254       151,041  
Amortization of land use rights
    4,950       3,142  
Amortization of deferred financing costs
    26,383       -  
Allowance of bad debts
    51,469       85,681  
Employee stock-based compensation
    32,888       144,417  
Sales return allowance
    -       (45,520 )
Change in fair value of derivative liabilities
    (415,031 )        
Accretion of debt discount
    252,130       -  
Accretion of preferred stock
    1,626,379       -  
                 
(Increase) decrease in operating assets:
               
                 
Accounts receivable
    (1,898,163 )     (2,307,007 )
Other receivable
    72,729       (117,805 )
Inventories
    (171,163 )     (848,743 )
Prepaid expenses
    208,080       45,901  
Advances
    305,802       131,983  
Deferred tax asset and current assets
    194,130       (472,485 )
                 
Increase (decrease) in operating liability:
               
Accounts payable
    1,173,867       588,112  
Advance from customers
    30,863       (89,896 )
Income and other tax payable
    113,896       227,681  
Other payable, bills payable and accrued expenses
    (208,125 )     310,870  
Registration penalties and make good provision payable
    133,473       -  
Net cash provided by (used in) operating activities
    896,514       (3,202,660 )
                 
Cash flows from investing activities
               
Purchase of property, plant and equipment
    (620,775 )     (177,351 )
Deposit for construction of factory and warehouse
    (34,050 )     -  
Deposit for purchase of machinery and equipment
    -       (453,008 )
Proceeds from sale of livestock
    -       62,973  
Purchase and breeding of livestock
    (19,915 )     -  
Net cash used in investing activities
    (674,740 )     (567,386 )

 
6

 
 
Cash flows from financing activities
           
             
Proceeds from short term loans
    4,637,105       7,390,150  
Repayment of short term loans
    (4,620,857 )     (3,668,673 )
Change in restricted cash
    506,479       (42,551 )
Due (from) to shareholders
    -       (5,609 )
Net cash provided by financing activities
    522,727       3,673,317  
 
Effect of exchange rate changes in cash
    205,135       16,852  
                 
Net increase (decrease) in cash and cash equivalents
    949,636       (79,877 )
                 
Cash and cash equivalents, beginning of period
    13,360,392       4,727,677  
                 
Cash and cash equivalents, end of period
  $ 14,310,028     $ 4,647,800  
                 
Supplemental disclosure of cash flow information
               
Cash paid during the period
               
Interest paid
  $ 231,214     $ 97,995  
Income tax paid
  $ 140,046     $ 4,139  
           
 
 
Supplemental disclosure of non-cash financing and investing activities;
               
Acquisition of property, plant and equipment in other payable
  $ 683,395     $ -  
 Non-cash exercise of 117,504 warrants into common stock
  $ -     $ 45  
 Deposits transferred to property, plant and equipment
  $ 2,320     $ -  
 Accrued interest on convertible notes
  $ 200,700     $ -  

The accompanying notes are an integral part of these condensed consolidated financial statements

 
7

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Nature of Business

The interim condensed consolidated financial statements included herein, presented in accordance with United States generally accepted accounting principles and stated in US dollars, have been prepared by Yayi International Inc, a Delaware corporation and its subsidiaries (collectively, the “Company”) , without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These statements reflect all adjustments, consisting of normal recurring adjustments, which, in the opinion of management, are necessary for fair presentation of the information contained therein. The condensed consolidated statement of operations for the three months ended June 30, 2011 is not necessarily indicative of the results that may be expected for the entire year ending March 31, 2012. It is suggested that these interim consolidated financial statements be read in conjunction with the financial statements and related notes thereto included in the Company’s amended Annual Report on Form 10-K for the year ended March 31, 2011. The Company follows the same accounting policies in the preparation of interim reports.

On August 18, 2010, one of the Company’s subsidiaries, Charleston Industrial Limited changed its name to Milkgoat Industrial Co., Ltd. (“Milkgoat Industrial”), under the BVI Business Companies Act, 2004.

On December 17, 2010, one of the Company’s subsidiaries, Tianjin Yayi Industrial Co., Ltd. changed its name to Milkgoat (China) Goat Dairy Co., Ltd. (“Milkgoat China”), as approved by Tianjin City Administration for Industry & Commerce.

The principal business activities of the Company consist of manufacturing and selling of goat milk powder. All business activities of the Company are conducted principally by its subsidiaries Milkgoat China, WeinanMilkgoat Production Co., Ltd. (“WeinanMilkgoat”), FupingMilkgoat Dairy Co., Ltd (“FupingMilkgoat”) and Shaanxi Milkgoat Dairy Co., Ltd (“Shaanxi Milkgoat”) operating in the PRC whereas Milkgoat Industrial is a BVI investment holding company.

2. Summary of Significant Accounting Policies

Basis of Consolidation - The consolidated financial statements include the accounts of Yayi International Inc. and its wholly-owned subsidiary, Milkgoat Industrial together with its wholly-owned subsidiaries, Milkgoat China, Weinan Milkgoat, Fuping Milkgoat and Shaanxi Milkgoat. All material intercompany transactions have been eliminated in consolidation.

Use of estimates - The preparation of the Company’s financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts in the financial statements and related disclosure in the accompanying notes. Actual results could differ from those estimates. The financial statements include some amounts that are based on management’s best estimates and judgments. The most significant estimates relate to warrants valuation, discount on convertible notes, debts issuance cost, allowance for uncollectible accounts receivable, work in process inventory valuation, inventory obsolescence, depreciation, useful lives of property, plant and equipment, taxes, contingencies and employee benefit plans. These estimates may be adjusted as more current information becomes available and any adjustment could be significant. Estimates and assumptions are periodically reviewed and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.

Research and development - Research and development costs are expensed as incurred. Research and development expenses amounted to $17,241 and $19,704 for the three months ended June 30, 2011 and June 30, 2010, respectively.

Advertising and promotion costs - Costs incurred in direct-response advertising are capitalized and amortized on a straight-line basis over the duration of the advertising campaign. As of June 30, 2011, there was no capitalized direct-response advertising. All other advertising costs are expensed as incurred. Advertising and promotion costs amounted to $2,011,341 and $2,433,448 for the three months ended June 30, 2011 and June 30, 2010, respectively.

 
8

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
2. Summary of Significant Accounting Policies – Continued

Shipping and handling cost - Shipping and handling costs related to delivery of finished goods are included in sales and marketing expenses. During the three months ended June 30, 2011 and June 30, 2010, shipping and handling costs were $92,622 and $121,112, respectively.

Slotting fees - The Company accounts for slotting fees in accordance with ASC 605-50. ASC 605-50 requires that cash considerations, including sales incentives, given by a vendor to a customer is presumed to be a reduction of the selling price, and therefore, should be characterized as a reduction to gross sales. This presumption is overcome and the consideration would be characterized as an expense incurred if the vendor receives an identifiable benefit in exchange for the consideration and the fair value of that identifiable benefit can be reasonably estimated. Furthermore, if the consideration recorded is in excess of gross sale of any retailer, the amount in excess will be recorded as selling expense.

The Company treats one-time slotting fees paid to retails shops who are direct customers of the Company’s distributors and the fees pays to distributors upon signing of contract as a reduction in gross sales.

Slotting fees of $204,830 and $2,315,605 were recorded as a reduction of sales revenue for the three months ended June 30, 2011 and June 30, 2010, respectively.

Capitalized Interest - Interest is capitalized as part of the historical cost during the construction period for qualified assets . Interest is capitalized until the asset is ready for service. Capitalized interest is determined based upon the Company’s weighted-average borrowing cost on debt for the average amount of qualifying costs incurred.  Once an asset subject to interest capitalization is completed and placed in service, the associated capitalized interest is expensed through depreciation or impairment, along with other capitalized costs related to that asset.

Guarantee fee - The Company pays guarantee fee at the inception of certain loans to guarantee companies in order to obtain loans from banks.  Guarantee fee is initially recorded in prepaid expenses and amortized on a straight-line basis over the duration of the loan as guarantee fee expense which is reflected in interest expense on the Statement of Operations.

Recently Adopted Accounting Pronouncements

In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that provide disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this update did not have a material impact to the Company’s financial position.

In December 2010, FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this amendment did not have a material impact to the Company’s financial position.

 
9

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
2. Summary of Significant Accounting Policies - Continued

In April 2010 the FASB issued Accounting Standards Update (ASU) No. 2010-13, Compensation – Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. This Update provides amendments to Accounting Standards Codification (ASC) Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency  of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendments in this Update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. The cumulative-effect adjustment should be presented separately. Earlier application is permitted.  This standard was adopted effective April 1, 2011 and the adoption of this standard did not have a material impact to the Company’s financial position.

Recently Issued Accounting Pronouncements Not yet Adopted

In December 2010, FASB issued ASU No. 2010-28, Intangibles – Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this Update affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments in this Update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. Upon adoption of the amendments, any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of an adoption. Any goodwill impairments occurring after the initial adoption of the amendments should be included in earnings.  This standard is not currently applicable to the Company because the Company currently does not have reporting units with zero or negative carrying amounts.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about the fair value measurements. The amendments include the following:

 
·
Those that clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements.
 
·
Those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.

The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted.
 
 
10

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
2. Summary of Significant Accounting Policies – Continued

Nonpublic entities may apply the amendments in this Update early, but no earlier than for interim periods beginning after December 15, 2011.

The Company is currently evaluating the impact, and do not expect the adoption of this amendment have a material impact on the Company’s financial position and results of operations.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The presentation option under current GAAP to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity has been eliminated.

The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. Early adoption is permitted because compliance with amendments is already permitted. The Company already complies with this presentation.

 
11

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



3. Restricted Cash
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
Bank deposits held as collateral for bills payable
  $ 510,919     $ 1,004,314  
Bank deposits held in escrow (Note 13)
    408,090       408,090  
    $ 919,009     $ 1,412,404  

Cash of $408,090 from the private placement was held in escrow for the Company as of June 30, 2011 (Note 12).

4. Other Receivable
 
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
Advance to staff
  $ 27,454     $ 37,892  
Security deposit
    488,892       470,313  
Sundry
    36,133       109,408  
      552,479       617,613  
Less: allowance for bad debts
    (72,710 )     (43,230 )
    $ 479,769     $ 574,383  

The amount due from an unrelated party is interest-free, unsecured and has no stated terms of repayment.
 
5. Inventories

Inventories consist of:
 
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
Raw materials
  $ 2,371,866     $ 2,709,596  
Packaging
    493,950       497,341  
Finished goods
    1,254,206       678,544  
    $ 4,120,022     $ 3,885,481  

As of June 30, 2011 and March 31, 2010, there was no allowance made for obsolete or slow moving inventory.

As of June 30, 2011, the Company had approximately $1,702,367 of inventory that is pledged as collateral for loan.
 
 
12

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
6. Deposits on Property, Plant and Equipment

Deposits on property, plant and equipment consist of:
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
Advances to Tianjin Mengyang Biological Development Co., Ltd ("Tianjin
           
Menyang"), formerly Tianjin Milkgoat Dairy Co., Ltd.
           
   - purchase of office building (Note 16)
  $ 4,419,864     $ 4,348,488  
   - purchase of factory and warehouse (Note 16)
    11,677,676       11,489,095  
   - advances for renovation of office building (Note 16)
    362,005       356,159  
Deposits for construction in progress (Note 16)
    581,761       572,366  
Advanced payment for purchasing machinery and equipment
    2,390,589       2,297,331  
    $ 19,431,895     $ 19,063,439  

The main body construction of office building had been completed as of September 2010. The construction project is under inspection and the completion date is subject to the inspection report to be issued. Based on the Company’s estimate, the completion date is expected to be postponed to the fourth calendar quarter of 2011 (Note 16). The Company expects that the building will be operational during the fourth calendar quarter of 2012.

The main body construction of factory and warehouse had been completed as of September 2010. The construction project is under inspection and the completion date is subject to the inspection report to be issued. Based on the Company’s estimate, the completion date is expected to be postponed to the fourth calendar quarter of 2011 (Note 16). The Company expects that the facility will start operating during the fourth calendar quarter of 2012.

The construction in progress relates to the construction and installation of central system pipelines. The estimated completion date of installation is postponed to the fourth calendar quarter of 2013 (Note 16).

The advanced payment for purchasing machinery and equipment relates to the purchases of machinery and equipment from several suppliers. They are expected to be delivered to the Company between July 2012 and March 2013 after the approval of final inspection.

 
13

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
7. Property, Plant and Equipment, net

Property, plant and equipment, net consist of the following:
 
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
At cost:
           
Leasehold improvement
  $ 72,891     $ 71,714  
Plant and buildings
    4,411,718       4,338,544  
Machinery
    3,964,457       3,895,981  
Furniture, fixtures and equipment
    243,687       239,364  
Motor vehicles
    343,641       338,091  
      9,036,394       8,883,694  
Less: accumulated depreciation and amortization
    (2,068,521 )     (1,799,269 )
      6,967,873       7,084,425  
Construction in progress
    2,234,559       979,082  
    $ 9,202,432     $ 8,063,507  

During the three months ended June 30, 2011, depreciation expenses amounted to $238,120, of which $214,164 and $23,956 was recorded as cost of sales and other selling, general and administrative expense, respectively.

During the three months ended June 30, 2010, depreciation expenses amounted to $126,597, of which $102,817 and $23,780 was recorded as cost of sales and other selling, general and administrative expense, respectively.

As of June 30, 2011, the Company is in the process of negotiating the total consideration of the agreement for construction of a dormitory project.  The construction of the dormitory started on February 15, 2011 and the estimated completion date is June 30, 2012.  As the total consideration was not confirmed yet when the construction started, the contractor, China Tenth Metallurgy Group Limited Corporation signed a memorandum of understanding with the Company on January 24, 2011 agreeing to prepay the estimated construction fee of RMB4,500,000 (approximately $696,163) on behalf of the Company because of their long-term business relationship and this is recorded in other payable, bills payable and accrued expenses on the balance sheet as of June 30, 2011.  As of June 30, 2011, the main body of the dormitory was completed but it needs renovation and installation of furniture and equipment before it can be used and hence RMB4,500,000 (approximately $696,163) was recorded in construction in progress until the renovation and installation is completed.  On August 10, 2011, the Company obtained the signed construction agreement and the contract value is confirmed to be RMB4,519,617 (approximately $699,198) (Note 20).

8. Short Term Loans

On June 3, 2010, the Company entered into three loan agreements with Tianjin Rural Commercial Bank for RMB8,000,000 (approximately $1,237,624) each and a loan agreement for RMB6,000,000 (approximately $928,218). The annual interest rate is 5.8% and the loans were renewed on June 10, 2011. We have renewed the loan agreements with Tianjin Rural Commercial Bank for RMB30,000,000(approximately$4,641,089), and the annual interest rate is 7.572%. The new due date of the loans is June 9, 2012. These loans are guaranteed by Tianjin Haitai Investment Guarantee Co., Ltd. with the guarantee fee of RMB600,000 (approximately $92,822).

On June 8, 2011, the Company entered into a loan agreement with Citibank for RMB175,500 (approximately $27,150). The annual interest rate is 8.593% and the loan is due on September 5, 2011. The loan is guaranteed by Tianjin Mengyang with the guarantee fee of RMB70,200 (approximately $10,860).  This loan was extended under a revolving credit facility of RMB 8,000,000 (approximately $1,237,623) entered into with Citibank on November 6, 2010.  The unused amount as of June 30, 2011 was RMB 7,824,500 (approximately $1,210,473) (Note 20).
 
 
 
14

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


9. Due to Shareholders
           
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
             
Li Liu, a director of the Company, officer and principal shareholder
  $ 3,589,941     $ 3,531,966  
Other shareholders
    1,918,267       1,918,267  
    $ 5,508,208     $ 5,450,233  

On June 12, 2009, the persons who were shareholders of Milkgoat China before Milkgoat Industrial acquired their interests in Milkgoat China on January 15, 2008 (the “Original Shareholders”) entered into a restructuring agreement whereby the Original Shareholders, upon receipt of RMB30,500,000 (approximately $4,718,441) of dividend payable from Milkgoat Industrial agreed to provide an interest-free loan of the same amount to Milkgoat China. The entire amount of dividend was paid to the Original Shareholders and was lent to Milkgoat China by the Original Shareholders.

The amounts due to director, Li Liu and the other shareholders are unsecured with no stated interest and are not expected to be repaid within the fiscal year ending March 31, 2012.
 
10. Convertible notes, net

The convertible notes payable, net of debt discount consists of the following as of June 30, 2011 and 2010:

   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
Convertible notes payable
  $ 4,604,447     $ 4,604,447  
Accretion of debt discount - warrants and beneficial conversion feature
    708,844       456,714  
Convertible notes payable, net
  $ 5,313,291     $ 5,061,161  

Accrued interest on the convertible notes payable as of June 30, 2011 was $200,700. The interest expense on the convertible notes for the three months ended June 30, 2011 was $202,930.

 
15

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
11. Income Tax

The enterprise income tax is reported on a separate entity basis.

United States

The Company was incorporated in Delaware and is subject to United States of America tax law. No provisions for income taxes have been made as the Company has a taxable loss for the three months ended June 30, 2011. No tax benefit has been realized since a valuation allowance has offset the deferred tax asset resulted from the net operating loss.

BVI

Milkgoat Industrial was organized in the British Virgin Islands and is not subject to income taxes under the current laws of the British Virgin Islands.

PRC

Milkgoat China, Weinan Milkgoat, Fuping Milkgoat and Shaanxi Milkgoat are subject to PRC income tax. Income tax  (expense) benefits for the three months ended June 30, 2011 and 2010 were ($459,482) and $211,466, respectively.

Effective January 1, 2008, the statutory PRC tax rate is 25%. Therefore, the statutory PRC rate for the three months ended June 30, 2011 and year ended March 31, 2011 was 25%.


The following is a reconciliation of the tax derived by applying the PRC statutory rate to the earnings before income taxes, and comparing that to the recorded income tax (expense) benefits:
 
   
Three months ended
   
June 30,
   
2011
 
2010
   
(unaudited)
 
(unaudited)
         
Tax (expense) benefits at PRC statutory rate
 
25.0%
 
25.0%
(Under) over accrual in prior years
 
(0.5%)
 
5.1%
Unrecognized tax benefit of current period tax losses
 
(9.9%)
 
(3.0%)
Parent company's expenses not subject to PRC tax
 
(119.3%)
 
(9.8%)
Effective tax rate
 
(104.7%)
 
17.3%
         

The Company did not recognize any interest or penalties related to unrecognized tax benefits in the three months ended June 30, 2011 and 2010. The Company had no uncertain positions that would necessitate recording of tax related liability. The Company is subject to examination by the respective tax authorities.

 
16

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
12. Issuance of Convertible Notes and Series of Warrants

On September 27, 2010, the Company issued and sold to certain investors 892 units at a purchase price of $10,000 per unit, resulting in gross proceeds of $8.92 million to the Company. Each unit consists of a three-year, 9% convertible promissory note in the principal amount of $10,000 (the “9% Convertible Note”) and a three-year Series F common stock purchase warrant (the “Series F Warrant”), to purchase 1,250 shares of the Company’s common stock at an exercise price of $2.50 per share.

The 9% Convertible Notes are payable at an interest rate of 9% per annum, payable semiannually in arrears on the last day of the first and third calendar quarters (i.e., March 31 and September 30) commencing March 31, 2011 and mature on September 26, 2013 (the “Maturity Date”). Except for the secured Indebtedness (as defined in the 9% Convertible Note) of the Company and its subsidiaries in existence on September 27, 2010, the obligations of the Company under the 9% Convertible Notes will rank senior with respect to all existing indebtedness of the Company as of September 27, 2010 and to any and all Indebtedness incurred thereafter. The 9% Convertible Notes are also convertible into shares of common stock at any time prior to the Maturity Date at $2.00 per share, which conversion price is subject to weighted average and other customary anti-dilution protections. At any time after September 26, 2011, the Company may redeem all but not less than all of the outstanding principal amount of any 9% Convertible Notes by payment of 108% of the outstanding principal amount of the 9% Convertible Notes, together with accrued but unpaid interest.

The 9% Convertible Notes contain customary affirmative and negative covenants. The 9% Convertible Notes also contain customary events of default, upon which the holders of the 9% Convertible Notes may declare all outstanding 9% Convertible Notes to be due and payable immediately.

The Series F Warrants issued in connection with the private placement in September 2010 entitle the investors to purchase an aggregate of 1,115,000 shares of common stock at an initial exercise of $2.50 per share, which exercise price is subject to the customary weighted average and stock based anti-dilution protection. The Series F Warrants may be exercised in a cash or cashless way at any time upon the election of the holders until September 26, 2013.

Placement Agent Fee

The Company paid a cash commission of $713,600, which is equal to 8% of the gross proceeds of the financing to the placement agent. In addition, the Company issued Series F Warrants to the designees of the placement agent to purchase an aggregate of 312,200 shares of common stock of the Company at an exercise price of $2.50 per share, as partial compensation for services provided by them in connection with the private placement.

Make Good Escrow Agreement

On September 27, 2010, the Company, a major shareholder of the Company, Global Rock, Euro Pacific Capital, Inc. and Escrow, LLC entered into a make good escrow agreement (the “Make Good Escrow Agreement”). Pursuant to the Make Good Escrow Agreement, Global Rock agreed to place a total of 669,000 shares of common stock held by it, which is equal to 15% of the amount of shares of common stock issuable upon conversion of the 9% Convertible Notes (the “Make Good Shares”), into escrow to secure certain make good obligations of the Company. In the event that the combined net sales of the Company of both of the fiscal years ending March 31, 2011 and 2012 is less than $125 million, Global Rock will transfer the Make Good Shares to the investors, on a pro rata basis to the extent of shortfall of the actual net sales achieved compare to the guaranteed net sales of $125 million for no additional consideration. As of June 30, 2011, it is probable that the guaranteed net sales of $125 million for fiscal years ending March 31, 2011 & 2012 may not be achieved. The estimated fair value as of June 30, 2011 of the 266,390 shares expected to be delivered is $218,304 and is reflected as Registration penalties and make good provision payable on the balance sheet as of June 30, 2011. The fair value of Make Good Escrow Agreement will be analyzed every period end using a probability weighted assessment method and adjusted if necessary.

 
17

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
12. Issuance of Convertible Notes and Series of Warrants - Continued

Registration Rights Agreement

In connection with the private placement of September 2010, the Company and the investors entered into a registration rights agreement (the “Registration Rights Agreement”), pursuant to which, the Company granted registration rights to holders of registrable securities, which include (i) the shares of common stock issuable upon the conversion of the 9% Convertible Notes, (ii) the Make Good Shares, as applicable, (iii) the shares of common stock issuable upon the exercise of Series F Warrants issued to the investors and the placement agent, and (iv) any securities issued or issuable upon any stock split, dividend or other distribution, recapitalization or similar event, or any price adjustment as a result of such stock splits, reverse stock splits or similar events with respect to any of the securities referenced in (i) – (iii) above.

Pursuant to the Registration Rights Agreement, the Company is required to file a registration statement on Form S-1 (the “Registration Statement”), within 30 days after the closing of the private placement, or the Closing, and cause the Registration Statement to be declared effective by the Securities and Exchange Commission with 180 days after the Closing. The Company may be subject to liquidated damages in an amount up to 8% ($713,600) of the aggregate investment amount paid by the investors in the private placement if it is unable to file, obtain and maintain effectiveness of the Registration Statement as required by the Registration Rights Agreement by March 27, 2011. The Company filed the Registration Statement on October 27, 2010 and it is effective on August 8, 2011. As of June 30, 2011, the Company has accrued a registration penalty of $388,452 and is reflected as Registration penalties and make good provision payable on the balance sheet as of June 30, 2011.

Closing Escrow Agreement

On September 27, 2010, the Company also entered into a closing escrow agreement with the placement agent and the escrow agent (the “Closing Escrow Agreement”), pursuant to which, among other things, the Company has placed a certain amount of cash received from the private placement ($408,090) (the “Holdback Amount”), with the escrow agent, which is sufficient to satisfy the payment to the investors of one semiannual interest payment due on the aggregate principal amount of all 9% Convertible Notes issued in the private placement, which includes accrued interest due on the principal amount of the 9% Convertible Notes from September 27, 2010 through March 31, 2011. If, an event of default (as defined in the 9% Convertible Notes) is declared by the placement agent with respect to a failure by the Company to make a semiannual interest payment to the investors in accordance with the 9% Convertible Notes, the escrow agent will disburse a certain portion of the Holdback Amount to the investors, and within 30 days following the disbursement, the Company will deposit an additional amount equal to the Holdback Amount with the escrow agent to be retained and disbursed. On the Maturity Date or at any time prior to the Maturity Date when 75% of all 9% Convertible Notes have been converted, all remaining funds of the Holdback Amount will be disbursed to the Company.

Accounting for Convertible Notes and Series F Common Stock Warrants

The 9% Convertible Notes and Series F Warrants (issued to both investors and the placement agent) contain ratchet provision which will reduce the conversion and exercise price, based on a formula, if the Company sells or issues securities at a price lower than the conversion or exercise price. The embedded conversion option of the 9% Convertible Notes and the warrants do not meet the test of being indexed only to the Company’s common stock as defined in ASC 815-40-15 because the formula is not based on the market price. Accordingly, the embedded conversion option and warrants are accounted for as derivative liabilities and are required to be re-measured at the end of every reporting period with the change in fair value in the statement of operations.
 
 
18

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
12. Issuance of Convertible Notes and Series of Warrants – Continued

The 8% placement agent fee and other offering costs totaling $888,180 and the fair value of the Series F warrants issued to the placement agent of $231,929 are accounted for deferred financing fees. The gross proceeds of $8,920,000 are allocated to the fair value of the Series F warrants issued to the investors of $828,319, fair value of the embedded conversion option of $3,487,233, and the carrying value of the convertible notes of $4,604,447. The fair value of the embedded conversion option is calculated using a Cox-Ross-Rubinstein (“CRR”) binomial model with the following assumptions: conversion price of $2.00, risk free interest rate of 0.66%, expected term of 3 years, and a volatility of 130%. The fair value of the warrants is calculated using the CRR binomial model with the following assumptions: exercise price of $2.5 per share, risk free interest rate of 0.66%, expected term of 3 years, and a volatility of 130%. The expected volatility is based on average volatility of five comparable companies in the same industry and the Company’s historical volatility.

The value of the embedded conversion option and the warrants are re-measured at June 30, 2011 using the CRR binomial model with the same assumptions as stated above except for a risk free interest rate of 0.54% and volatility of 120%. The decrease in fair value of these derivative liabilities for the three months ended June 30, 2011 totaled $415,031, respectively (Note 14).

The initial carrying value of the convertible notes will be accreted to their redemption value of $8,920,000 over the three years term of the convertible notes at an effective interest rate of 34.77 %. Effective interest expense recorded for the three months ended June 30, 2011 is $452,830.

 
19

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
13. Warrants

Series A, B, C and D Warrants expired on June 6, 2011.



   
Shares outstanding
   
Fair Value
 
Series E Warrants issued for extension of maturity date of loan from Allied Merit
    250,000     $ 233,547  
Series F Warrants issued to Investor (Note 12)
    1,115,000       230,805  
Series F Warrants issued to Placement agent (Note 12)
    312,200       64,624  
      1,677,200     $ 528,976  

:
               
Exercise Price
 
   
Warrant
   
Vested
   
per Common
 
   
Shares
   
Shares
   
Stock Range
 
                   
Balance, March 31, 2011
    4,414,439       4,414,439     $ 1.08-2.50  
                         
Granted or vested during the three months ended June 30, 2011
    -       -       -  
Exercised during the three months ended June 30, 2011
    -       -       -  
Expired during the three months ended June 30, 2011
    (2,737,239 )     (2,737,239 )   $ 1.08-1.35  
Balance, June 30, 2011
    1,677,200       1,677,200     $ 1.08-2.50  

The following table summarizes the weighted average remaining contractual life and exercise price of the Company’s outstanding warrants.
 
Warrants Outstanding
   
Number Outstanding and
         
Weighted Average Exercise
 
Range of Exercise Prices
 
Currently
Exercisable at June 30, 2011
   
Weighted Average Remaining Contractual Life (Years)
   
Price of Warrants outstanding and Currently Exercisable
 
                   
$1.08
 
250,000
   
0.04
 
$
1.08
 
$2.50
 
1,427,200
   
2.25
 
$
2.5
 

 
20

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. Fair Value Measurements

Fair Value Measurements and Fair Value of Financial Instruments

The Company adopted the guidance of Accounting Standards Codification 820, or ASC 820, for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The following table sets forth a summary of changes in fair value of Level 3 liabilities for the three months ended June 30, 2011:
 
Liabilities:
     
Balance of derivative liabilities as of March 31, 2011
  $ 1,776,400  
Initial fair value of derivative liabilities
    -  
Change in fair value of derivative liabilities
    (415,031 )
Balance of derivative liabilities as of June 30, 2011
  $ 1,361,369  

The fair value of the derivative liabilities was determined using the CRR binominal model (Note 15), the following table sets forth the components of derivative liabilities:
 
   
June 30,
   
March 31,
 
   
2011
   
2011
 
   
(unaudited)
   
(audited)
 
Derivative liabilities – warrants to investors and placement agent
  $ 295,429     $ 394,802  
Derivative liabilities – conversion option on convertible notes
    1,065,940       1,381,598  
Balance of derivative liabilities
  $ 1,361,369     $ 1,776,400  

Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, valuation techniques are sensitive to changes in the trading market price of our common stock and its estimated volatility. Because derivative financial instruments are initially and subsequently carried at fair values, the Company’s income may include significant charges or credits as these estimates and assumptions change.

The carrying amounts reported in the balance sheets for cash, accounts receivable, other receivables, short-term borrowings, accounts payable and accrued expenses, customer advances, and amounts due to/from related parties approximate their fair market value based on the short-term maturity of these instruments. The carrying value of long-term loans approximates fair value since the interest rate associated with the debt approximates the current market interest rate.

 
21

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

15. Employee Stock Ownership Plan

On May 31, 2010, the Company adopted 2010 Employee Stock Option and Stock Award Plan (the “Plan”). Up to 2,359,974 shares of common stock of the Company may be issued under the Plan. The Plan permits the grant of Nonqualified Stock Options, Restricted Stock, and Incentive Stock to employees, officers, directors, and consultants of the Company and its subsidiaries. The Plan became effective on May 31, 2010 when it was adopted by the Board of Directors but is subject to approval by the stockholders of the Company within twelve months after it.

The Company also entered into separate Yayi International Inc. 2010 Employee Stock Option and Stock Award Plan Award Agreements (the “Option Agreements”), with each of Ms. Jing Chen, the Company's Chief Financial Officer and Mr. Fung Shek, the Company's Vice President and Director. Under the terms of the Option Agreements, the Company agreed to grant a stock option, at an exercise price at $2.25 per share, to each of Ms. Chen and Mr. Shek for the purchase of 250,000 shares of common stock and 106,000 shares of common stock, respectively. According to the Option Agreements, 25% of the option granted to each of Ms. Chen and Mr. Shek will vest on the first anniversary of the grant date, and the balance will vest in equal quarterly installments over the next three years on the last day of each quarter, subject to Ms. Chen's and Mr. Shek's continuing employment with the Company through these dates. 62,500 and 26,500 options to Ms. Chen and Mr. Shek are vested as of June 30, 2011, respectively.

On May 31, 2010, the company also entered into separate Option Agreements under the Plan with certain non-executive employees, pursuant to which the Company granted to these employees options to purchase an aggregate of 842,400 shares of common stock, at an exercise price of $2.25 per share. These options vests evenly over 4 years subject to such employees’ continuing employment with the Company through these dates and meeting the performance goals established by the department manager and/or the Company’s CEO as the case may be subject to the understanding that the Company’s CEO’s assessment shall be final.

These options have been valued at $1,184,979 on grant date. The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 54%, risks free interest rate of 2.75% and expected option life of seven years. The options expire ten years from the date of issuance.

The compensation expenses accrued for the Plan which is subject to employees’ continuing employment and meeting the performance goals established by the department manager and/or the Company’s CEO. During the year ended March 31, 2011, a total of 385,300 options, originally valued at $380,985, failed to vest and have been cancelled due to employee resignation and employees not meeting performance target. During the three months ended June 30, 2011, a total of 60,450 options, originally valued at $59,773, failed to vest and have been cancelled due to employee resignation and employees not meeting perform target. 104,900 options are vested as of June 30, 2011.

On June 11, 2010, the Company entered into an Option Agreement under the Plan with Mr. Kenneth Lee. Under the terms of the Option Agreement, the Company granted a stock option, at an exercise price at $0.98 per share, to Mr. Lee for the purchase of 707,992 shares of common stock of the Company. According to the Option Agreement, the Option will fully vest after six months from the grant date. Pursuant to the employment arrangement between Mr. Lee and SAIF Partner, Mr. Lee is deemed to hold such option for the benefit of SAIF Partner. These options are fully vested as of March 31, 2011.

These options have been valued at $951,315, the Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of the options, with the following assumptions: no dividend yield, expected volatility of 55%, risk free interest rate of 2.03%, expected term of 5.25 years. All of the options shall vest in one time after six months from the grand date. The options expire ten years from the date of issuance.

The following table summarizes the weighted average remaining contractual life and exercise price of the Company’s outstanding options as of June 30, 2011:
 
Options Outstanding
Range of Exercise Prices
 
Number of options
Outstanding at June 30, 2011
 
Weighted Average Remaining
Contractual Life (Years)
         
$0.98-2.25
 
1,460,642
 
8.94
 
 
22

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
15. Employee Stock Ownership Plan - Continued

The Company accounts for share-based payments in accordance with ASC 718. Accordingly, the Company expenses the fair value of awards made under its share-based plan. Total compensation expense related to the stock options for the three months ended June 30, 2011 was $32,888. For the three months ended June 30, 2011, $28,941 and $3,947 were recorded as general and administrative expense and selling expense respectively. As of June 30, 2011, there was $536,064 of unrecognized compensation costs related to unvested share-based compensation arrangements granted under the Plan that is expected to be recognized through May 31, 2014. There were 193,900 shares of options vested during the three months ended June 30, 2011.

Expected volatilities utilized in the model are based on average volatility of three comparable companies in the same industry. The risk free interest rate is derived from the U.S. Treasury yield with a remaining term equal to the expected life of the option in effect at the time of the grant. Since the Company has limited option exercise history, it has elected to estimate the expected life of an award based upon the SEC-approved “simplified method” noted under the provisions of ASC 718-10-S99.

A summary of the Company’s stock option activity as of June 30, 2011, and changes during the three months ended June 30, 2011 is presented in the following table:

         
Weighted-Average
 
   
Options
   
Exercise Price
 
             
Outstanding at March 31, 2011
    1,521,092     $ 1.66  
Granted
    -       -  
Exercised
    -       -  
Cancelled
    (60,450 )     2.25  
Outstanding at June 30, 2011
    1,460,642     $ 1.63  
                 
Exercisable at June 30, 2011
    901,892     $ 1.25  

The weighted average remaining contractural life of the currently exercisable options is 8.94 years.

16. Commitments and Contingencies

Purchase of Office Building with a total consideration of $4,585,396

On January 15, 2007, the Company signed a sales and purchase agreement with Tianjin Mengyang to buy a four-story office building of an approximate construction area of 7,800 square meters located at Jinghai Industrial Park, or Jinghai Project, for a total consideration of RMB29,640,000 (approximately $4,585,396). The main body construction of office building was completed in September 2010. The construction project is under inspection and the completion date is subject to the issuance of inspection report. Based on the Company’s estimate, the completion date of inspection would be October 2011 and the Company would receive the certificate of right to use in December 2011.  As of June 30, 2011, RMB28,570,000 (approximately $4,419,864) was paid and recorded as advances on property, plant and equipment. The remaining RMB1,070,000 (approximately $165,532) would be paid in 2 installments of RMB535,000 (approximately $82,766) each upon receiving the certificate of right to use.

Renovation of Office Building with a total consideration of $724,010

As of June 30, 2011, the first payment of RMB2,340,000 (approximately $362,005) was paid to Tianjin Mengyang for interior renovation of the building and was recorded as advances and deposits on property, plant and equipment. The remaining RMB936,000(approximately $144,802), RMB936,000(approximately $144,802) and RMB468,000 (approximately $72,401) are to be paid in July, September and October 2012, respectively, upon the inspection of the completed renovation project . Based on the Company’s estimate, the completion date would be fourth calendar quarter of 2011.  If the remaining balance is not paid upon completion of the project, the balances will bear interest at the PRC prime interbank rate of 6.03% per annum for a three months loan from Tianjin Mengyang.
 
 
23

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
16. Commitments and Contingencies - Continued

Purchase of Factory & Warehouse with a total consideration of $13,999,845

On September 26, 2008, the Company signed a factory transfer agreement with Tianjin Mengyang to purchase three warehouses and a factory of an approximate construction area of 30,165 square meters situated at Jinghai Industrial Park for a total consideration of RMB90,495,000 (approximately $13,999,845). The Company paid a total of RMB44,404,000 (approximately $6,869,431) in 2008.

On January 20, 2009, the Company signed a supplemental agreement with Tianjin Mengyang to postpone the construction completion date to December 31, 2009. Under the first supplement agreement, the parties agreed that the RMB33,000,000 (approximately $5,105,199) is to be paid by 11 monthly installments of RMB3,000,000 (approximately $464,109) each from January 2009 to November 2009. The company paid RMB9,000,000 (approximately $1,392,327) in cash and settled the other RMB6,000,000 (approximately $928,218) by offsetting a short term loan due from Tianjin Mengyang up to May, 2009.

On June 12, 2009, the Company signed a second supplemental agreement with Tianjin Mengyang under which the parties agreed that the remaining balance for factory and warehouse of RMB31,091,000 (approximately $4,809,869), will be paid by 3 installments. The first installment of RMB16,080,500 (approximately $2,487,701) was paid on the completion of the main framework of the construction in Oct, 2009. The second installment of RMB7,505,250 (approximately $1,161,084) is due upon satisfactory inspection of the construction. The final installment of RMB7,505,250 (approximately $1,161,084) is due upon receiving the certificate of right to use.

The construction of the main office buildings, factory and warehouse was completed in September 2010. Tianjin Construction Commission requires the Company to provide the inspection report before the renovation projects could begin. On September 16, 2010, the Chinese State Council issued a “Circular on Further Strengthening the Quality and Safety of Dairy Products No. (2010) 42”, which requires newly established dairy product manufacturing companies to comply with “Rules for Implementation of Regulations on Issuing Infant Formula Milk Powder Production License” which was issued by the Administration of Quality Supervision, Inspection and Quarantine (AQSIQ) in November 2010. The rules tighten the examination criteria of production license and inspection standard of milk product. Therefore, Jinghai Project is subject to more stringent inspection before the inspection report could be issued. Based on the Company’s estimate, the completion date of Jinghai Project is postponed to the fourth calendar quarter of 2011.

As of June 30, 2011, total payments of RMB75,484,500 (approximately $11,677,676) were made and recorded as advances and deposits on property, plant and equipment. The remaining RMB15,010,500 (approximately $2,322,168) are to be paid by 2 installments of RMB7,505,250 (approximately $1,161,084) each. The first installment is due upon satisfactory inspection of the construction. The second installment is due upon receiving the certificate of ownership.

Purchase of Machinery & Equipment of a total consideration of $7,704,976

During the fiscal year ended March 31, 2010, the Company signed a contract to purchase machinery and equipment to expand its liquid goat milk production line, totaling RMB25,627,000 (approximately $3,964,573) and has been paid to the supplier as of June 30, 2011. RMB1,703,000 (approximately $263,459) of it was recorded in construction in progress and RMB5,266,600 (approximately $814,759) of it was recorded in advances on property, plant and equipment for those machinery and equipment not delivered yet. After March 31, 2010, the Company adopted a new marketing strategy and signed a memorandum with the supplier for switching the purchase contract of machinery and equipment RMB 5,266,600 (approximately $814,759) from Milkgoat China, our subsidiary company to Shaanxi Milkgoat, our another subsidiary. The remaining of RMB18,657,400 (approximately $2,886,355) is expected to be paid in the fourth quarter calendar year 2013.

On May 25, 2010, the Company entered into a construction agreement with Tianjin Jinghai Power Co., Ltd., for the installation of a 10KV-1250KVA substation with a total amount of RMB5,000,000 (approximately $773,514). As of June 30, 2011, the first payment of RMB1,000,000 (approximately $154,703) were paid and recorded in advances and deposits on property, plant and equipment. The remaining RMB2,500,000 (approximately $386,757) and RMB1,500,000 (approximately $232,054) are to be paid in July and September 2012, respectively, when the construction is completed. Based on the Company’s estimate, the completion date would be in the fourth calendar quarter of 2012.
 
 
24

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
16. Commitments and Contingencies – Continued

On May 26, 2010, the Company signed a contract with Tianjin Jinquan Co., Ltd. for the GMP Cleaning Workshop Installation with the total amount of RMB3,000,000 (approximately $464,108). As of June 30, 2011, the first payment of RMB1,500,000 (approximately $232,054) were paid and recorded in advances and deposits on property, plant and equipment. The remaining RMB1,500,000 (approximately $232,054) are to be paid by 2 installments. The first installment of RMB 1,050,000 (approximately $162,438) will be paid in August 2012 when the main construction materials are delivered. The final installment of RMB 450,000 (approximately $ 69,616) will be paid in September 2012 when the construction is completed.  Based on the Company’s estimate, the completion date would be in the fourth calendar quarter of 2012.

During the fiscal year ended March 31, 2011, the Company signed a contract with Shantou Xinyi for milk production equipment, totaling RMB670,000 (approximately $103,651). As of June 30, 2011, the Company paid RMB201,000 (approximately $31,095) and was recorded in advances on property, plant and equipment. The Company expects the equipment will be delivered in the third calendar quarter of 2012. The remaining  RMB 335,000 (approximately $51,825) and RMB 67,000 (approximately $10,365) will be paid in July and September 2012, respectively, when the machinery and equipment is delivered and inspected. The final payment of RMB 67,000 (approximately $10,365) is to be paid in February 2013 after the approval of final inspection of equipment.

There is a contract signed with ShangHaiDahe for purchasing goat milk powder production lines, totaling RMB16,379,500 (approximately $2,533,957). As of June 30, 2011, the Company paid RMB5,732,700 (approximately $886,866) and recorded in advances on property, plant and equipment. The remaining RMB10,646,800 (approximately $1,647,091) will be paid progressively, RMB7,339,550 ($1,135,450), RMB2,456,925 ($380,094) and RMB850,325 ($131,547) will be paid in July, September 2012 and March 2013, respectively when the construction of factory and warehouse pass the inspection and upon receiving the certificate of ownership.

The Company signed some small contracts for purchasing machinery and equipment with a total amount of RMB625,000 (approximately $96,689) and recorded in advances and deposits on property, plant and equipment as of June 30, 2011.

Installation of central system pipelines with a total consideration of $1,939,202

On October 28, 2009, Shaanxi Milkgoat entered into a Project Installation Agreement (the “Installation Agreement”), with Heilongjiang Tianhong Food Equipment Co., Ltd. (“Heilongjiang Tianhong”), which provided for, among others, and install all the process pipelines and the central system pipelines at Shaanxi Milkgoat’s new joint production facility. Pursuant to the Installation Agreement, Shaanxi Milkgoat agreed to pay Heilongjiang Tianhong an aggregate of RMB 12,535,000 (approximately $1,939,202) in five installments for the service that Heilongjiang Tianhong will provide.

As of June 30, 2011, the first payment of RMB3,760,500 (approximately $581,761) representing 30% of the consideration, was paid and recorded in advances and deposits on property, plant and equipment. The remaining balance of RMB8,774,500 (approximately $1,357,441) includes RMB3,760,500 (approximately $581,761) is expected to be paid within seven days after the beginning of installation, RMB1,253,500 (approximately $193,920) is expected to be paid within ten days after the completion of installation, RMB3,133,750 (approximately $484,800) is expected to be paid within ten days after the inspection of installation and RMB626,750 (approximately $96,960) is expected to be paid one year after the inspection of installation. Heilongjiang Tianhong agreed to complete the installation within 90 days after Shaanxi Milkgoat provides to Heilongjiang Tianhong an appropriate construction site for the installation according to the Installation Agreement. The estimated completion date of installation is postponed to fourth calendar quarter of 2013.

Construction of a research and development building with a total consideration of $1,651,225

On June 16, 2011, the Company signed a construction agreement with China Tenth Metallurgy Group Limited Corporation for the construction of a research and development building in Weinan, PRC, for a total consideration of RMB10,673,523 (approximately $1,651,225).  As of June 30, 2011, total payment of RMB7,000,000 (approximately $1,082,921) was paid to the contractor.  The estimated completion date of the construction is in fourth calendar quarter of 2011 and the balance will be paid progressively during the construction.  The Company expected to pay RMB1,000,000 (approximately $154,703) in August 2011, RMB2,139,847 (approximately $331,040) in December 2011 and RMB533,676 (approximately $82,561) in March 2014.
 
 
25

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
17. Concentrations, Risks, and Uncertainties

The Company did not have any customer constituting 10% or greater of net sales for the three months ended June 30, 2011 and 2010.

The Company has not experienced any significant difficulty in collecting its accounts receivable in the past and is not aware of any financial difficulties of its major customers.

The Company has the following concentrations of business with suppliers constituting 10% or greater of the Company’s purchased value for the three months ended June 30, 2011 and 2010:
 
   
Three months ended
   
June 30,
   
2011
 
2010
   
(unaudited)
 
(unaudited)
Tianjin Hua Ai Co., Ltd.
 
11.9%
 
*

* Constitute less than 10% of the Company's purchased value.

As of June 30, 2011, amount due to Tianjin Hua Ai Co., Ltd. was $243,829.

 
26

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
18. Series A Redeemable Convertible Preferred Stock

On June 18, 2009, the Company entered into a series A preferred stock purchase agreement, or the Stock Purchase Agreement, where it issued and sold to SAIF Partners 1,530,612 shares of the Company’s Series A Preferred Stock, par value $0.001 per share, or the Series A Redeemable Convertible Preferred Stock, at a price per share of $9.80 for an aggregate purchase price of $15.0 million. The Series A Redeemable Convertible Preferred Stock is convertible into the Company’s common stock, at the option of the holder at any time, at an initial conversion price at $0.98 per share, which conversion price is subject to stock split, recapitalization and other anti-dilution protection, as well as adjustments based on the Company’s financial performance.

On June 16, 2009, the Company filed a Certificate of Designation of Series A Preferred Stock with the Secretary of State of the State of Delaware, or the Certificate, which became effective upon filing. Pursuant to the Certificate, there are 1,530,612 shares of Series A Redeemable Convertible Preferred Stock authorized.

Series A Redeemable Convertible Preferred Stock, subject to stock split, stock dividend, recapitalization or other similar events as provided for in the Certificate.

Redemption

At any time and from time to time after June 30, 2012, the holders of not less than a majority of the then outstanding Series A Redeemable Convertible Preferred Stock have the right to request the Company to redeem all of the then outstanding shares of Series A Redeemable Convertible Preferred Stock in cash, if the following qualified events has not occurred: (i) the Company’s shares of common stock or American Depository Shares representing shares of the common stock are listed on the New York Stock Exchange or the NASDAQ Global Market, and (ii) the closing market price of such listing securities represents a price of no less than $4.25 per share of common stock, subject to adjustment, in any consecutive 30-trading-day period. The per share redemption amount is equal to the sum of (i) the purchase price of $9.8 per share plus an internal rate of return of 25% for the period from the issuance date of the Series A Redeemable Convertible Preferred Stock to the redemption date, and (ii) an amount equal to all declared but unpaid dividends for each outstanding share of Series A Redeemable Convertible Preferred Stock.
 
In accordance with FASB Accounting Standards Codification (ASC), the initial amount of such redeemable preferred stock should be its fair value at date of issue. If such convertible preferred stock is not currently redeemable and it is not probable that such convertible preferred stock will become redeemable, subsequent adjustment to its redemption amount is not necessary until it is probable that the such convertible preferred stock will become redeemable. The Series A Redeemable Convertible Preferred Stock is not redeemable currently. Management assesses the probability of the above two qualified events not occurring on a quarterly basis. The Company is currently working on complying with the NASDAQ listing requirements however based on management’s future projection of earnings per share and considering P/E ratio of similar companies in the dairy industry, management believes it is not probable that the Company will be able to maintain a closing market price of no less than $4.25 per share of common stock for 30 consecutive trading days. Therefore, the Company accreted the change in the redemption value using the effective interest method starting from January 2011. The fair value of the Series A Redeemable Convertible Preferred Stock of $15,000,000 is accreted to equal the redemption value of $26,383,562 over the 18 months period from January 1, 2011 to June 30, 2012 at an effective interest rate of 45.7%. Interest expenses of $1,626,379 are being accreted for the three months ended June 30, 2011.

In accordance with FASB ASC, the Series A Redeemable Convertible Preferred Stock is classified outside of permanent equity because the occurrence of the qualified events are not solely within the control of the Company. In accordance with FASB ASC, the issuance costs of $735,129 are netted against the Private Placement of the Series A Redeemable Convertible Preferred Stock.

19. Earnings Per Share

Basic earnings per share are computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the if-converted method for the convertible notes and preferred stock and the treasury stock method for warrants and options. The following table sets forth the computation of basic and diluted net income per share:

   
Three months ended
 
   
June 30,
 
   
2011
   
2010
 
   
(unaudited)
   
(unaudited)
 
             
Net loss available for common shareholders - basic
  $ (898,297 )   $ (1,010,032 )
Net loss available for common shareholders - diluted
  $ (898,297 )   $ (1,010,032 )
                 
Weighted average outstanding shares of common stock
    26,454,558       26,409,719  
Diluted weighted average outstanding shares
    26,454,558       26,409,719  
                 
Loss per share:
               
Basic
  $ (0.03 )   $ (0.04 )
Diluted
  $ (0.03 )   $ (0.04 )
                 

 
27

 
YAYI INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
19. Earnings Per Share – Continued

The computation of basic loss per share for the three months ended June 30, 2011 and 2010 excludes the following potentially dilutive securities because their inclusion would be anti-dilutive.
 
   
Three months ended
 
   
June 30,
 
   
2011
   
2010
 
   
(unaudited)
   
(unaudited)
 
Warrants outstanding
    1,677,200       3,084,814  
Options outstanding
    1,460,642       1,906,392  
Series A convertible preferred stock outstanding
    15,306,120       15,306,120  
Convertible promissory notes outstanding
    4,460,000       -  
      22,903,962       20,297,326  
 
For the three months ended June 30, 2011 and 2010, no convertible preferred stock, convertible notes and warrants were included in the calculation of the Company's diluted loss per share because the Company reported net losses from continuing operations.

20. Subsequent Events

Subsequent to June 30, 2011, the Company entered into 5 loan agreements with Citibank totaling of RMB1,017,363 (approximately $157,389). The annual interest rate is 8.8% and the loan is due between September 30, 2011 and October 20, 2011.  The loan is extended under the RMB 8,000,000 (approximately $1,237,623) revolving facility entered into on November 8, 2010 with Citibank (Note 8) and is guaranteed by Tianjin Mengyang with the guarantee fee totaling of RMB406,955 (approximately $62,957).

On August 1, 2011, the Company renewed the loan agreements with Shanghai PuDong Development Bank for RMB10,000,000 (approximately$1,547,030).  The annual interest rate is 7.872% and the new due date of the loans is August 1, 2012. These loans are guaranteed by Tianjin Haitai Investment Guarantee Co., Ltd.

On August 10, 2011, the Company signed a construction agreement with China Tenth Metallurgy Group Limited Corporation for the construction of dormitory, for a total consideration of RMB4,519,617 (approximately $699,198).  The estimated completion date of the dormitory is June 30, 2012.  The Company expected to pay 2 installments of RMB1,350,000 (approximately $208,849) each in September and October 2011, respectively.  The balance of RMB1,575,000 (approximately $243,657) and RMB244,617 (approximately $37,843) are expected to pay in November 2011 and June 2014, respectively.

 
28

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Special Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q, including the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that are based on the beliefs of our management, and involve risks and uncertainties, as well as assumptions, that, if they ever materialize or prove incorrect, could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The words “believe,” “expect,” “anticipate,” “project,” “targets,” “optimistic,” “intend,” “aim” or similar expressions are intended to identify forward-looking statements. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including statements regarding new and existing products, technologies and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; and any statements of belief or intention. As such, they are subject to risks and uncertainties that could cause our results to differ materially from those expressed or implied by such forward looking statements.  Such risks and uncertainties include any of the factors and risks mentioned in the “Risk Factors” sections of our Annual Report on Form 10-K for the year ended March 31, 2011 and subsequent SEC filings, and any statements of assumptions underlying any of the foregoing. All forward-looking statements included in this report are based on information available to us on the date of this report. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.

Certain Terms

In this report, unless indicated otherwise:

 
“BVI” refers to the British Virgin Islands;
 
“China,” “Chinese” and “PRC,” refer to the People’s Republic of China;
 
“Exchange Act” refers to the Securities Exchange Act of 1934, as amended
 
“Fuping Milkgoat” refers to Fuping Milkgoat Dairy Co., Ltd., a company organized under the laws of the PRC;
 
“Milkgoat China” refers to Milkgoat (China) Goat Dairy Co., Ltd., a company organized under the laws of the PRC;
 
“Renminbi” and “RMB” refer to the legal currency of PRC;
 
“SEC” refers to the United States Securities and Exchange Commission;
 
“Securities Act” refers to the Securities Act of 1933, as amended;
 
“U.S. dollars,” “dollars” and “$” refer to the legal currency of the United States;
 
“we,” “us,” “our company,” “our” and “Yayi” refer to the combined business of Yayi International Inc. and/or its consolidated subsidiaries, as the case may be; and
 
“Weinan Milkgoat” refers to Weinan Milkgoat Production Co., Limited, a company organized under the laws of the PRC.

Overview of Our Business

According to the China Quality Net, maintained by China Quality Inspection Association, we are the first and one of the leading producers and distributors of premium goat milk formula products for infants, toddlers, young children, and adults in China. We began selling powder products in Tianjin and Beijing in 2001, in Southern China in 2004 and Northern China in 2006. Our current formula product lines are targeted at the premium segment of the dairy market and health-conscious consumers. Headquartered in Tianjin, we sell and distribute our products through a nationwide network of retail points across China in 23 provinces and municipalities including infant-maternity chain stores, supermarkets (including multinational chains) and drug stores, as well as catalogue sales and our dedicated online store at Taobao.com. We are vertically integrated and source raw goat milk from our proprietary dairy farms as well as neighboring goat dairy farmers on a long-term contract basis in milk collection centers, which helps us maintain quality control.

 
29

 
 
Our powder products are sold throughout most of China. Since the end of 2009, we have been working with Trout & Partners to streamline our product portfolio and refine our brand image in order to position and strengthen our “Milk Goat” brand as the premium goat milk brand throughout China. Our portfolio has been streamlined to feature 14 product varieties under the MilkGoat brand as well as 13 additional product varieties targeting infant-maternity stores to better fit the diverse needs of our consumers. Most of our goat milk products are formulated through the inclusion of supplements such as vitamins, calcium, iron, selenium, chromium and omega-3 fatty acids, as needed to address the nutritional or health needs of the consumers. We sell and distribute our products through a network of approximately 3,800 retail points including infant-maternity chain stores, domestic and multinational supermarkets and drug stores, as well as catalogue sales across China. We sell most of our products to more than 200 distributors, who in turn sell our products to the retail points. The distributors are located in 23 provinces in China. In order to streamline the distribution process, we directly contract with infant-maternity store chains with more than 20 stores. This allows us to sell directly to the chains without an agent. We also hope to shift our revenue mix towards greater infant-maternity stores sales as they have lower slotting fees and higher margins.

First Quarter Financial Performance Highlights

With an efficient slotting fee control and increasing demand for our raw goat milk powder, we experienced a significant growth in our revenues during the first fiscal quarter ended June 30, 2011.

The following shows financial highlights for the fiscal quarter ended June 30, 2011:

 
Net Sales: Net sales for the three months ended June 30, 2011 were more than $8.3 million, an increase of 34.1% from the three months ended June 30, 2010.

 
Gross Margin: Gross margin was 62.6% for the three months ended June 30, 2011, as compared to 56.9% for the three months ended June 30, 2010.

 
Operating Profit: Operating profit was approximately $1.6 million for the three months ended June 30, 2011, which is an increase of $2.7 million as compared to the three months ended June 30, 2010.

 
Net Loss: Net loss was approximately $0.9 million for the three months ended June 30, 2011, which is a decrease of $0.1 million as compared to the three months ended June 30, 2010.

 
Loss per Share: Fully diluted loss per share was $0.03 for the three months ended June 30, 2011.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

The following table sets forth a summary of certain key components of our results of operations for periods indicated, in dollars and the percentage of change from the same period in the prior year.

   
Three Months Ended June 30,
             
   
2011
   
2010
             
               
change
   
variance
 
                         
Net Sales
  $ 8,343,694     $ 6,219,693     $ 2,124,001       34.1 %
Cost of goods sold
    (3,124,247 )     (2,680,237 )     (444,010 )     16.6 %
Gross profit
    5,219,447       3,539,456       1,679,991       47.5 %
Operating expenses:
                               
Sales and marketing expenses
    (2,778,562 )     (3,559,166 )     780,604       -21.9 %
General and administrative expenses
    (816,598 )     (1,031,526 )     214,928       -20.8 %
Income (loss) from continuing operations
    1,624,287       (1,051,236 )     2,675,523       -254.5 %
Other (expenses) income, net
    (2,063,102 )     (170,262 )     (1,892,840 )     1111.7 %
Income tax (expense) benefit
    (459,482 )     211,466       (670,948 )     -317.3 %
Net (loss) income attributable to Yayi International Inc.
  $ (898,297 )   $ (1,010,032 )   $ 111,735       -11.1 %

 
30

 
 
Net Sales.  Our net sales are generated from sales of premium goat milk formula products and raw milk powder.  Net sales for the three months ended June 30, 2011 were approximately $8.3 million, an increase of 34.1% from the three months ended June 30, 2010.  This increase was primarily due to a decrease of $2.1 million in the slotting fees as compared to the prior year period, which are offset to revenue as they are incurred. In the past, we paid a substantial amount of slotting fees when we developed new supermarket distribution channels. Since the first fiscal quarter of 2012, we have changed our marketing strategy and focused on increasing sales volume on the existing supermarkets and slowed down the pace of opening new stores. The decrease in slotting fees resulted in the unit sales price of our formula product being increased to $29,533 per ton from $21,709 per ton for the prior year period. Excluding the impact of slotting fees, the sales in formula products decreased by 4.3% from $8.5 million to $8.2 million, mainly because we launched new products since second calendar quarter of 2010, which cause some delay to make the new products available to our consumers at stores. As the amount of Chinese raw milk powder producers decreased due to the government-mandated manufacturing license renewals, the market demand for raw milk powder increased.  As a result, we sold approximately $0.4 million raw milk powder to external customers through our subsidiary Fuping Milkgoat during the first quarter ended June 30, 2011, compared to $0 sold in the same period in prior year.

The following table sets forth the information relating to the quantity and sales price of goat milk powder we sold during the periods indicated:

     
Three Months ended
   
Three Months ended
 
Product Name
   
June 30, 2011
   
June 30, 2010
 
Goat Milk Powder
Quantity (ton)
    270       287  
Products
Unit price
  $ 29,533       21,709  
Raw Milk Powder
Quantity (ton)
    82       -  
 
Unit price
  $ 4,614       -  

Cost of goods sold. Our cost of goods sold is primarily comprised of the costs of our raw materials, labor and overhead.  Cost of goods sold for the three months ended June 30, 2011 was approximately $3.1 million, an increase of 16.6% from the three months ended June 30, 2010, primarily attributable to general increase in raw milk and costs of added nutrients, partially offset by a decrease in giveaway cost. The unit cost of powdered formula products increased by 6.4% from $9,355 per ton to $9,957 per ton. The giveaway cost, which was involved in the cost of powdered formula products, decreased by 46.6% from $0.4 million to $0.2 million, mainly attributable to the “buy two new products get one old product free” offers to clean up the inventory of our original products during the three months ended June 30, 2010. Excluding the impact of the giveaway cost, the unit cost of powdered formula products increased by 15.3% from $7,942 per ton to $9,155 per ton.

Gross Profit.  Our gross profit is equal to the difference between our net sales and our cost of goods sold.  Gross profit for the three months ended June 30, 2011 was approximately $5.2 million, an increase of 47.5% from the three months ended June 30, 2010.  Our gross margin for the three months ended June 30, 2011 increased to 62.6% from 56.9% for the three months ended June 30, 2010, which is mainly attributable to the significant decrease in slotting fees paid and the giveaway cost.

Operating expenses. Our total operating and administrative expenses consist primarily of sales and marketing expenses and general and administrative expenses.  Our total operating expenses decreased by approximately $1.0 million to $3.6 million or 21.7% from the three months ended June 30, 2010.  Following is a discussion of the reasons for this decrease broken down by category of operating expense:

Sales and marketing expenses. For the three months ended June 30, 2011, sales and marketing expenses decreased approximately 21.9% to $2.8 million from $3.6 million for the three months ended June 30, 2010.  The decrease was primarily attributable to the decrease in advertising expenses and salary of marketing staff, partially offset by the increase in promotion expenses. Advertising expenses for the three months ended June 30, 2011 was approximately $0.2 million, a decrease of 88.7% compared with $1.7 million from the three months ended June 30, 2010, reflecting our decision to realign our marketing efforts. From January through June of 2010, we advertised during primetime on CCTV’s premier news channel in China. After evaluating the effectiveness and efficiency of its marketing dollars, we chose to shift to our advertising spending on CCTV’s finance, arts and entertainment and music channels to more directly reach our target, high-end consumer base. Promotional expenses were approximately $1.8 million for the three months ended June 30, 2011, an increase of 139.5% compared with $0.8 million for the three months ended June 30, 2010, which is mainly due to the fact that we shifted the investment from large input in TV ads to promotion activities in the terminal stores. The salary of marketing staff decreased approximately 22.9% to $0.5 million from $0.7 million. During the three months ended June 30, 2011, we improved the effectiveness of sales and marketing efforts at existing sales points, rather than focusing on the expansion of our distribution network.

 
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General and administrative expenses. General and administrative expenses for the three months ended June 30, 2011 decreased by 20.8% to $0.8 million from $1.0 million for the three months ended June 30, 2010.  It was primarily attributable to a $0.1 million decrease for stock compensation, and a $0.1 million decrease in compensations to senior managers and executives.

Other expenses. Our other expenses consist primarily of interests, finance cost, change in fair value of derivative liabilities, expenses on make good provision and registration penalties related to $8.92 million convertible notes.  Other expenses increased by approximately 1111.7% to $2.1 million for the three months ended June 30, 2011 from $0.2 million for the three months ended June 30, 2010, primarily due to an increase of $1.6 million in interest expenses we accrued for Series A Preferred Stock (see Note 18 to the Condensed Consolidated Financial Statements) and an increase of $0.5 million in amortization of deferred debt issuance cost for the Convertible Notes as described below.

Income Tax (expenses) benefits. Our income tax expenses for the three months ended June 30, 2011 increased to $0.5 million, compared with a benefit of approximately $0.2 million for the three months ended June 30, 2010. The increase was primarily attributable to the increase in income before tax for PRC subsidiaries for the three months ended June 30, 2011.

Net (loss) Income. As a result of the factors described above, net loss was $0.9 million for the three months ended June 30, 2011, compared with $1.0 million net loss for the prior year period.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2011, we had cash and cash equivalents of approximately $14.3 million and working capital of approximately $9.6 million.

We intend to, and are in the process of, expanding our administrative and production facilities to meet our current needs and anticipated increased demand for our products. In connection therewith, we plan to spend approximately $9.9 million during the 24 months ending March 31, 2013 ($2.6 million during the fiscal year ending March 31, 2012 and $7.3 million during the fiscal year ending March 31, 2013). The $9.9 million in capital expenditure is expected to be mainly used for the following items:

 
the purchase of machineries and equipment for the new powder processing plant in Weinan, Shaanxi and machineries and equipment in Fuping, Shaanxi with the capital expenditure of $3.0 million;
 
the purchase of livestock, the construction of goat farms and goat milk collection stations in an amount of $0.5 million;
 
the packing equipment purchase, the purchase of factory and warehouse, renovation of the office facility and staff apartment building in Jinghai, Tianjin in an amount of $6.0 million and the purchase of information technology equipment and systems in an amount of $0.4 million.

On September 27, 2010, we entered into a securities purchase agreement, or the Securities Purchase Agreement, with 119 U.S. accredited investors, or the PIPE Investors, and Euro Pacific Capital, Inc., as representative of the PIPE Investors, pursuant to which we issued and sold to the PIPE Investors 892 units at a purchase price of $10,000 per unit, resulting in gross proceeds of $8.92 million to us. Each unit consists of a three-year, 9% convertible promissory note in the principal amount of $10,000, or the Convertible Note, and a three-year Series F Warrant, to purchase 1,250 shares of our common stock at an exercise price of $2.50 per share. The Convertible Notes are payable at an interest rate of 9% per annum, payable semiannually in arrears on the last day of the first and third calendar quarters commencing March 31, 2011 and mature on September 26, 2013, or the Maturity Date. The Convertible Notes are also convertible into shares of our common stock at any time prior to the Maturity Date at $2.00 per share, which conversion price is subject to weighted average and other customary anti-dilution protections. See our Current Report on Form 8-K filed on October 1, 2010 for more information of this private placement transaction.

 
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On November 4, 2010, Milkgoat China entered into a working capital loan agreement with Tianjin Bank, Shaoxing Dao Branch, or Tianjin Bank, pursuant to which, Tianjin Bank loaned to Milkgoat China RMB20,000,000 (approximately $2,991,862) to purchase raw materials. The loan has a term of 12 months and expires on November 3, 2011. The fixed annual interest rate of the loan is 6.672%.  Under the terms of the loan agreement, Milkgoat China is subject to customary affirmative and negative covenants. The loan may be accelerated and Tianjin Bank may demand immediate payment of the principal and accrued interests upon the occurrence of an event of default which includes, among other things, a failure to make principal or interest payments timely, a failure to comply with other covenants and certain events of bankruptcy. On November 5, 2010, RMB15, 000,000 (approximately $2,246,922) was disbursed to Milkgoat China, and the remaining RMB 5,000,000 (approximately $744,940) was disbursed to Milkgoat China on January 6, 2011.

On November 8, 2010, Milkgoat China entered into a non-committed short term revolving facility agreement with CITI Bank (China) Co., Ltd, Tianjin Branch, or Citi Bank, pursuant to which, Citi Bank agreed to make available to Milkgoat China a RMB 8 million (approximately $1,217,637) revolving credit facility to purchase raw materials and for working capital purposes. A separate agreement will be entered into each time as advance is made under the credit facility. The term of each advance is up to three months. The interest rate on each advance will be memorialized in the separate agreement. Tianjin Mengyang Biotechnology Co., Ltd., Fung Shek and Li Liu acted as guarantors under this agreement. As of June 30, 2011, we have borrowed RMB 175,500 (approximately $27,150) under this agreement.

On January 6, 2011, Milkgoat China entered into a working capital loan agreement with Bank of Beijing. Pursuant to the short-term loan agreement, Bank of Beijing agreed to loan to Milkgoat China an aggregate RMB 10,000,000 (approximately $1,489,880) for working capital. The loan has a monthly interest rate of 0.5084% and the interests must be paid on a quarterly basis on the 20th of the last month of each quarter. The loan expires on January 5, 2012 but can be renewed upon the written consent by Bank of Beijing. Under the terms of the loan agreement, we are subject to customary affirmative and negative covenants. The loan may be accelerated and Bank of Beijing may demand immediate payment of the principal and accrued interests upon the occurrence of an event of default which includes, among other things, a failure to make principal or interest payments, a failure to comply with other covenants and certain events of liquidation or bankruptcy.

On June 10, 2011, Milkgoat China renewed a loan agreement with Tianjin Rural Commercial Bank for RMB30,000,000 (approximately $4,566,140). The annual interest rate is 7.572% and the loan is due on June 9, 2012. The loan is guaranteed by Tianjin Haitai Investment Guarantee Co., Ltd.

On August 1, 2011, Milkgoat China renewed a loan of RMB 10,000,000 (approximately $1,547,000) from Shanghai Pudong Development Bank, Tianjin Branch, or Pudong Bank, for use as working capital. The loan has an annual interest rate of 7.872% and the interest must be paid on a quarterly basis on the 20th of the last month of each quarter. Under the terms of the loan agreement, Milkgoat China is subject to customary affirmative and negative covenants. The loan may be accelerated and Pudong Bank may demand immediate payment of the principal and accrued interest upon the occurrence of an event of default which includes, among other things, a failure to make principal or interest payments, a failure to comply with other covenants and certain events of liquidation or bankruptcy.

We believe that our currently available working capital should be adequate to sustain our operations at our current levels through at least the next twelve months. However, depending on our future needs, changes and trends in the capital markets affecting our shares and the company, we may determine to seek additional debt financing from commercial bank or equity financing in the private or public markets.

 
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Cash Flow

 
Three Months Ended June 30,
 
2011
2010
Net cash provided by (used in) operating activities
$896,514
$(3,202,660)
Net cash (used in) investing activities
(674,740)
(567,386)
Net cash provided by (used in) financing activities
522,727
3,673,317
Net increase (decrease) in cash and cash equivalent
949,636
(79,877)

Operating Activities

Net cash provided by operating activities for the three months ended June 30, 2011 was approximately $0.9 million that was mainly attributable to net loss of $0.9 million, non-cash items not affecting cash flows of $1.8 million and a $0.04 million increase in net operating assets and liabilities, as compared to net cash used in operating activities of $3.2 million for the three months ended June 30, 2010.  The changes in net operating assets and liabilities for the three months ended June 30, 2011 was primarily related to a $1.9 million increase in accounts receivables due to our extended term for new products promotion,  offset by a $1.2 million increase in accounts payable due to the peak season for collecting raw goat milk and preparing for the upcoming sales demand,  a $0.2 million decrease in prepaid expenses mainly due to amortizing on advertising expenses prepaid in March 2011, a $0.3 million decrease in advances mainly due to we received raw goat milk that was prepaid in last quarter, a $0.2 million decrease in deferred tax asset and current assets due to reversing of deferred tax asset related to slotting fees adjustment. Net cash used in operating activities for the three months ended June 30, 2010 was mainly attributable to net loss of $1.0 million, non-cash items not affecting cash flows of $0.3 million and a $2.5 million increase in net operating assets and liabilities. We are enhancing our production planning and accounts receivables collection to improve our operating cash flow performance.

Investing Activities

Net cash used in investing activities for the three months ended June 30, 2011 was approximately $0.7 million, an increase of approximately $0.1 million from approximately $0.6 million of the corresponding period in the prior year.  The change was mainly caused by the fact that we paid $0.5 million for Shaanxi new processing plant for the three months ended June 30, 2011, whereas we prepaid $0.4 million for ordering Jinghai equipment during the prior year period.

Financing Activities

Net cash provided by financing activities for the three months ended June 30, 2011 was approximately $0.5 million compared to approximately $3.7 million of net cash provided by these activities during the corresponding period in the prior year.  The change is primarily attributable to our borrowing of approximately $3.0 million from SAIF Partners on April 30, 2010 and $0.7 million bank loan net increase during the three months ended June 30, 2010, while we did not make similar financing during the three months ended June 30, 2011. We had $0.5 million bank’s acceptable bills matured for internal purchase during this period of time, which caused $0.5 million decrease in restricted cash.
 
Effects of Inflation

Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor the price change and continually maintain effective cost control in operations.

 
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Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.

Seasonality

Goat milk production is seasonal because goats generally do not produce milk from November through February. During such period, we generate sales of goat milk powder from our inventory that builds during the period preceding such hiatus.  In addition, the consumption of goat milk is also seasonal with greater demand in winter and public holiday seasons.

Critical Accounting Policies

Critical accounting policies are those we believe are most important to portraying our financial conditions and results of operations and also require the greatest amount of subjective or complex judgments by management.  Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions.  There have been no material changes to the critical accounting policies previously disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures.

Our management, with the participation of our chief executive officer and chief financial officer, Ms. Li Liu and Ms. Jing Chen, respectively, evaluated the effectiveness of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this report, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, Ms. Li Liu and Ms. Jing Chen concluded that as of June 30, 2011, our disclosure controls and procedures were not effective due to the significant deficiencies in our internal control over financial reporting for the period as disclosed below.

Changes in Internal Control Over Financial Reporting.

As we disclosed in our Annual Report on Form 10-K filed with the SEC on June 29, 2011, during our assessment of the effectiveness of internal control over financial reporting as of March 31, 2011, management identified the following significant deficiencies:

 
Our internal audit function is significantly deficient due to insufficient qualified resources and appropriate system to perform such function. Therefore, our ability to prevent and control lapses and errors in our accounting function could not be rendered effectively.

 
Our current accounting staff is relatively inexperienced with respect to U.S. GAAP and needs substantial training to meet the higher demands of being a U.S. public company.

 
35

 
 
In order to correct the foregoing significant deficiencies, during the fiscal quarter ended June 30, 2011, we have taken and are taking the following remediation measures that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting:

 
We have engaged a third party professional consultant, as announced on November 17, 2009, to assist us in assessing, improving and monitoring our internal control over financial reporting. We have been actively working with the external consultant to assess our data collection, financial reporting, and control procedures and to strengthen our internal controls over financial reporting.  The consultant has completed the control tests and another round of control tests will be conducted by December 2011.

 
We are committed to develop a comprehensive and risk-based internal audit function within the Company. Due to the scarcity of qualified candidates with extensive experience in U.S. GAAP reporting and accounting in the region, we have engaged an external professional consultancy firm to assist the management in developing the internal audit system. At the same time, we have employed experienced staff with respect to U.S. GAAP-based reporting. We have enhanced our efforts to hire sufficient internal audit resources with assistance from recruiters and through referrals.

In connection with the above remediation measures, we agreed to pay the third party professional consultant a service fee of approximately RMB 0.7 million (approximately $0.11 million) for their assistance in the improvement of our internal control over financial reporting. In addition, we hired five more staff to work in our Sarbanes-Oxley Act compliance department with an aggregate monthly salary of RMB17, 980 (approximately $2,700).

Our management is committed to improving our internal controls. We believe that the foregoing steps will remediate the significant deficiencies identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate to put effective controls in place.

Our management does not believe that these significant deficiencies in our internal control over financial reporting had a material effect on our financial condition or results of operations or caused our financial statements for the three months ended June 30, 2011 to contain a material misstatement.

 
36

 
 
PART II
OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business.  We are currently not aware of any legal proceedings or claims that would require disclosure under Item 103 of Regulation S-K.  However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.

ITEM 1A.  RISK FACTORS

Not applicable.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

We have not sold any unregistered equity securities during the fiscal quarter ended June 30, 2011 that were not previously disclosed in a current report on Form 8-K that was filed during that period.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4.  [REMOVED AND RESERVED]

ITEM 5.  OTHER INFORMATION.

On August 10, 2011, Shaanxi Milkgoat Dairy Co., Ltd., or Shaanxi Milkgoat, our indirect wholly owned subsidiary, entered into a construction agreement, or the Construction Agreement, with China Tenth Metallurgical Group Corporation, or China Metallurgical, pursuant to which China Metallurgical agreed to construct an employee dormitory building for the raw goat milk processing project of Shaanxi Milkgoat for a construction fee of RMB 4,519,617.17 (approximately $696,163). According to the Construction Agreement, the construction should be completed by June 30, 2012.  Shaanxi Milkgoat is allowed to pay the construction fee in four installments.

The foregoing description of the Construction Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the English translation of the Construction Agreement attached as Exhibit 10.1 hereto and incorporated herein by reference.

ITEM 6.  EXHIBITS.

EXHIBITS.

10.1
Construction Agreement, by and between Shaanxi Milkgoat and China Metallurgical, dated August 10, 2011.
10.2
Working Capital Loan Agreement, by and between Milkgoat China and Shanghai Pudong Development Bank, dated August 1, 2011.
31.1
Certification of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 
 

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
DATED:  August 15, 2011

 
YAYI INTERNATIONAL INC.
   
   
 
By: /s/ Li Liu
 
Li Liu
 
Chief Executive Officer
 
(Principal Executive Officer)
   
 
By: /s/ Jing Chen
 
Jing Chen
 
Chief Financial Officer
 
(Principal Financial and Accounting Officer)
 

 
 
38

 

EXHIBIT INDEX
Exhibit  
Number Description
   
10.1
Construction Agreement, by and between Shaanxi Milkgoat and China Metallurgical, dated August 10, 2011.
10.2
Working Capital Loan Agreement, by and between Milkgoat China and Shanghai Pudong Development Bank, dated August 1, 2011.
31.1
Certification of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.