Yayi International Inc - FORM 10-Q

Attached files

file	filename
EXCEL - IDEA: XBRL DOCUMENT - Yayi International Inc	Financial_Report.xls
EX-31.2 - EXHIBIT 31.2 - Yayi International Inc	a50165723_ex312.htm
EX-31.1 - EXHIBIT 31.1 - Yayi International Inc	a50165723_ex311.htm
EX-32.2 - EXHIBIT 32.2 - Yayi International Inc	a50165723_ex322.htm
EX-32.1 - EXHIBIT 32.1 - Yayi International Inc	a50165723_ex321.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: December 31, 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 incorporation or organization)		(I.R.S. Empl. Ident. No.)

	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 X 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 February 10, 2012 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	2
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.	Controls and Procedures	43

	PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	45
Item 1A.	Risk Factors	45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.	Defaults Upon Senior Securities	45
Item 4.	Mine Safety Disclosures	45
Item 5.	Other Information	45
Item 6.	Exhibits	45

PART I FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES
FOR THE THREE AND NINE MONTHS ENDED DECEMBER 31, 2011 AND 2010
INDEX TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

	Page
Condensed Consolidated Balance Sheets (Unaudited)	3-4
Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)	5-6
Condensed Consolidated Statement of Stockholders’ Equity (Unaudited)	7
Condensed Consolidated Statements of Cash Flows (Unaudited)	8-9
Notes to Condensed Consolidated Financial Statements (Unaudited)	10

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	December 31		March 31
	2011		2011
	(unaudited)

ASSETS
Current assets:
Cash and cash equivalents	$	16,894,253	$	13,360,392
Restricted cash		408,090		1,412,404
Accounts receivable, net of allowances of $91,699 and $72,036		5,993,752		4,776,780
Other receivable, net of allowances of $59,428 and $43,230		862,149		574,383
Inventories		3,872,826		3,885,481
Prepaid expenses		155,304		309,894
Land use rights - current portion		20,263		19,611
Advances		861,918		900,033
Deferred tax asset		-		374,124
Deferred financing cost		337,237		159,496
Total current assets		29,405,792		25,772,598

Property, plant and equipment, net		6,619,985		8,063,507
Livestock, net		287,168		563,402
Assets held for sale		1,871,623		-
Goodwill		299,281		289,643
Land use rights		950,678		942,939
Deposits on property, plant and equipment		19,865,064		19,063,439
Deferred tax asset		46,122		31,225
Deferred financing cost		655,162		867,552

Total assets	$	60,000,875	$	55,594,305

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short term loans	$	13,120,881	$	10,654,328
Accounts payable		2,196,524		884,407
Other payable, bills payable and accrued expenses		2,939,263		3,172,782
Advance from customers		133,215		90,232
Income and other tax payable		1,039,405		1,214,494
Make good provision		169,875		-
Long term loans - current portion		-		17,697

Total current liabilities		19,599,163		16,033,940

Long-term liabilities:
Due to stockholders		5,567,772		5,450,233
Derivative liabilities		730,191		1,776,400
Convertible notes, net of discount of $3,025,865 and $3,858,839		5,894,135		5,061,161
Registration penalties and make good provision		-		473,283

		12,192,098		12,761,077

Total liabilities		31,791,261		28,795,017

Commitments and contingencies (Note 18)		-		-

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 internal rate of return of 25% from date of issuance to date of redemption, 1,530,612 shares issued and outstanding		21,121,644		15,745,165


STOCKHOLDERS' EQUITY

Common stock, par value $0.001, 100,000,000 shares authorized, 26,454,558 shares issued and outstanding, respectively		26,454		26,454
Additional paid-in capital		2,931,498		5,840,290
Statutory surplus reserve fund		1,442,434		1,142,397
Retained Earnings		-		2,529,601
Accumulated other comprehensive income		2,687,584		1,515,381

Total stockholders’ equity		7,087,970		11,054,123

Total liabilities and stockholders' equity	$	60,000,875	$	55,594,305

See accompanying notes to these condensed consolidated financial statements

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(UNAUDITED)

	Three months ended						Nine months ended
	December 31,						December 31,
	2011			2010			2011			2010

Net sales	$	8,005,888		$	6,429,936		$	24,919,126		$	20,717,005

Cost of goods sold		2,698,622			2,467,795			8,957,173			8,022,963

Gross profit		5,307,266			3,962,141			15,961,953			12,694,042

Operating expenses:
Sales and marketing expenses		4,215,861			3,089,641			10,930,172			10,835,434
General and administrative expenses		874,888			1,127,672			2,481,109			3,365,857

Total operating expenses		5,090,749			4,217,313			13,411,281			14,201,291

Income (loss) from operations		216,517			(255,172	)		2,550,672			(1,507,249	)

Other income (expenses):
Interest income		15,853			5,782			51,471			11,293
Interest expenses		(309,365	)		(142,583	)		(831,733	)		(506,253	)
Amortization of deferred financing costs, debt discount and convertible notes’ interest		(558,711	)		(429,176	)		(1,553,502	)		(499,009	)
Change in fair value of derivative liabilities		201,948			979,923			1,438,689			843,037
Loss on write down of assets held for sale		(623,305	)		-			(623,305	)		-
Expense on make good provision		17,286			(293,029	)		35,808			(293,029	)
Reversal of registration penalties		388,452			-			267,600			-
Settlement of registration penalties		(392,480	)		-			(392,480	)		-
Other (expenses) income		699			(1,555	)		(25,204	)		(26,356	)

(Loss) income before income tax		(1,043,106	)		(135,810	)		918,016			(1,977,566	)

Income tax (expense)/benefits		(111,581	)		(98,530	)		(807,536	)		20,831

Net (loss) income		(1,154,687	)		(234,340	)		110,480			(1,956,735	)

Accretion of preferred stock		(1,963,220	)		-			(5,376,479	)		-

Net loss attributable to common stockholders		(3,117,907	)		(234,340	)		(5,265,999	)		(1,956,735	)

Other comprehensive income
Foreign currency translation adjustment		211,971			405,959			1,172,203			994,361

Comprehensive (loss) income attributable to common stockholders	$	(2,905,936	)	$	171,619		$	(4,093,796	)	$	(962,374	)

Loss per share of common stock
- Basic	$	(0. 12	)	$	(0.01	)	$	(0.20	)	$	(0.07	)
- Diluted	$	(0.12	)	$	(0.01	)	$	(0.20	)	$	(0.07	)

Weighted average shares of common stock outstanding
- Basic		26,454,558			26,454,394			26,454,558			26,433,743
- Diluted		26,454,558			26,454,394			26,454,558			26,433,743

See accompanying notes to these condensed consolidated financial statements

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

	Common stock							Statutory		(Accumulated			Accumulated		Total
	Number of shares		Amount		Additional paid-in capital			Surplus Reserve Fund		Deficit) / Retained Earnings			Other 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		-		-		127,643			-		-			-		127,643

Transfer to statutory surplus reserve fund		-		-		-			300,037		(300,037	)		-		-

Net income for the period ended December 31, 2011		-		-		-			-		110,480			-		110,480

Accretion of preferred stock		-		-		(3,036,435	)		-		(2,340,044	)		-		(5,376,479	)

Foreign currency translation		-		-		-			-		-			1,172,203		1,172,203

Balance at December 31, 2011		26,454,558	$	26,454	$	2,931,498		$	1,442,434	$	-		$	2,687,584	$	7, 087,970

See accompanying notes to these condensed consolidated financial statements

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Nine Months Ended
	December 31,
	2011			2010
Cash flow from operating activities
Net (loss) income	$	110,480		$	(1,956,735	)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization of livestock		791,130			503,235
Amortization of land use rights		23,392			12,724
Amortization of deferred financing costs		118,428			72,506
Allowance of bad debts		31,128			3,620
Employee stock-based compensation		127,643			1,133,854
Sales return allowance		-			(45,520	)
Change in fair value of derivative liabilities		(1,438,689	)		(843,037	)
Loss on write down of assets held for sale		623,305			-
Accretion of debt discount		832,974			426,503
Settlement of registration penalties		124,880			-

(Increase) decrease in operating assets:
Restricted cash		-			29,665
Accounts receivable		(1,031,086	)		(716,068	)
Other receivable		(288,048	)		210,722
Inventories		139,378			(1,714,974	)
Prepaid expenses		159,786			939
Advances		63,316			422,022
Deferred tax asset and current assets		366,698			(281,850	)

Increase (decrease) in operating liability:
Accounts payable		1,234,068			866,248
Advance from customers		39,687			(98,496	)
Income and other tax payable		(217,268	)		(176,197	)
Other payable, bills payable and accrued expenses		(823,076	)		142,288
Make good provision payable		(35,808	)		293,029
Net cash provided by (used in) operating activities		952,318			(1,715,522	)

Cash flows from investing activities
Purchase of property, plant and equipment		(851,808	)		(578,270	)
Advance for construction of factory and warehouse		(78,759	)		-
Deposit for purchase of machinery and equipment		(73,112	)		(723,842	)
Proceeds from sale of livestock		56,639			62,973
Purchase and breeding of livestock		(19,915	)		(60,392	)

Net cash used in investing activities		(966,955	)		(1,299,531	)

Cash flows from financing activities
Proceeds from short term loans		11,747,751			11,114,894
Repayment of short term loans		(9,670,225	)		(9,608,176	)
Repayment of long term loans		-			(30,965	)
Net proceeds from issuance of Series A preferred stock		-			8,031,819
Change in restricted cash		1,021,445			(408,090	)
Due (from) to stockholders		-			(6,026	)
Net cash provided by financing activities		3,098,971			9,093,456

Effect of exchange rate changes in cash		449,527			153,780

Net increase in cash and cash equivalents		3,533,861		6,232,183

Cash and cash equivalents, beginning of period		13,360,392		4,727,677

Cash and cash equivalents, end of period	$	16,894,253	$	10,959,860

Supplemental disclosure of cash flow information
Cash paid during the period

Interest paid	$	1,230,903	$	464,016

Income tax paid	$	803,202	$	327,710

Supplemental disclosure of non-cash financing and investing activities:

Accretion of preferred stock	$	5,376,479	$	-

Acquisition of property, plant and equipment in other payable	$	700,291	$	-

Non-cash exercise of warrants into common stock	$	-	$	67

Deposits transferred to construction in progress	$	-	$	65,828

Deposits transferred to property, plant and equipment	$	9,765	$	-

Transfer of property, plant and equipment and livestock to assets held for sale	$	1,871,623	$	-

Accrued interest on convertible notes	$	200,700	$	-

Fair value of placement agent warrants in deferred cost financing	$	-	$	231,929

See accompanying notes to these condensed consolidated financial statements

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 and nine months ended December 31, 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, Weinan Milkgoat Production Co., Ltd. (“Weinan Milkgoat”), Fuping Milkgoat Dairy Co., Ltd. (“Fuping Milkgoat”) 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 $39,508 and $19,791 for the three months ended December 31, 2011 and December 31, 2010, respectively. Research and development expenses amounted to $84,060 and $61,012 for the nine months ended December 31, 2011 and December 31, 2010, respectively.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies – Continued

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 December 31, 2011, there was no capitalized direct-response advertising. All other advertising costs are expensed as incurred. Advertising and promotion costs amounted to $3,267,577 and $2,137,896 for the three months ended December 31, 2011 and December 31, 2010, respectively. Advertising and promotion costs amounted to $8,400,216 and $7,435,867 for the nine months ended December 31, 2011 and December 31, 2010, respectively.

Impairment of long-lived assets – Financial Accounting Standards Board Accounting Standards Codifications requires that long-lived assets and certain intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If impairment has occurred, an impairment loss must be recognized.

The Company periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets subject to amortization, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.

A long-lived asset is classified as held for sale in the period it meets all of these criteria:

●	Management with the authority to approve the action commits to a plan to sell.

●	The asset is available for immediate sale in its present condition, subject only to terms that are usual and customary when selling such assets.

●	The company has initiated an active program to locate a buyer.

●	The sale is probable and the asset transfer is expected to qualify as a completed sale within one year (there are some circumstances beyond the entity’s control that may extend the time for completion beyond one year).

●	The company is actively marketing the asset at a reasonable price in relation to its current fair value.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies – Continued

A long-lived asset held for sale is not depreciated or amortized but is measured at the lower of its carrying amount or fair value less cost to sell, which is the incremental direct costs that would not have incurred if not for the decision to sell.

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 December 31, 2011 and December 31, 2010, shipping and handling costs were $85,700 and $107,898, respectively. During the nine months ended December 31, 2011 and December 31, 2010, shipping and handling costs were $268,125 and $367,447, respectively.

Slotting fees - The Company accounts for slotting fees in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“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 $119,790 and $1,238,574 were recorded as a reduction of sales revenue for the three months ended December 31, 2011 and December 31, 2010, respectively. Slotting fees of $478,015 and $4,553,219 were recorded as a reduction of sales revenue for the nine months ended December 31, 2011 and December 31, 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.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies – Continued

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 Company adopted the disclosure requirements effective April 1, 2011. 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 Company will adopt the disclosure requirements for any business combinations in 2011. The adoption of this amendment did not have a material impact to the Company’s financial position.

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.

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.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Recently Issued Accounting Pronouncements Not yet Adopted

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. 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.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment . The objective of this Update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis of determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company intends to adopt the amendments in this Update effective April 1, 2012.

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update will enhance disclosures that will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect of potential effect of rights of setoff associated with certain financial instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

3. Going Concern

At any time after June 30, 2012, the holders of not less than a majority of the then outstanding Series A Redeemable Convertible Preferred Stock (“Series A 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, amounted to $26,383,562, if certain qualified events have not occurred (Note 20). These conditions raise substantial doubt about the Company’s ability to continue as a going concern, as the cash redemption requirement could pose a significant impact on the Company’s cash flow.

The financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty as of December 31, 2011.

4. Restricted Cash

	December 31,		March 31,
	2011		2011
	(unaudited)		(audited)
Bank deposits held as collateral for bills payable	$	-	$	1,004,314
Bank deposits held in escrow (Note 12)		408,090		408,090
	$	408,090	$	1,412,404

Cash of $408,090 from the private placement was held in escrow for the Company as of December 31, 2011 (Note 12).

5. Other Receivable

	December 31,			March 31,
	2011			2011
	(unaudited)			(audited)
Advance to staff	$	24,551		$	37,892
Security deposit		858,945			470,313
Sundry		38,081			109,408
		921,577			617,613
Less: allowance for bad debts		(59,428	)		(43,230	)
	$	862,149		$	574,383

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6. Inventories

Inventories consist of:

	December 31,		March 31,
	2011		2011
	(unaudited)		(audited)
Raw materials	$	2,792,577	$	2,709,596
Packaging		457,874		497,341
Finished goods		622,375		678,544
	$	3,872,826	$	3,885,481

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

As of December 31, 2011, the Company had approximately $1,729,968 of inventory that is pledged as collateral for a loan (Note 10).

7. Deposits on Property, Plant and Equipment

Deposits on property, plant and equipment consist of:

	December 31,		March 31,
	2011		2011
	(unaudited)		(audited)
Advances to Tianjin Mengyang Biological Development Co., Ltd. ("Tianjin Mengyang"), formerly Tianjin Milkgoat Dairy Co., Ltd.
- purchase of office building (Note 18)	$	4,493,198	$	4,348,488
- purchase of factory and warehouse (Note 18)		11,871,432		11,489,095
- advances for renovation of office building (Note 18)		368,011		356,159
Deposits for construction in progress (Note 18)		597,232		572,366
Advanced payment for purchasing machinery and equipment (Note 18)		2,535,191		2,297,331
	$	19,865,064	$	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. The inspection is still in progress and the management is uncertain for the date of receiving the inspection report (Note 18). 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. The inspection is still in progress and the management is uncertain for the date of receiving the inspection report (Note 18). The Company expects that the facility will start operating during the fourth calendar quarter of 2012.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

7. Deposits on Property, Plant and Equipment-Continued

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 18).

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 (Note 18).

8. Property, Plant and Equipment, net

Property, plant and equipment, net consist of the following:

	December 31,			March 31,
	2011			2011
	(unaudited)			(audited)
At cost:
Leasehold improvement	$	74,101		$	71,714
Plant and buildings		2,052,474			4,338,544
Machinery		3,750,346			3,895,981
Furniture, fixtures and equipment		253,114			239,364
Motor vehicles		357,844			338,091
		6,487,879			8,883,694
Less: accumulated depreciation and amortization		(2,116,222	)		(1,799,269	)
		4,371,657			7,084,425
Construction in progress		2,248,328			979,082
	$	6,619,985		$	8,063,507

During the three and nine months ended December 31, 2011, depreciation expenses amounted to $243,981 and $724,362, respectively. Among which $157,100 and $563,736 was recorded as cost of sales, and $86,881 and $160,626 was recorded as other selling, general and administrative expense for the three and nine months ended December 31, 2011, respectively.

During the three and nine months ended December 31, 2010, depreciation expenses amounted to $161,814 and $430,155, respectively. Among which $138,006 and $358,707 was recorded as cost of sales, and $23,808 and $71,448 was recorded as other selling, general and administrative expense for the three and nine months ended December 31, 2010, respectively.

As of December 31, 2011, the main body of the dormitory was completed by the contractor, China Tenth Metallurgy Group Limited Corporation for RMB1,250,000 (approximately $196,587) and was recorded in construction in progress until the renovation and installation of machineries and equipment are completed.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

9. Assets Held for Sale

Assets held for sale represents fair value of plant and buildings machinery and livestock of eight of the Company’s goat farms located in Weinan, Shanxi Province. In December, 2011, the Company commenced process of negotiating with various third parties to lease these farms to them by the end of March 2012 for a period of 10 years and to transfer the ownership of the assets on the farms to the lessees by the end of the lease term. The lease will be non-cancellable and all risks including but not limited to loss, destruction, damage, deterioration and depreciation of these assets will be assumed by the lessees. A one-year security deposit which is refundable without interest accrued at the expiration of the lease term will be required to be paid upon commencement of the lease. Delay of lease payment will result in certain interest penalties and in the event of default, the Company shall be entitled to sell these assets, the goat milk and breeding goats at these farms to other parties to recover the lease payments. These conditions meet the criteria described in FASB ASC 840-10 and this lease arrangement qualifies as a capital lease. As such, the plant and buildings, machinery and livestock on these farms were presented as assets held for sale as of December 31, 2011. Assets held for sale are measured at the lower of cost or fair value less cost to sell. As of December 31, 2011, assets held for sale was written down to fair value less cost to sell of $1,871,623. A loss of $623,305 was recognized for the write-down to fair value for the three and nine months ended December 31, 2011.

10. Short Term Loans

As of December 31, 2011, the Company has 8 loan agreements with Citibank for total of RMB3,429,121 (approximately $539,297). The annual interest rates range from 9.3% to 9.6% and the due dates of the loans range from January 6, 2012 to March 14, 2012. Five of these loans for a total of RMB1,195,874 (approximately $188,075) have been repaid subsequent to December 31, 2011. These loans are guaranteed by Tianjin Mengyang and an amount of RMB1,371,649 (approximately $215,719) was held by the bank as a security deposit. This amount will be refunded upon the settlement of the loan. This loan was extended under a revolving credit facility of RMB8,000,000 (approximately $1,258,158) entered into with Citibank on November 6, 2010. The unused amount as of December 31, 2011 was RMB4,570,879 (approximately $718,861).

On November 8, 2011, the Company renewed the loan agreements with Bank of Tianjin for RMB20,000,000 (approximately $3,145,395). The annual interest rate is 8.53% and the new due date of the loans is November 9, 2012. These loans are guaranteed by BoHai Investment Guarantee Co., Ltd. with the guarantee fee of RMB400,000 (approximately $62,907) and 50% of the loan is secured against inventory(Note 6).

11. Due to Stockholders


	December 31,		March 31,
	2011		2011
	(unaudited)		(audited)

Li Liu, a director of the Company, officer and principal stockholder	$	3,649,505	$	3,531,966
Other stockholders		1,918,267		1,918,267
	$	5,567,772	$	5,450,233

On June 12, 2009, the persons who were stockholders of Milkgoat China before Milkgoat Industrial acquired their interests in Milkgoat China on January 15, 2008 (the “Original Stockholders”) entered into a restructuring agreement whereby the Original Stockholders, upon receipt of RMB30,500,000 (approximately $4,769,729) 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 Stockholders and was lent to Milkgoat China by the Original Stockholders.

The amounts due to director, Li Liu and the other stockholders are unsecured with no stated interest and are not expected to be repaid within the next one year and they are reflected as long-term liabilities on the balance sheet.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

12. Convertible notes, net

The convertible notes payable, net of debt discount consists of the following as of December 31, 2011 and 2010:

	December 31,		March 31,
	2011		2011
	(unaudited)		(audited)
Convertible notes payable	$	4,604,447	$	4,604,447
Accretion of debt discount - warrants and beneficial conversion feature		1,289,688		456,714
Convertible notes payable, net	$	5,894,135	$	5,061,161

Accrued interest on the convertible notes payable as of December 31, 2011 was $200,700 and is included in the other payable, bills payable and accrued expenses. Interest expense included in the amortization of debt discount on the convertible notes for the three and nine months ended December 31, 2011 was $202,930 and $608,790. Interest expense on the convertible notes for the three and nine months ended December 31, 2010 was nil.

13. 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 and nine months ended December 31, 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, WeinanMilkgoat, FupingMilkgoat and Shaanxi Milkgoat are subject to PRC income tax. Income tax expense for the three months ended December 31, 2011 and 2010 were $111,581 and $98,530, respectively. Income tax expense (benefits) for the nine months ended December 31, 2011 and 2010 were $807,536 and ($20,831), respectively.

Effective January 1, 2008, the statutory PRC tax rate is 25%. Therefore, the statutory PRC rate for the period ended December 31, 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):

	For The Three Months Ended						For The Nine Months Ended
	December 31,						December 31,
	2011			2010			2011			2010
Tax provision (benefits) at PRC statutory rate		-25.0	%		-25.0	%		25.0	%		-25.0	%
Under (over) accrual in prior years		-			7.5	%		0.2	%		-4.8	%
Unrecognized tax benefit of current period tax losses		20.3	%		16.7	%		34.7	%		3.3	%
Parent company's net loss not subject to PRC tax		15.4	%		73.3	%		28.0	%		25.4	%

Effective tax rate		10.7	%		72.5	%		87.9	%		-1.1	%

The Company did not recognize any interest or penalties related to unrecognized tax benefits in the three and nine months ended December 31, 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.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. 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.

On December 31, 2011, the Company entered into an Amendment and Agreement (the “Amendment”) with Euro Pacific Capital, Inc., as investor representative (the “Investor Representative”), pursuant to which the Company and the Investor Representative agreed to reduce the initial exercise price per share of outstanding Series F warrants from $2.50 to $0.24.

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 initial exercise price of $2.50 per share, as partial compensation for services provided by them in connection with the private placement. The exercise price of these warrants was subsequently reduced to $0.24 on December 31, 2011.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. Issuance of Convertible Notes and Series of Warrants-Continued

Make Good Escrow Agreement

On September 27, 2010, the Company, a major stockholder 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 December 31, 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 December 31, 2011 of the 339,750 shares expected to be delivered is $169,875 and make good provision payable on the balance sheet as of December 31, 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.

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 March 31, 2011, the Company has accrued a registration penalty of $267,600 and is reflected as registration penalties and make good provision payable on the balance sheet as of March 31, 2011. Upon the execution of the Amendment entered into on December 31, 2011, pursuant to which the Company and the Investor Representative agreed to reduce the initial exercise price per share of outstanding Series F warrants from $2.50 to $0.24, the Company has no obligation or liability to pay the liquidated damages pursuant to the Registration Rights Agreement due to the Company’s failure to cause the Registration Statement to be declared effective by the Commission on or before the Effective Date. As a result, there was no registration penalties payable as of December 31, 2011.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. Issuance of Convertible Notes and Series of Warrants – Continued

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.

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 as 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 initial fair value of the warrants is calculated using the CRR binomial model with the following assumptions: exercise price of $2.50 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.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. Issuance of Convertible Notes and Series of Warrants – Continued

The value of the embedded conversion option and the warrants are re-measured at December 31, 2011 using the CRR binomial model with the same assumptions as stated above except for the reduced exercise price of $0.24 per share, risk free interest rate of 0.22% and volatility of 89%. The change in fair value of these derivative liabilities for the three and nine months ended December 31, 2011 was a decrease of $201,948 and $1,483,689 respectively before the December 31, 2011 modification. Included in the fair value of the derivatives as at December 31, 2011 is an increase of $392,480 attributable to the reduction in exercise price of the Series F warrants to settle the registration penalties as of the December 31, 2011 (Note 16). The decrease in fair value of these derivative liabilities for the three and nine months ended December 31, 2010 totaled $979,923 and $843,037.

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 and nine months ended December 31, 2011 is $500,531 and $1,435,075, respectively. Effective interest expense recorded for the three and nine months ended December 31, 2010 is $413,161 and $426,503, respectively.

15. Warrants

Series A, B, C and D Warrants expired on June 6, 2011 and Series E expired on July 15, 2011.

	Shares outstanding		Fair Value
Series F Warrants issued to Investor (Note 14)		1,115,000		357,915
Series F Warrants issued to Placement agent (Note 14)		312,200		100,216
		1,427,200	$	458,131

							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 nine months ended December 31, 2011		-			-			-
Exercised during the nine months ended December 31, 2011		-			-			-
Expired during the nine months ended December 31, 2011		(2,987,239	)		(2,987,239	)	$	1.08-1.35
Balance, December 31, 2011		1,427,200			1,427,200		$	0.24

On December 31, 2011, the Company entered into an Amendment and Agreement with Euro Pacific Capital, Inc. to reduce the initial exercise price per share of outstanding Series F common stock purchase warrants from $2.50 to $0.24.

The following table summarizes the weighted average remaining contractual life and exercise price of the Company’s outstanding warrants.

Warrants Outstanding
				Weighted Average Exercise
Range of Exercise Prices	Number Outstanding and Currently Exercisable at December 31, 2011	Weighted Average Remaining Contractual Life (Years)		Price of Warrants outstanding and Currently Exercisable

$0.24	1,427,200	1.74	$	0.24

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

16. 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 nine months ended December 31, 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 (Note 14)		(1,438,689)
Settlement of registration penalties (Note 14)		392,480
Balance of derivative liabilities as of December 31, 2011	$	730,191

The fair value of the derivative liabilities was determined using the CRR binominal model (Note 14), the following table sets forth the components of derivative liabilities:

	December 31,		March 31,
	2011		2011
	(unaudited)		(audited)
Derivative liabilities – warrants to investors and placement agent	$	458,131	$	394,802
Derivative liabilities – conversion option on convertible notes		272,060		1,381,598
Balance of derivative liabilities	$	730,191	$	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.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

17. 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 stock options, 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. 93,750 and 39,750 options to Ms. Chen and Mr. Shek are vested as of December 31, 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. 25% of these options vests on the first anniversary of the grant date, then the balance will vest in equal quarterly installments over the next three years on the last day of each quarter 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 and nine months ended December 31, 2011, a total of 25,656 options and 118,356 options, originally valued at $25,369 and $117,030, failed to vest and have been cancelled due to employee resignation and employees not meeting perform target. 266,056 options are vested as of December 31, 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 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 grant date. The options expire ten years from the date of issuance. These options are fully vested as of March 31, 2011.

The following table summarizes the weighted average remaining contractual life and exercise price of the Company’s outstanding options as of December 31, 2011:

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

17. Employee Stock Ownership Plan – Continued

Options Outstanding
Range of Exercise Prices	Number of options Outstanding at December 31, 2011	Weighted Average Remaining Contractual Life (Years)

$0.98-2.25	1,402,736	8.44

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 and nine months ended December 31, 2011 was $48,714 and $127,643. For the three months ended December 31, 2011, $54,735 and ($6,021) were recorded as general and administrative expense and selling expense respectively. For the nine months ended December 31, 2011, $131,380 and ($3,737) were recorded as general and administrative expense and selling expense respectively. As of December 31, 2011, there was $423,886 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.

Total compensation expense related to the stock options for the three months and nine months ended December 31, 2010 was $437,376 and $1,133,854 respectively. For the three months ended December 31, 2010, $412,200 and $25,176 were recorded as general and administrative expense and cost of goods sold respectively. For the nine months ended December 31, 2010, $1,071,800 and $62,054 were recorded as general and administrative expense and cost of goods sold, respectively.

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 December 31, 2011, and changes during the nine months ended December 31, 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		(118,356	)		2.25
Outstanding at December 31, 2011		1,402,736		$	1.61

Exercisable at December 31, 2011		974,048		$	1.33

The weighted average remaining contractual life of the currently exercisable options is 8.44 years.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

18. Commitments and Contingencies

Purchase of Office Building with a total consideration of $4,661,476

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 $4,661,476). 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 the third calendar quarter of 2012 and the Company would receive the certificate of right to use in the fourth calendar quarter of 2012. As of December 31, 2011, RMB28,570,000 (approximately $4,493,198) was paid and recorded as advances on property, plant and equipment. The remaining RMB1,070,000 (approximately $168,278) would be paid in 2 installments of RMB535,000 (approximately $84,139) each upon receiving the certificate of right to use.

Renovation of Office Building with a total consideration of $736,024

As of September 30, 2011, the first payment of RMB2,340,000 (approximately $368,012) 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 $147,205), RMB936,000 (approximately $147,205) and RMB468,000 (approximately $73,602) are to be paid in July, September and November 2012, respectively, upon the inspection of the completed renovation project . The inspection of the renovation project is still in progress and the management is uncertain for the date of receiving the inspection report. 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.

Purchase of Factory & Warehouse with a total consideration of $14,232,130

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 $14,232,130). The Company paid a total of RMB44,404,000 (approximately $6,983,408) 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 $5,189,899) is to be paid by 11 monthly installments of RMB3,000,000 (approximately $471,809) each from January 2009 to November 2009. The company paid RMB9,000,000 (approximately $1,415,427) in cash and settled the other RMB6,000,000 (approximately $943,618) 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 $4,889,675), will be paid by 3 installments. The first installment of RMB16,080,500 (approximately $2,528,977) was paid on the completion of the main framework of the construction in Oct, 2009. The second installment of RMB7,505,250 (approximately $1,180,349) is due upon satisfactory inspection of the construction. The final installment of RMB7,505,250 (approximately $1,180,349) is due upon receiving the certificate of right to use.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

18. Commitments and Contingencies – Continued

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. The inspection of Jinghai Project is still in progress and the management is uncertain for the date of receiving the inspection report.

As of December 31, 2011, total payments of RMB75,484,500 (approximately $11,871,432) were made and recorded as advances and deposits on property, plant and equipment. The remaining RMB15,010,500 (approximately $2,360,698) are to be paid by 2 installments of RMB7,505,250 (approximately $1,180,349) 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 $8,177,508

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 $4,030,353) and has been paid to the supplier as of December 31, 2011. RMB1,703,000 (approximately $267,830) of it was recorded in construction in progress and RMB5,266,600 (approximately $828,277) 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 $828,277) from Milkgoat China, our subsidiary company to Shaanxi Milkgoat, our another subsidiary. The remaining of RMB18,657,400 (approximately $2,934,246) 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 $786,349). As of December 31, 2011, the first payment of RMB1,000,000 (approximately $157,270) were paid and recorded in advances and deposits on property, plant and equipment. The remaining RMB2,500,000 (approximately $393,174) and RMB1,500,000 (approximately $235,905) 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.

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 $471,810). As of December 31, 2011, the first payment of RMB1,500,000 (approximately $235,905) were paid and recorded in advances and deposits on property, plant and equipment. The remaining RMB1,500,000 (approximately $235,905) are to be paid by 2 installments. The first installment of RMB1,050,000 (approximately $165,134) will be paid in August 2012 when the main construction materials are delivered. The final installment of RMB450,000 (approximately $70,771) 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 $105,371). As of December 31, 2011, the Company paid RMB536,000 (approximately $84,296) 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 RMB100,500 (approximately $15,806) will be paid in September 2012, respectively, when the machinery and equipment is delivered and inspected. The final payment of RMB33,500 (approximately $5,269) is to be paid in November 2012 after the approval of final inspection of equipment.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

18. Commitments and Contingencies – Continued

There is a contract signed with ShangHaiDahe for purchasing goat milk powder production lines, totaling RMB16,379,500 (approximately $2,576,000). As of December 31, 2011, the Company paid RMB6,067,700 (approximately $954,266) and recorded in advances on property, plant and equipment. The remaining RMB10,311,800 (approximately $1,621,734) will be paid progressively, RMB7,004,550 ($1,101,604), RMB2,456,925 ($386,400) and RMB850,325 ($133,730) 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 RMB1,320,180 (approximately $207,624) and recorded in advances and deposits on property, plant and equipment as of December 31, 2011.

Installation of central system pipelines with a total consideration of $1,971,377

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 RMB12,535,000 (approximately $1,971,377) in five installments for the service that Heilongjiang Tianhong will provide.

As of December 31, 2011, the first payment of RMB3,760,500 (approximately $591,413) 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 $1,379,964) includes RMB3,760,500 (approximately $591,413) is expected to be paid within seven days after the beginning of installation, RMB1,253,500 (approximately $197,138) is expected to be paid within ten days after the completion of installation, RMB3,133,750 (approximately $492,844) is expected to be paid within ten days after the inspection of installation and RMB626,750 (approximately $98,569) 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 $1,678,623

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 $1,678,623). As of December 31, 2011, total payment of RMB7,000,000 (approximately $1,100,889) 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 RMB 348,872 (approximately $54,867) per month from April to December in 2012, and the rest of RMB 533,676 (approximately $83,931) will be paid in March 2014.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

19. Concentrations, Risks, and Uncertainties

The Company did not have any customer constituting 10% or greater of net sales for the three and nine months ended December 31, 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 and nine months ended December 31, 2011 and 2010:

	Three months ended		Nine months ended
	December 31,		December 31,
	2011	2010	2011	2010
	(unaudited)	(unaudited)	(unaudited)	(unaudited)

Tianjin Hua Ai Co., Ltd.	*	*	*	10.2%
Tianjin Galaxy Co., Ltd.	10.8%	*	*	*

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

As of December 31, 2011, amount due to Tianjin Hua Ai Co., Ltd. and Tianjin Galaxy Co., Ltd. were $41,790 and $108,681, respectively.

20. 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, is 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.

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

20. Series A Redeemable Convertible Preferred Stock- Continued

In accordance with ASC 480-10-S99, 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 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%. In accordance with ASC 480-10-S99, the accretion to redemption value of redeemable preferred stock is charged against retained earnings. Accretion to redemption value totaled $1,963,220 and $5,376,479 for the three and nine months ended December 31, 2011.

In accordance with ASC 480-10-S99, 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. The issuance costs of $735,129 are netted against the Private Placement of the Series A Redeemable Convertible Preferred Stock.

21. Loss Per Share

Basic earnings (loss) per share are computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) 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 loss per share:

		Three months ended			Nine months ended
		December 31,			December 31,

	2011			2010			2011			2010
	(unaudited)			(unaudited)			(unaudited)			(unaudited)

Net (loss) income	$	(1,154,687	)	$	(234,340	)	$	110,480		$	(1,956,735	)
Accretion of preferred stock		(1,963,220	)		-			(5,376,479	)		-
Net loss attributable to common stockholders - basic	$	(3,117,907	)	$	(234,340	)	$	(5,265,999	)	$	(1,956,735	)
Net loss attributable to common stockholders - diluted	$	(3,117,907	)	$	(234,340	)	$	(5,265,999	)	$	(1,956,735	)

Weighted average outstanding shares of common stock		26,454,558			26,454,394			26,454,558			26,433,743
Dilutive effect of warrants		-			-			-			-
Dilutive effect of options		-			-			-			-
Diluted weighted average outstanding shares of common stock		26,454,558			26,454,394			26,454,558			26,433,743

Loss per share:
Basic	$	(0.12	)	$	(0.01	)	$	(0.20	)	$	(0.07	)

Diluted	$	(0.12	)	$	(0.01	)	$	(0.20	)	$	(0.07	)

YAYI INTERNATIONAL INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

21. Loss Per Share-Continued

The computation of diluted loss per share for the three and nine months and December 31, 2011 excludes the following potentially dilutive securities because their inclusion would be anti-dilutive.

	December 31,
	2011		2010
	(unaudited)		(unaudited)
Warrants outstanding		1,427,200		4,414,439
Options outstanding		1,402,736		1,906,392
Series A convertible preferred stock outstanding		15,306,120		15,306,120
Convertible promissory notes outstanding		4,460,000		4,460,000
		22,596,056		26,086,951

For the three and nine months ended December 31, 2011, 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 loss from continuing operations attributed to common shareholders.

For the three and nine months ended December 31, 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.

22. Subsequent Events

On January 10, 2012, Milkgoat China renewed its working capital loan agreement with Bank of Beijing, Tianjin Nankai Branch (" Bank of Beijing"), pursuant to which Bank of Beijing loaned to Milkgoat China RMB10,000,000 (approximately $1,572,698) to purchase raw materials. The loan has a term of 12 months and expires on January 9, 2013. The initial annual interest rate is 20% above the benchmark interest rate on the date of withdrawal of the loan principal which is 7.87%. The loan is guaranteed by Huaxia Jingu Guarantee Co., Ltd.

On February 10, 2012, the Board of Directors of the Company adopted an amendment and restatement (the “Amendment”) of the Plan. Pursuant to the Amendment, the Board of Directors may authorize the repricing of previously granted options by lowering the exercise price (the “Repricing”) without stockholder approval, if the Company’s shares of common stock are not listed on the New York Stock Exchange, the NYSE Amex, the NASDAQ Global Select Market, the NASDAQ Global Market, the NASDAQ Capital Market or any other exchange that would require stockholder approval as a result of such a repricing.

According to the amended and restated Plan adopted by the Board of Directors, the Company and Mr. Kenneth Lee entered into an amendment to the Stock Option and Stock Award Plan Award Agreement (the “Option Agreement”), effective February 10, 2012, pursuant to which the parties amended the Option Agreement and reduced the option exercise price to $0.12 per share.

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;

·	“Milkgoat Industrial” refers to Milkgoat Industrial Co., Ltd., a company organized under the laws of the British Virgin Islands;

·	“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;

·	“Shaanxi Milkgoat” refers to Shaanxi Milkgoat Dairy Co., Ltd., a company organized under the laws of the PRC;

·	“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 official website of, 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.

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 categories varieties under the MilkGoat brand as well as 13 additional product categories 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.

Third 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 third fiscal quarter ended December 31, 2011.

The following shows financial highlights for the fiscal quarter ended December 31, 2011:

·	Net Sales: Net sales for the three months ended December 31, 2011 were $8.0 million, an increase of 25% from the three months ended December 31, 2010.

·	Gross Margin: Gross margin was 66.3% for the three months ended December 31, 2011, as compared to 61.6% for the three months ended December 31, 2010.

·	Operating Profit: Operating profit was $216,517 for the three months ended December 31, 2011, which is an increase of $471,689 as compared to the three months ended December 31, 2010.

·	Net Loss: Net loss was $1,154,687 for the three months ended December 31, 2011, as compared to net loss of approximately $234,340 for the three months ended December 31, 2010.

·	Loss per Share: Loss per share was $0.12 for the three months ended December 31, 2011.

Taxation

United States

Yayi International Inc. is subject to United States federal income tax at a tax rate of 41%. No provision for income taxes in the United States has been made as Yayi International Inc. had no income taxable in the United States.

British Virgin Islands

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

PRC

In 2007, the PRC government promulgated the new Enterprise Income Tax Law, or EIT Law, and the relevant implementation rules, which became effective on January 1, 2008. Under the EIT Law and its implementation rules, all domestic and foreign investment companies will be subject to a uniform enterprise income tax at the rate of 25% and dividends from PRC subsidiaries to their non-PRC shareholders will be subject to a withholding tax at a rate of 20%, which is further reduced to 10% by the implementation rules, if the non-PRC shareholder is considered to be a non-PRC tax resident enterprise without any establishment or place within China or if the dividends payable has no connection with the non-PRC shareholder’s establishment or place within China, unless any such non-PRC shareholder’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. In addition, pursuant to the EIT Law, enterprises established under the laws of non-PRC jurisdictions, but whose “de facto management body” is located in the PRC, should be treated as resident enterprises for PRC tax purposes. However, it is currently uncertain whether we may be deemed a resident enterprise, or how to interpret whether any income or gain is derived from sources within China. Such classification will likely result in unfavorable tax consequences to our non-PRC shareholders and us. If we, as a Delaware company with substantially all of our management located in China, were treated as a resident enterprise for PRC tax purposes, we will be subject to PRC tax on our worldwide income at the 25% uniform tax rate, which would have an impact on our effective tax rate.

The EIT Law and the Implementing Rules also imposes a unified EIT of 25% on both foreign invested enterprises and domestic enterprises, effective January 1, 2008. As a result, each of our PRC subsidiaries, Milkgoat China, Weinan Milkgoat, Fuping Milkgoat, and Shaanxi Milkgoat have been subject to a 25% income tax rate in each of calendar years 2008, 2009, 2010 and 2011.

RESULTS OF OPERATIONS

Three Months Ended December 31, 2011 Compared to Three Months Ended December 31, 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 prior period.

	Three Months Ended December 31,
	2011			2010
							change			variance

Net Sales	$	8,005,888		$	6,429,936		$	1,575,952			25	%
Cost of goods sold		(2,698,622	)		(2,467,795	)		(230,827	)		9	%
Gross profit		5,307,266			3,962,141			1,345,125			34	%
Operating expenses:
Sales and marketing expenses		(4,215,861	)		(3,089,641	)		(1,126,220	)		36	%
General and administrative expenses		(874,888	)		(1,127,672	)		252,784			-22	%
Income (loss) from continuing operations		216,517			(255,172	)		471,689			185	%
Other income (expenses), net		(1,259,623	)		119,362			(1,378,985	)		-1155	%
Income tax (expense) benefit		(111,581	)		(98,530	)		(13,051	)		13	%
Net income(loss)		(1,154,687	)		(234,340	)		(920,347	)		393	%
Accretion of preferred stock		(1,963,220	)					(1,963,220	)		N/A
Net (loss) income attributable to Yayi International, Inc.		(3,117,907	)		(234,340	)		(2,883,567	)		1231	%

Net Sales. Our net sales are generated from sales of premium goat milk formula products. Net sales for the three months ended December 31, 2011 were approximately $8.0 million, an increase of 25% from the same period last year. This increase was primarily due to a decrease of $1.1 million in 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 quarter of fiscal 2012, we have changed our marketing strategy, 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 an increase in the unit sales price of our formula product to $31,872 per ton from $23,448 per ton for the prior year period. Excluding the impact of slotting fees, the sales in formula products increased by 3.4% from $7.9 million to $8.1 million. In order to develop infant-maturity stores as a sales channel alongside our commitment to establish our presence in supermarkets, we launched three new infant formula products specifically targeting infant-maternity stores in this quarter. We refined our brand image and positioned ourselves as a provider of premium milk powder products.

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		December 31, 2011		December 31, 2010
Goat Milk Powder	Quantity (ton)		251		274
Products	Unit price	$	31,872		23,448
Raw Milk Powder	Quantity (ton)		2		-
	Unit price	$	8,336		-

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 December 31, 2011 was approximately $2.7 million, an increase of 9% from the three months ended December 31, 2010 which is primarily due to the increase of the unit cost of powdered formula products by 14.8% from $9,338 per ton to $10,917 per ton as a result of the increase in the cost of raw milk and added nutrients.

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 December 31, 2011 was approximately $5.3million, an increase of 34% from the three months ended December 31, 2010. Our gross margin for the three months ended December 31, 2011 increased to 66.3% from 61.6% for the three months ended December 31, 2010, which is mainly attributable to the increased unit price of our powder products. In addition, we reduced the sale of raw milk powder, which has a lower margin.

Operating expenses. Our total operating and administrative expenses consist primarily of sales and marketing expenses and general and administrative expenses. Our total operating expenses increased by approximately $1 million to $5.1 million or 21% from the three months ended December 31, 2011. Following is a discussion of the reasons for this increase broken down by category of operating expense:

Sales and marketing expenses. For the three months ended December 31, 2011, sales and marketing expenses increased approximately 36% to $4.2 million from $3.1 million for the three months ended December 31, 2010. The increase was primarily attributable to the increase of in-store promotion activities. The promotion fee for the in-store promotion were approximately $3.2 million for the three months ended December 31, 2011, an increase of 53% compared with $2.1 million for the three months ended December 31, 2010.

For the three months ended December 31, 2011, the salaries and benefits paid to our sales and marketing staff decreased approximately by 1.5% to 0.67 million from $0.68 million due to the decrease of the number of staff by 30.6% compared to the same period of last fiscal year. As a result, the productivity for the sales and marketing department increased significantly. Per Capita sales contribution increased by 79.5% from $6,273 per sales and marketing staff for the three months ended December 31, 2010 to $11,260 per sales and marketing staff for the three months ended December 31, 2011.Other miscellaneous expenses increased approximately 3.4% to $0.3 million from $0.29 million.

During the three months ended December 31, 2011, we improved the effectiveness of sales and marketing efforts at existing sales points, rather than focusing on the expansion of our distribution network. We believe that our investment in sales and marketing for building our brand “Milkgoat” as well as further strengthening our distribution capability will bring substantial, tangible benefits in terms of increase in our net sales going forward.

General and administrative expenses. General and administrative expenses for the three months ended December 31, 2011 decreased by 22% to $0.9 million from $1.1 million for the three months ended December 31, 2010 due to a decrease of $0.36 million of stock compensation to our officers.

Other income (expenses). Our other expenses consist primarily of interest, finance cost, change in fair value of derivative liabilities, loss on write down of assets held for sale and expenses on make good provision related to $8.92 million convertible notes. Other expenses increase by approximately $1.4 million for the three months ended December 31, 2011, primarily due to a decrease of income of $0.78 million in change in fair value of derivative liabilities from $0.98 million to $0.2 million, an increase of interest expense of $0.2 million to $0.3 million from $0.1 million. Amortization of deferred cost increased from $0.43 million to $0.56 million. The increase of other expenses was partially offset by a decrease of expense on make good provision by approximately $0.3 million from an expense of $0.3 million for the three months ended December 31, 2011 to an income of $0.02 million. We plan to lease and sell eight goat farms that we own in Shanxi Province in March 2012 to various third parties for a rent of $0.25 million per year. The value of the building and equipment located at the goat farms are reclassified from Property, plant and equipment to Assets held for sale according to the lower of its fair value and historical cost. We use a discount rate of 8% to calculate the present value. As a result, a shortfall of $623,305 are recognized in general and administrative expenses in the three months ended December 31, 2011 (see Note 9 to the Condensed Consolidated Financial Statements).

Income Tax. Our income tax expense in the three months ended December 31, 2011 increased by 13%, from approximately $0.1 million in the three months ended December 31, 2010 to approximately $0.11 million in the three months ended December 31, 2011. The increase was primarily attributable to the increase in income before tax in the three months ended December 31, 2011.

Net Loss. As a result of the factors described above, net loss attributable to Yayi International Inc. increased by 393% in the three months ended December 31, 2011 as compared to the three months ended December 31, 2010.

Net loss attributable to stockholders. Our net loss attributable to stockholders for the three months ended December 31, 2011 increased to $3.1 million, compared with approximately $0.2 million for the three months ended December 31, 2010, primarily due to the factors described above and an increase of $2.0 million in accretion of Series A Redeemable Convertible Preferred Stock, or Series A Preferred Stock (see Note 20 to the Condensed Consolidated Financial Statements).

Nine Months Ended December 31, 2011 Compared to Nine Months Ended December 31, 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 prior period.

	Nine Months Ended December 31,
	2011			2010
							change			variance

Net Sales	$	24,919,126		$	20,717,005		$	4,202,121			20	%
Cost of goods sold		(8,957,173	)		(8,022,963	)		(934,210	)		12	%
Gross profit		15,961,953			12,694,042			3,267,911			26	%
Operating expenses:
Sales and marketing expenses		(10,930,172	)		(10,835,434	)		94,738			1	%
General and administrative expenses		(2,481,109	)		(3,365,857	)		884,748			-26	%
Income (loss) from continuing operations		2,550,672			(1,507,249	)		4,057,921			269	%
Other income (expenses), net		(1,632,656	)		(470,317	)		(1,162,339	)		247	%
Income tax (expense) benefit		(807,536	)		20,831			(828,367	)		-3977	%
Net income(loss).		110.480			(1,956,735	)		2,067,215			106	%
Accretion of preferred stock		(5,376,479	)		-			(5,376,479	)		N/A
Net (loss) income attributable to Yayi International, Inc.		(5,265,999	)		(1,956,735	))		(3,309,264	)		169	%

Net Sales. Net sales for the nine months ended December 31, 2011 were approximately $25 million, an increase of 20% from the nine months ended December 31, 2010. This increase was primarily due to a decrease of $4.1 million in the slotting fees as compared to the prior year period, which are offset to revenue as they are incurred, as 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 since the first quarter of fiscal 2012. The decrease in slotting fees resulted in an increase in the unit sales price of our formula product to $30,390 per ton from $23,364 per ton for the prior year period. As the number of Chinese raw milk powder producers decreased due to the government-mandated manufacturing license renewals, the market demand for our raw milk powder increased. As a result, we sold approximately $0.7 million raw milk powder to external customers through our subsidiary Fuping Milkgoat during the nine months ended December 31, 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:

		Nine Months ended		Nine Months ended
Product Name		December 31, 2011		December 31, 2010
Goat Milk Powder	Quantity (ton)		797		887
Products	Unit price	$	30,390		23,364
Raw Milk Powder	Quantity (ton)		149		-
	Unit price	$	4,602		-

Cost of goods sold. Cost of goods sold for the nine months ended December 31, 2011 was approximately $9.0 million, an increase of 12% from the nine months ended December 31, 2010, primarily due to an increase in the cost related to raw milk powder sales. In line with the decrease in the sales volume of formula products, the unit cost of powdered formula products increased by 12% from $9,153 per ton to $10,245 per ton, which is mainly due to general increases in the costs of raw milk and added nutrients.

Gross Profit. Gross profit for the nine months ended December 31, 2011 was approximately $16.0 million, an increase of 26% from the nine months ended December 31, 2010. Our gross margin for the nine months ended December 31, 2011 increased to 64.1% from 61.3% for the nine months ended December 31, 2010, which is mainly attributable to the decrease in slotting fees paid and the giveaway cost, partially offset by the increase in the costs of raw materials.

Operating expenses. Our total operating expenses decreased by approximately $0.8 million to $13.4 million or 5.6% from the nine months ended December 31, 2011. Following is a discussion of the reasons for this increase broken down by category of operating expense:

Sales and marketing expenses. For the nine months ended December 31, 2011, sales and marketing expenses increased approximately 1% to $10.9 million from $10.8 million for the nine months ended December 31, 2010. The increase was primarily attributable to the increase in promotion expenses, partially offset by the decrease in advertising expenses, salaries of marketing staff and other miscellaneous expenses.

Advertising and promotional expenses for the nine months ended December 31, 2011 was approximately $8.4 million, an increase of 13.4% from the nine months ended December 31, 2010. Advertising expenses were approximately $0.25 million for the nine months ended December 31, 2011, a decrease of 86.2% from $1.8 million for the nine months ended December 31, 2010. The primary reason for the decrease was due to our decision to realign our marketing efforts. Promotional expenses were approximately $8.2 million for the nine months ended December 31, 2011, an increase of 45.6% compared with $5.6 million for the nine months ended December 31, 2010, which is mainly due to the fact that we shifted from large investment in TV commercials to promotion activities in stores.

For the nine months ended December 31, 2011, the salaries and benefits paid to our sales and marketing staff decreased approximately 19.1% to $1.8 million from $2.3 million for the nine months ended December 31, 2010 due to the decrease of the number of staff by 22% compared to the same period of last fiscal year. As a result, the productivity for the department increased significantly. Per Capita sales contribution increased by 75.2% from $19,563 per sales and marketing staff for the nine months ended December 31, 2010 to $34,277 per sales and marketing staff for the nine months ended December 31, 2011.

Other miscellaneous expenses such as travel expenses decreased approximately 39.7% to $0.7 million from $1.2 million. During the nine months ended December 31, 2011, we improved the effectiveness of sales and marketing efforts at existing sales points, rather than focusing on the expansion of our distribution network during this period. We believe that our investments in sales and marketing for building our brand “Milkgoat” as well as further strengthening our distribution capability will bring substantial, tangible benefits in terms of increase in our net sales going forward.

General and administrative expenses. General and administrative expenses for the nine months ended December 31, 2011 decreased by 26% to $2.5 million from $3.4 million for the nine months ended December 31, 2010. It was primarily attributable to $0.8 million decrease in stock compensation.

Other expenses. Other expenses increased by approximately $1.2 million, or 247%, primarily attributable to an increase in change in amortization of deferred financing cost and debt discount which offset the gain on fair value of derivative liabilities. We plan to lease and sell eight goat farms that we own in Shanxi Province in March 2012 to various third parties for a rent of $0.25 million per year. The value of the building and equipment located at the goat farms are reclassified from Property, plant and equipment to Assets held for sale according to the lower of its fair value and historical cost. We use a discount rate of 8% to calculate the present value. As a result, a shortfall of $623,305 are recognized in general and administrative expenses in the three months ended December 31, 2011 (see Note 9 to the Condensed Consolidated Financial Statements).

Income Tax. Our income tax expense in the nine months ended December 31, 2011 increased by $0.8 million, from a benefit of approximately $0.02 million in the nine months ended December 31, 2010 to an expense of approximately $0.8 million in the nine months ended December 31, 2011. The increase was primarily attributable to the increase in income before tax for PRC subsidiaries for the nine months ended December 31, 2011.

Net Income. As a result of the factors described above, net income attributable to Yayi International Inc. increased by 106% in the nine months ended December 31, 2011 as compared to the nine months ended December 31, 2010.

Net loss attributable to stockholders. Our net loss attributable to stockholders for the nine months ended December 31, 2011 increased to $5.3 million, compared with approximately $2.0 million for the nine months ended December 31, 2010, primarily due to the factors described above and an increase of $5.4 million in accretion of Series A Preferred Stock (see Note 20 to the Condensed Consolidated Financial Statements)

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2011, we had cash and cash equivalents of approximately $16.9 million and working capital of approximately $9.8 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 $12.6 million during the 15 months ending March 31, 2013 ($1.6 million during the fiscal year ending March 31, 2012 and $11 million during the fiscal year ending March 31, 2013). The $12.6 million in capital expenditure is expected to be mainly used for the following items:

●	$3.8 million for the purchase of machineries and equipment for the new powder processing plant in Weinan, Shaanxi and Fuping, Shaanxi ;
●	$0.8million for the purchase of livestock, construction of goat farms and goat milk collection stations;
●	$7.4million for the purchase of packing equipment, factory and warehouse, renovation of the office facility and staff apartment building in Jinghai, Tianjin and $0.6 million for the purchase of information technology equipment and systems.

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.

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 $3,127,346) 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 $2,345,509) was disbursed to Milkgoat China, and the remaining RMB5,000,000 (approximately $781,836) was disbursed to Milkgoat China on January 6, 2011. On November 8, 2011, Milkgoat China renewed this loan agreement and extended the term of loan to November 9, 2012. The fixed annual interest rate of the loan was changed to 8.528%.

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 RMB8 million (approximately $1,250,938) 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 December 31, 2011, we have totally borrowed RMB3,429,121 (approximately $539,297) under this agreement and we have repaid RMB1,798,959 (approximately $282,922) in the three months ended December 31, 2011. Five of these loans for a total of RMB1,195,874 (approximately $188,075) have been repaid subsequent to December 31, 2011.

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 RMB10,000,000 (approximately $1,563,673) for working capital, guaranteed by Beijing Huaxia Jingu Guarantee Co., Ltd. The loan has an annual interest rate of 6.1005%, and the interests must be paid on a quarterly basis on the 20th of the last month of each quarter with the initial annual interest rate of 20% above the benchmark interest rate on the date of withdrawal of the loan principal which is 7.87%. 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 August 18, 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 RMB10,000,000 (approximately $1,563,673) for working capital, guaranteed by Tianjin Haitai Investment Guarantee Co., Ltd. The loan has an annual interest rate of 7.872% and the interests must be paid on a quarterly basis on the 20th of the last month of each quarter. The loan expires on August 16, 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.

In addition, at any time after June 30, 2012, the holders of not less than a majority of the then outstanding Series A Preferred Stock have the right to request the Company to redeem all of the then outstanding shares of Series A Preferred Stock in cash, amounted to $26,383,562, if certain qualified events have not occurred by June 30, 2012 (Note 20). These conditions raise substantial doubt about the Company’s ability to continue as a going concern, as the cash redemption requirement could post a significant impact on the Company’s cash flow.

The financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, they do not include any adjustments that might result from the outcome of this uncertainty.

Except for the above going concern, we believe that our currently available working capital should be adequate to sustain our daily 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.

Cash Flow

	Nine Months Ended December 31,
	2011	2010
Net cash provided by (used in) operating activities	$952,318	$(1,715,522)
Net cash (used in) investing activities	(966,955)	(1,299,531)
Net cash provided by financing activities	3,098,971	9,093,456
Net increase (decrease) in cash and cash equivalent	3,533,861	6,233,183

Operating Activities

Net cash provided by operating activities for the nine months ended December 31, 2011 was approximately $0.95 million compared to net cash used in operating activities of $1.7 million for the nine months ended December 31, 2010. The changes in net operating assets and liabilities for the nine months ended December 31, 2011 were primarily related to a $1.03 million increase in accounts receivables due to our extended term for new products promotion, partially 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 $0.4 million decrease in accrued interest on convertible notes as we paid $0.4 million interests at the end of December 2011, a $0.4 million decrease in other payable and accrued expenses mainly due to $0.6 million of bills payable had been paid for the nine months ended December 31,2011. Net cash used in operating activities for the nine months ended December 31, 2010 was mainly attributable to the net loss from operations of $2.0 million, non-cash items not affecting cash flows of $1.3 million and a $1.0 million increase in working capital. 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 nine months ended December 31, 2011 was approximately $1.0 million, a decrease of approximately $0.3 million from approximately $1.3 million of the corresponding period in the prior year. The change was mainly caused by the fact that we paid fewer amounts for investing activities compared to last period. For the nine months ended December 31, 2011, we prepaid $0.4 million for the Jinghai equipment purchase and $0.5 million Fuping Milkgoat and Milkgoat China equipment upgrade.

Financing Activities

Net cash provided by financing activities for the nine months ended December 31, 2011 was approximately $3.1 million compared to approximately $9.1 million of net cash provided by these activities during the corresponding period in the prior year. The change is primarily attributable to the $8.92 million gross proceeds from the private placement transaction closed on September 27, 2010, while we did not make similar financing during the nine months ended December 31, 2011. The decrease in the net cash provided by financing activities was partially offset by $2.5 million bank loans increase during the nine months ended December 31, 2011 as compared to the corresponding period in the prior year. We had $1.0 million bank’s acceptance bills matured during this period of time, which resulted in a $1.0 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.

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.

Recently Issued Accounting Pronouncements

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 December 31, 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.

In order to correct the foregoing significant deficiencies, during the fiscal quarter ended December 31, 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.

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 December 31, 2011 to contain a material misstatement.

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 December 31, 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. MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

EXHIBITS.

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.
101	The following financial information from The Yayi International Inc.'s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at December 31, 2011 and March 31, 2011, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss for the nine months ended December 31, 2011 and 2010, (iii) Condensed Consolidated Statements of Stockholders’ Equity, (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2011 and 2010, and (v) Notes to Condensed Consolidated Financial Statements.

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: February 14, 2012



	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)

EXHIBIT INDEX

Exhibit
Number	Description
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 adoptedpursuant 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 adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial information from The Yayi International Inc.'s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at December 31, 2011 and March 31, 2011, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss for the nine months ended December 31, 2011 and 2010, (iii) Condensed Consolidated Statements of Stockholders’ Equity, (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2011 and 2010, and (v) Notes to Condensed Consolidated Financial Statements.

Attached files

Stock widget

Investing forum

Yayi International Inc Reports

Also read