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EX-10.32 - EXHIBIT 10.32 - Shengkai Innovations, Inc.exh_1032.htm
EX-23.2 - EXHIBIT 23.2 - Shengkai Innovations, Inc.exh_232.htm
EX-32.1 - EXHIBIT 32.1 - Shengkai Innovations, Inc.exh_321.htm
EX-23.1 - EXHIBIT 23.1 - Shengkai Innovations, Inc.exh_231.htm
EX-32.2 - EXHIBIT 32.2 - Shengkai Innovations, Inc.exh_322.htm
EX-31.1 - EXHIBIT 31.1 - Shengkai Innovations, Inc.exh_311.htm
EX-31.2 - EXHIBIT 31.2 - Shengkai Innovations, Inc.exh_312.htm
EX-10.31 - EXHIBIT 10.31 - Shengkai Innovations, Inc.exh_1031.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
(Mark One)
 
[X]
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended June 30, 2011

[  ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____________ to____________

Commission file number: 001-34587

SHENGKAI INNOVATIONS, INC.
(Exact name of registrant as specified in its charter)

Florida
 
11-3737500
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
 
No. 106 Zhonghuan South Road
Airport  Industrial  Park
Tianjin, People’s Republic of China
   
300308
(Address of principal executive offices)
  (Zip Code)

Registrant’s telephone number, including area code + (86) 22-5883-8509
 
Securities registered under Section 12(b) of the Exchange Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.001 per share
 
 
The NASDAQ Stock Market LLC
 
 
Securities registered pursuant to section 12(g) of the Act
 
Common Stock, par value $0.001 per share
 
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     [  ] Yes     [X] No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.     [  ] Yes     [X] No
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

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

 
1

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

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.

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 Act).
[  ] Yes                               [X] No

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

Note – If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
 
The aggregate market value of the voting and non-voting common stock of the issuer held by non-affiliates was approximately $53,419,947 based upon the closing price of the common stock ($5.74) as quoted by NASDAQ on December 31, 2010.
 
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
 
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
 
[  ] Yes                                [  ] No

 
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
 
As of September 22, 2011, there were 33,226,611 issued and outstanding shares of the issuer’s common stock.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g. Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g. annual report to security holders for fiscal year ended December 24, 1980).
 
 
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FORWARD LOOKING STATEMENTS
 
This Annual Report on Form 10-K contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this Annual Report on Form 10-K. Additionally, statements concerning future matters are forward-looking statements.
 
Although forward-looking statements in this Annual Report on Form 10-K reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
 
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report on Form 10-K, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Annual Report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

Currency, exchange rate, and “China” and other references

Unless otherwise noted, all currency figures in this filing are in U.S. dollars. References to "yuan" or "RMB" are to the Chinese yuan, which is also known as the Renminbi. According to the currency exchange website www.xe.com, on September 20, 2011, $1.00 was equivalent to 6.3878 yuan.

References to “PRC” and “China” are to the People’s Republic of China.

References to “Tianjin Shengkai” are to Tianjin Shengkai Industrial Technology Development Co. Ltd., a PRC company that we control.

Unless otherwise specified or required by context, references to “we,” “the Company”, “our” and “us” refer collectively to (i) Shengkai Innovations, Inc., (ii) the subsidiaries of the Company, Shen Kun International Limited, a British Virgin Islands limited liability company (“Shen Kun”), Shengkai (Tianjin) Limited, a wholly foreign-owned enterprise under the laws of the PRC (“SK WFOE”), Shengkai (Tianjin) Trading Ltd., a wholly-owned subsidiary of SK WFOE incorporated under the laws of the PRC, and (iii) Tianjin Shengkai.
 
References to Tianjin Shengkai’s “registered capital” are to the equity of Tianjin Shengkai, which under PRC law is measured not in terms of shares owned but in terms of the amount of capital that has been contributed to a company by a particular shareholder or all shareholders. The portion of a limited liability company’s total capital contributed by a particular shareholder represents that shareholder’s ownership of the company, and the total amount of capital contributed by all shareholders is the company’s total equity. Capital contributions are made to a company by deposits into a dedicated account in the company’s name, which the company may access in order to meet its financial needs. When a company’s accountant certifies to PRC authorities that a capital contribution has been made and the company has received the necessary government permission to increase its contributed capital, the capital contribution is registered with regulatory authorities and becomes a part of the company’s “registered capital.”

 
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SHENGKAI INNOVATIONS, INC.
FORM 10-K
For the Fiscal Year Ended June 30, 2011

  TABLE OF CONTENTS

   
PAGE
PART I
   
     
5
29
37
37
38
38
     
  38
     
38
39
40
 47
 47
49
49
50
     
PART III
   
     
51
56
59
61
62
     
PART IV
   
     
62
     
   

 
4

 
 
 
Corporate History and Structure

We were incorporated in Florida under the name Southern Sauce Company, Inc. on December 8, 2004.  Our initial business plan was to establish a successful specialty food business based on proprietary recipes for barbecue sauces and other condiments for the retail market.

By a Stock Purchase and Sale Agreement dated February 14, 2008, we experienced a change in control whereby Vision Opportunity China LP and a number of other investors acquired an aggregate of 2,575,000 shares of common stock from former shareholders for a purchase price of $635,000. Upon this change in control, our board of directors determined that the implementation of our business plan prior to the change in control was no longer financially feasible, and we adopted an acquisition strategy focused on pursuing growth by acquiring undervalued businesses with a history of operating revenues. We utilized several criteria to evaluate prospective acquisitions, including whether the business to be acquired (1) was an established business with viable services or products, (2) had an experienced and qualified management team, (3) had room for growth and/or expansion into other markets, (4) was accretive to earnings, (5) offered the opportunity to achieve and/or enhance profitability, and (6) increased shareholder value.

Our board of directors approved the Merger Agreement and Plan of Reorganization on May 30, 2008, and we entered into the Merger Agreement and Plan of Reorganization with Shen Kun and all of the Shen Kun shareholders on June 9, 2008 as part of the reverse merger transaction described in further detail below.

Following the reverse merger transaction, our corporate structure is now as follows:
 


Shen Kun was incorporated under the laws of the British Virgin Islands on November 7, 2007, and Shen Kun formed SK WFOE under the name “Sheng Kai (Tianjin) Ceramic Valves Co., Ltd.” as a wholly foreign-owned enterprise under the laws of the PRC on April 9, 2008. SK WFOE, one of our operating entities, was subsequently renamed as “Shengkai (Tianjin) Limited” on April 15, 2010.
 
Tianjin Shengkai, our other operating entity, was organized under the laws of the PRC in June 1994 under the name Tianjin Shengkai Industrial Technology Development Company. Tianjin Shengkai’s business was formerly operated as a collective-owned enterprise. The business was reorganized under the laws of the PRC as a limited liability company under its current name, Tianjin Shengkai Industrial Technology Development Co., Ltd. in April 1999.
 
 
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Shengkai (Tianjin) Trading Ltd., which is wholly-owned by SK WFOE, was organized as a wholly owned enterprise under the laws of the PRC on June 25, 2010 with a total registered capital of RMB500,000. Shengkai (Tianjin) Trading Ltd. is primarily engaged in the international trading of non-valve products to better serve the Company’s international customers.

Under the laws of the PRC, certain restrictions are placed on round trip investments, which are defined under PRC law as an acquisition of a PRC entity by an offshore special purpose vehicle owned by one or more PRC residents. As a result, SK WFOE entered into a series of agreements with Tianjin Shengkai which we believe give us effective control over the business of Tianjin Shengkai, one of the entities through which we now operate our business. These agreements are described above in the section entitled “PRC Restructuring.”

Our executive offices are located at No. 106 Zhonghuan South Road, Airport Industrial Park, Tianjin, PRC 300308, and our telephone number is (86) 22-5883-8509. Our website is www.shengkaiinnovations.com. Information on our website or any other website is not a part of this report.

Reverse Merger and Private Placements

In June and July 2008, we consummated a number of related transactions through which we acquired control of Tianjin Shengkai, a PRC-based company and consummated two private placements for gross proceeds of $15 million and $5 million, respectively (the “Private Placements”).

We acquired control of Tianjin Shengkai through two separate transactions: (i) a restructuring transaction which granted control of Tianjin Shengkai to another PRC entity, SK WFOE, and (ii) a reverse merger transaction transferring control of SK WFOE to the Company. We refer to the restructuring transaction and the reverse merger transaction together as the “Reverse Merger.”

Restructuring Transaction: Under the laws of the PRC, certain restrictions are placed on round trip investments, which are defined under PRC law as an acquisition of a PRC entity by an offshore special purpose vehicle owned by one or more PRC residents. As a result, SK WFOE entered into a series of agreements with Tianjin Shengkai which we believe gives us effective control over the business of Tianjin Shengkai.
  
Reverse Merger Transaction:  In the reverse merger transaction, through our wholly-owned subsidiary Shen Kun Acquisition Sub Limited, we acquired control of Shen Kun, a British Virgin Islands company and the parent company of SK WFOE, by issuing to the Shen Kun Shareholders 20,550,000 shares of our common stock, as consideration for all of the outstanding capital stock of Shen Kun.

Private Placements : In connection with the reverse merger transaction, on June 11, 2008 we sold to Vision Opportunity China LP Units (the “Units”) for aggregate gross proceeds of $15,000,000, at a price of $2.5357 per Unit (the “June 2008 Financing”). Each Unit consists of one share of the Company’s Series A Convertible Preferred Stock, par value $0.001 per share (the “Series A Preferred Stock”), convertible into one share of common stock, par value $0.001 per share (the “common stock”), and one Series A Warrant to purchase common stock equal to 120% of the number of shares of common stock issuable upon conversion of the Series A Preferred Stock (“Warrant”).

Additionally, on July 18, 2008, we sold Units to Blue Ridge Investments, LLC for aggregate gross proceeds of $5,000,000, at a price of $2.5357 per Unit (the “July 2008 Financing”). Each Unit consists of one share of Series A Preferred Stock, convertible into one share of common stock, and one Warrant to purchase common stock equal to 120% of the number of shares of common stock issuable upon conversion of the Series A Preferred Stock.

A detailed description of the agreements entered into in connection with the Reverse Merger and Private Placements is provided below.

PRC Restructuring

The PRC restructuring transaction was effected by the execution of five agreements between SK WFOE, on the one hand, and Tianjin Shengkai (and in some cases the shareholders of Tianjin Shengkai), on the other hand (the “PRC Restructuring Agreements”). Under the laws of the PRC, certain restrictions are placed on round trip investments, which are defined under PRC law as an acquisition of a PRC entity by an offshore special purpose vehicle owned by one or more PRC residents. To comply with these restrictions, in conjunction with the reverse acquisition, we (via our wholly-owned subsidiary, SK WFOE) entered into and consummated certain contractual arrangements with Tianjin Shengkai and their respective shareholders pursuant to which we provide these companies with technology consulting and management services. Through these contractual arrangements, we have the ability to substantially influence these companies’ daily operations and financial affairs, appoint their senior executives and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control Tianjin Shengkai and operate our business in the PRC through Tianjin Shengkai, we are considered the primary beneficiary of Tianjin Shengkai.

 
6

 
On May 30, 2008, we entered into the following contractual arrangements, each of which is enforceable and valid in accordance with the laws of the PRC:

Consigned Management Agreement

The Consigned Management Agreement, among SK WFOE, Tianjin Shengkai, and all of the shareholders of Tianjin Shengkai, provides that SK WFOE will provide financial, business, technical and human resources management services to Tianjin Shengkai that will enable SK WFOE to control Tianjin Shengkai’s operations, assets and cash flow, and in exchange, Tianjin Shengkai will pay a management fee to SK WFOE equal to 2% of Tianjin Shengkai’s annual revenue. The management fee for each year is due by January 31 of the following year. The term of the agreement is until SK WFOE acquires all of the equity or assets of Tianjin Shengkai.

Technology Service Agreement

The Technology Service Agreement, among SK WFOE, Tianjin Shengkai, and all of the shareholders of Tianjin Shengkai, provides that SK WFOE will provide technology services, including the selection and maintenance of Tianjin Shengkai’s computer hardware and software systems and training of Tianjin Shengkai employees in the use of those systems. SK WFOE will also provide research and development into new formulations of ceramics and methods that will increase the toughness and machinability of ceramics, raise manufacturing ceramic materials burn rate and lower sintering temperature, and lower production costs. The agreement also provides that SK WFOE will train Tianjin Shengkai’s staff to increase productive use of the new equipments and increase Tianjin Shengkai’s overall production capacity.

As consideration for such services, Tianjin Shengkai will pay a technology service fee to SK WFOE equal to 1% of Tianjin Shengkai’s annual revenue. The technology service fee for each year is due by January 31 of the following year. The term of the agreement is until SK WFOE acquires all of the equity or assets of Tianjin Shengkai.
 
Loan Agreement     

The Loan Agreement, among SK WFOE and all of the shareholders of Tianjin Shengkai, provides that SK WFOE will make a loan in the aggregate principal amount of RMB49,000,000 (approximately $7,153,702) to the shareholders of Tianjin Shengkai, each shareholder receiving a share of the loan proceeds proportional to its shareholding in Tianjin Shengkai, and in exchange each shareholder agreed (i) to contribute all of its proceeds from the loan to the registered capital of Tianjin Shengkai in order to increase the registered capital of Tianjin Shengkai, (ii) to cause Tianjin Shengkai to complete the process of registering the increase in its registered capital with PRC regulatory authorities within 30 days after receiving the loan, and (iii) to pledge their equity to SK WFOE under the Equity Pledge Agreement described below.
 
The loan is repayable at the option of SK WFOE either in cash or by transfer of Tianjin Shengkai equity or all of its assets to SK WFOE. The loan does not bear interest, except that if (x) SK WFOE is able to purchase the equity or assets of Tianjin Shengkai, and (y) the lowest allowable purchase price for that equity or those assets under PRC law is greater than the principal amount of the loan, then, insofar as it is allowable under PRC law, interest will be deemed to have accrued on the loan in an amount equal to the difference between the lowest allowable purchase price for Tianjin Shengkai and the principal amount of the loan. The effect of this interest provision is that, if and when permitted under PRC law, SK WFOE may acquire all of the equity or assets of Tianjin Shengkai by forgiving the loan, without making any further payment.

If the principal amount of the loan is greater than the lowest allowable purchase price for the equity or assets of Tianjin Shengkai under PRC law, then even though one might expect that SK WFOE would be entitled to receive the difference between those two amounts in repayment of the loan, Tianjin Shengkai is not obligated to make such a payment. The effect of this provision is that (insofar as allowable under PRC law) Tianjin Shengkai may satisfy its repayment obligations under the loan by transferring all of its equity or assets to SK WFOE, without making any further payment.

The Loan Agreement also contains agreements from the shareholders of Tianjin Shengkai that during the term of the agreement, they will elect as directors of Tianjin Shengkai only candidates nominated by SK WFOE, and they will use their best efforts to ensure that Tianjin Shengkai does not take certain actions without the prior written consent of SK WFOE, including (i) supplementing or amending its articles of association or bylaws, (ii) changing its registered capital or shareholding structure, (iii) transferring, mortgaging or disposing of any interests in its assets or income, or encumbering its assets or income in a way that would affect SK WFOE’ security interest, (iv) incurring or guaranteeing any debts not incurred in its normal business operations, (v) entering into any material contract (exceeding RMB 3,000,000, or approximately $439,741, in value), unless it is necessary for the company’s normal business operations; (vi) providing any loan or guarantee to any third party; (vii) acquiring or consolidating with any third party, or investing in any third party; and (viii) distributing any dividends to the shareholders in any manner. In addition, the Loan Agreement provides that at SK WFOE’ request, Tianjin Shengkai will promptly distribute all distributable dividends to the shareholders of Tianjin Shengkai.

 
7

 
The funds that SK WFOE used to make the loan came from the proceeds received by us, its indirect parent company, in the Private Placements described in further detail below.

Exclusive Purchase Option Agreement    

The Exclusive Purchase Option Agreement, among SK WFOE, Tianjin Shengkai, and all of the shareholders of Tianjin Shengkai, provides that Tianjin Shengkai will grant SK WFOE an irrevocable and exclusive right to purchase all or part of Tianjin Shengkai’s assets, and the shareholders of Tianjin Shengkai will grant SK WFOE an irrevocable and exclusive right to purchase all or part of their equity interests in Tianjin Shengkai. Either right may be exercised by SK WFOE in its sole discretion at any time that the exercise would be permissible under PRC law, and the purchase price for SK WFOE’ acquisition of equity or assets will be the lowest price permissible under PRC law. Tianjin Shengkai and its shareholders are required to execute purchase agreements and related documentation within 30 days of receiving notice from SK WFOE that it intends to exercise its right to purchase.
 
The Exclusive Purchase Option Agreement contains agreements from Tianjin Shengkai and its shareholders that they will refrain from taking actions, such as voting to dissolve or declaring dividends, that could impair SK WFOE’s security interest in the equity of Tianjin Shengkai or reduce its value. These agreements are substantially the same as those contained in the Loan Agreement described above.

The agreement will remain effective until SK WFOE or its designees have acquired 100% of the equity interests of Tianjin Shengkai or substantially all of the assets of Tianjin Shengkai. The exclusive purchase options were granted under the agreement on May 30, 2008.

Equity Pledge Agreement

The Equity Pledge Agreement, among SK WFOE, Tianjin Shengkai, and all of the shareholders of Tianjin Shengkai, provides that the shareholders of Tianjin Shengkai will pledge all of their equity interests in Tianjin Shengkai to SK WFOE as a guarantee of the performance of the shareholders’ obligations and Tianjin Shengkai’s obligations under each of the other PRC restructuring agreements. The Equity Pledge Agreement contains promises from Tianjin Shengkai and its shareholders that they will refrain from taking actions, such as voting to dissolve or declaring dividends, that could impair SK WFOE’ security interest in the equity of Tianjin Shengkai or reduce its value. These promises are substantially the same as those contained in the Loan Agreement described above.

Under the Equity Pledge Agreement, the shareholders of Tianjin Shengkai have also agreed (i) to cause Tianjin Shengkai to have the pledge recorded at the appropriate office of the PRC Bureau of Industry and Commerce, (ii) to deliver any dividends received from Tianjin Shengkai during the term of the agreement into an escrow account under the supervision of SK WFOE, and (iii) to deliver Tianjin Shengkai’s official shareholder registry and certificate of equity contribution to SK WFOE. Additionally, on July 3, 2008, a Supplementary Agreement to the Equity Pledge was executed to authorize SK WFOE to fully and completely represent all shareholders of Tianjin Shengkai to exercise their shareholder's rights in Tianjin Shengkai, including shareholders’ voting rights at shareholder meetings.
 
Completion of the PRC Restructuring

The PRC Restructuring Agreements were executed on May 30, 2008. As of June 30, 2011, 100% of the registered capital of SK WFOE had been contributed in accordance with the PRC restructuring agreements.

As a result of the consummation of the PRC Restructuring Agreements above, the contributions of Tianjin Shengkai’s registered capital, and therefore the ownership of Tianjin Shengkai, took the form represented in the table below:

Name of Shareholder
 
Amount of Contribution
(RMB)
 
Percent of Capital
Contribution
Wang Chen
   
 
45,689,600
   
   
71.39
 
Guo Wei
   
8,531,200
     
13.33
 
Zhao Yanqiu
   
4,192,000
     
6.55
 
Ji Haihong
   
4,192,000
     
6.55
 
Zhang Ying
   
307,200
     
0.48
 
Miao Yang
   
307,200
     
0.48
 
Chen Fang
   
307,200
     
0.48
 
Wu Yanping
   
236,800
     
0.37
 
Liu Naifan
   
236,800
     
0.37
 
Total
   
RMB64,000,000
     
100
%


 
8

 

Reverse Merger Transaction

On June 9, 2008, through our wholly-owned subsidiary Shen Kun Acquisition Sub Limited, we entered into a Merger Agreement and Plan of Reorganization with (i) Shen Kun, (ii) the owners of all of the outstanding voting stock of Shen Kun, and (iii) our then-controlling shareholders, Vision Opportunity China LP, Castle Bison, Inc., Martin Sumichrast, and Ralph Olson. The Shen Kun shareholders with whom we consummated the merger included (i) the majority holder, Long Sunny Limited, a British Virgin Islands company (which owned 84.72% of Shen Kun’s common stock), a majority of the stock of which may be acquired in the future by our Chief Executive Officer, Mr. Wang Chen, pursuant to a call option held by Mr. Wang, (ii) five individual minority shareholders: Mr. Miao Yang, Ms. Zhang Ying, Ms. Chen Fang, Mr. Wu Yanping, Mr. Liu Naifan (who collectively owned 2.18% of Shen Kun’s common stock), and (iii) two entity minority shareholders, Groom Profit Holdings Limited, a British Virgin Islands company (solely owned by Ms. Zhao Yanqiu), and Right Idea Holdings Limited, a British Virgin Islands company (solely owned by Ms. Ji Haihong) (who each owned 6.55% of Shen Kun’s common stock, respectively).

Under the terms of the Merger Agreement and Plan of Reorganization, we acquired control of Shen Kun, a British Virgin Islands company and the parent company of SK WFOE, a wholly foreign-owned entity organized under the laws of the PRC, by issuing 20,550,000 shares of common stock to the Shen Kun shareholders as merger consideration for 100% of the common stock of Shen Kun. Immediately after the closing of the Merger Agreement and Plan of Reorganization, we had a total of 22,112,500 shares of common stock outstanding, with the Shen Kun shareholders (and their assignees) owning approximately 92.9% of our outstanding common stock on a non-diluted basis. Shen Kun Acquisition Sub Limited was dissolved and Shen Kun, the surviving entity, became our wholly-owned subsidiary.
 
Private Placement (June 2008 Financing)

In connection with the consummation of the reverse merger transaction, on June 11, 2008 we consummated a financing for the sale of Units for the aggregate gross proceeds of $15,000,000, at a price of $2.5357 per Unit (“the June 2008 Financing”). Each Unit consists of one share of the Company’s Series A Preferred Stock, convertible into one share of common stock, and one Warrant equal to 120% of the number of shares of common stock issuable upon conversion of the Series A Preferred Stock. The description of other material terms and conditions of the June 2008 Financing are set forth below.

Securities Purchase Agreement

In connection with the reverse merger transaction, on June 10, 2008 we entered into and on June 11, 2008 consummated a Securities Purchase Agreement (the “June 2008 Purchase Agreement”) with certain Purchasers, namely Vision Opportunity China LP, for the sale of Units at an aggregate purchase price of $15,000,000, each unit consisting of one share of Series A Preferred Stock and one Warrant with an exercise price of $3.52 per share, exercisable for a period of five years from the closing date.

On June 11, 2008, the aggregate purchase price paid for the Units was $15,000,000 (the “First Closing”). Pursuant to the June 2008 Purchase Agreement, on or before June 30, 2008, we had the option to sell in a second closing an additional number of Units for an aggregate price that was the difference between the gross proceeds from the First Closing and $20,000,000 (the “Second Closing”).

Each share of Series A Preferred Stock is convertible, at the option of the holder, into one share of our common stock, subject to certain limitations, conditions and anti-dilutive adjustments, and to a 9.9% limitation on beneficial ownership of stock. As such, the Series A Preferred Stock are convertible into an aggregate of 5,915,526 shares of our common stock    In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall either (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), or either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

The Warrants are exercisable in the aggregate for up to 7,098,632 shares of our common stock, or 120% of the total number of shares of common stock issuable upon conversion of the Series A Preferred Stock purchased by each Purchaser, subject to a 9.9% limitation on beneficial ownership of common stock. The Warrants are exercisable for a term of five years from June 10, 2008 and may be exercised at any time after 18 months following June 10, 2008 if we do not have an effective registration statement to cover the common stock underlying the Warrants.  In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), and either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

On September 16, 2007, the Company entered into a Financial Consulting Agreement (the “Mass Harmony Agreement”) with Mass Harmony Asset Management Limited (“Mass Harmony”). Pursuant to the Mass Harmony Agreement, Mass Harmony received an aggregate of
 
9

 
450,000 shares of common stock and 5% of the gross proceeds of the June 2008 Financing in Warrants, equivalent to warrants exercisable in the aggregate of up to 213,068 shares of our common stock. The services provided by Mass Harmony under the Mass Harmony Agreement include performing initial due diligence on the Company, preparing our business plan, and assisting in the corporate restructuring and financial documentation.
 
Pursuant to the Second Amendment to the June 2008 Purchase Agreement dated as of July 31, 2008, we are required to list and trade our shares of common stock on the Nasdaq Capital Market, the Nasdaq Global Market, the American Stock Exchange or any successor market thereto within eighteen (18) months of the First Closing, or our principal shareholder, Li Shaoqing (the “Principal Shareholder”), will be required to deliver to Vision Opportunity China LP an aggregate of 750,000 shares of common stock.

The Purchase Agreement also grants the following significant rights to Vision Opportunity China LP and places the following significant restrictions and obligations on us:

· 
 
Subsequent financing participation. For two years after the date on which the initial registration statement to be filed by the Company under the registration rights agreement described below is declared effective by the Securities and Exchange Commission (“SEC”), Purchasers who continue to hold Series A Preferred Stock have the right to participate in any subsequent sale of securities by the Company in order to purchase up to its pro rata portion of the total amount of securities sold in the subsequent sale equal to the percentage of the total Series A Preferred Stock issued in the June 2008 Financing.

· 
 
Consent for asset sale. We may not sell all or a substantial portion of our assets, except to a subsidiary, without the consent of the holders of a majority of the then-outstanding Series A Preferred Stock.

· 
 
Chief Financial Officer/Vice President of Investor Relations. As soon as possible after the First Closing, we are required to use our best efforts to appoint an individual who is fluent in English and acceptable to Vision Opportunity China LP to serve as Chief Financial Officer and/or Vice President of Investor Relations.

· 
 
Investor relations fund. We must maintain an escrow account with $500,000 in connection with monies to be used for investor and public relations services. The escrow account was established through the Investor and Public Relations Escrow Agreement described below and was funded at the Closing. Out of this amount, $150,000 shall be released from escrow once we appoint a Chief Financial Officer or Vice President of Investor Relations. An additional $150,000 will be released to us after we engage a new independent registered accounting firm that is listed as one of the top 20 firms by stock market client number as calculated by Hemscott Group Limited, a division of Morningstar, Inc. As of June 30, 2011, all of the $500,000 had been released back to the Company.

· 
 
U.S. visitation. For as long as Vision Opportunity China LP holds at least 5% of the aggregate total number of shares of common stock and Shares (as defined in the Purchase Agreement) of the Company on a fully-diluted basis, the Company must provide for its management to visit the United States at least twice each year to meet with potential investors.

Securities Escrow Agreement

On June 10, 2008 we entered into and on June 11, 2008 consummated a securities escrow agreement with Vision Opportunity China LP, as representative of the Purchasers under the June 2008 Purchase Agreement, the Principal Shareholder, and Loeb & Loeb LLP, as escrow agent (the “Securities Escrow Agreement”). In the Securities Escrow Agreement, as an inducement to the Purchasers to enter into the June 2008 Purchase Agreement, the Principal Shareholder agreed to deliver an aggregate of 5,915,526 shares of our common stock (the amount of common stock underlying the Series A Preferred Stock) (the “Vision Escrow Shares”) to the escrow agent for the benefit of the Purchasers, and to forfeit some or all of those shares to the Purchasers in the event we fail to achieve certain financial performance thresholds for the 12-month periods ending June 30, 2008 and June 30, 2009.

Pursuant to the Second Amendment to the June 2008 Purchase Agreement and the First Amendment to the June 2008 Securities Escrow Agreement, both dated as of July 31, 2008, if we fail to list our common stock on the Nasdaq Capital Market, Nasdaq Global Market, American Stock Exchange or any successor market thereto within eighteen (18) months of June 10, 2008, 750,000 shares of common stock owned by Principal Shareholder will be distributed to Vision Opportunity China LP.

As of June 30, 2011, pursuant to the terms of the Securities Escrow Agreement, all shares held in escrow had been released back to the Principal Shareholder.

 
10

 
Investor and Public Relations Escrow Agreement
 
On June 10, 2008 we entered into and on June 11, 2008 consummated an Investor and Public Relations Agreement with Vision Opportunity China LP and Sichenzia Ross Friedman Ference LLP, as escrow agent. Pursuant to the agreement, $500,000 of the proceeds of the June 2008 Financing was deposited into an escrow account with Sichenzia Ross Friedman LLP for use in investor and public relations services. The escrow account was established through the Investor and Public Relations Escrow Agreement described below and was funded at the closing. Out of this amount, $150,000 shall be released from escrow once we appoint a Chief Financial Officer or Vice President of Investor Relations. An additional $150,000 will be released to us after we engage a new independent registered accounting firm that is listed as one of the top 20 firms by stock market client number as calculated by Hemscott Group Limited, a division of Morningstar, Inc. As of June 30, 2011, all of the $500,000 had been released back to the Company.
 
Registration Rights Agreement

On June 10, 2008 we entered into and on June 11, 2008 consummated a Registration Rights Agreement with Vision Opportunity China LP (the “Vision RRA”), under which we agreed to prepare and file with the SEC and maintain the effectiveness of a “resale” registration statement pursuant to Rule 415 under the Securities Act (“Rule 415”) providing for the resale of (i) all of the shares of common stock issuable on conversion of the Series A Preferred Stock, (ii) all of the shares of common stock issuable upon exercise of the Warrants, (iii) 1,304,750 shares of common stock held by certain shareholders before the Reverse Merger Transaction, (iv) all of the Vision Escrow Shares delivered to Vision Opportunity China LP under the Securities Escrow Agreement described above, and (v) all of the 750,000 shares of common stock that the Principal Shareholder will be required to deliver to Vision Opportunity China LP in case the Company does not meet the deadline for listing on a national securities exchange.
 
Under the terms of the Vision RRA, we are required to have a registration statement filed with the SEC within 45 days after the earlier of the date of the Second Closing or June 30, 2008, and declared effective by the SEC not later than November 27, 2008. We filed the registration statement on August 7, 2008, and it was declared effective by the SEC on August 21, 2008.
 
We are required to pay liquidated damages in an amount equal to 1 percent of Vision Opportunity China LP’s initial acquisition of Series A Preferred Stock pursuant to the June 2008 Purchase Agreement for each month past the relevant deadline that the registration statement is not filed or not declared effective, for any period that we fail to keep the registration statement effective, or for any period that we cause our common stock to be delisted from the Over-the-Counter Bulletin Board (or other principal exchange on which it is traded), up to a maximum of 10 percent of the purchase amount of the Units. The number of shares of Series A Preferred Stock issuable pursuant to the liquidated damages provision is subject to reduction based on the maximum number of shares that can be registered under Rule 415.

The registration rights agreement also provides for additional demand registration rights in the event that Vision Opportunity China LP is unable to register all of the registrable securities in the initial registration statement and grants holders of registrable securities customary piggy back rights during any time when there is not an effective registration statement providing for the resale of the registrable securities.

The terms of the Vision RRA are subject to a registration rights agreement that was consummated on June 11, 2008 by and between the Company and certain shareholders pre-existing the reverse merger (the “Shareholder RRA”). Under the terms of the Shareholder RRA, the Company granted registration rights to certain shareholders existing prior to the reverse merger transaction, by which the shareholders were granted registration rights for the registration of an aggregate of 1,304,750 shares of common stock. The shareholders will be entitled to cash liquidated damages in the amount equal to .75% of the value of each shareholder’s registrable securities (using a value of $2.54 per share to calculate the amount of such shareholder’s registrable securities) on the date that it fails to register the securities under the terms of the agreement and for each calendar month or portion thereof until the failure is cured, up to a maximum amount of 10% of the value of the shareholder’s securities (using a value of $2.54 per share to calculate the amount of such shareholder’s registrable securities).

Lock-Up Agreement

On the Closing Date, we entered into an agreement with various shareholders of Long Sunny Limited and members of the Company’s management under which, in order to induce the Company and the Purchasers to enter into the June 2008 Financing, each of the seven shareholders and managers listed below agreed that (i) they will not sell or transfer any shares of our common stock held as of the Closing Date until at least 12 months after the effective date of the initial registration statement to be filed under the Vision RRA described above, and (ii) for an additional 24 months after the end of that 12 month period, it will not sell or transfer more than one-twelfth of its total shares of that common stock during any one month.

The shareholders subject to the Lock-Up Agreement are:  

·  
Wang Chen, our CEO.
·  
Li Shaoqing
·  
Guo Wei
 
 
11

 
 
·  
Liu Xiaoqian
·  
He Li
·  
Ruan Xiangyi
·  
Li Juan

Private Placement (July 2008 Financing)

On July 18, 2008, we sold to Blue Ridge Investment, LLC, Units for aggregate gross proceeds of $5,000,000, at a price of $2.5357 per Unit (the “July 2008 Financing”). As in the June 2008 Financing, each Unit consists of one share of Series A Preferred Stock, convertible into one share of common stock, and one Warrant to purchase common stock equal to 120% of the number of shares of common stock issuable upon conversion of the Series A Preferred Stock. The description of other material terms and conditions of the July 2008 Financing are set forth below.
 
Securities Purchase Agreement

On July 18, 2008, we entered into and consummated a Securities Purchase Agreement (the “July 2008 Purchase Agreement”) with Blue Ridge Investments, LLC for the sale of Units at an aggregate purchase price of $5,000,000, each unit consisting of one share of Series A Preferred Stock and one Warrant with an exercise price of $3.52 per share, exercisable for a period of five years from issuance.
 
Each share of Series A Preferred Stock is convertible, at the option of the holder, into one share of our common stock, subject to certain limitations, conditions and anti-dilutive adjustments, and to a 9.9% limitation on beneficial ownership of stock. As such, the Series A Preferred Stock are convertible into an aggregate of 1,971,842 shares of our common stock.  In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall either (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), or either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

The Warrants are exercisable in the aggregate for up to 2,366,211 shares of our common stock, or 120% of the total number of shares of common stock issuable upon conversion of the Series A Preferred Stock purchased by each Purchaser, subject to a 9.9% limitation on beneficial ownership of common stock. The Warrants are exercisable for a term of five years from July 18, 2008 and may be exercised at any time after 18 months following July 18, 2008 if we do not have an effective registration statement to cover the common stock underlying the Warrants.  In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), and either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

Pursuant to the Mass Harmony Agreement dated as of September 16, 2007, Mass Harmony also received 5% of the gross proceeds of the July 2008 Financing in Warrants, equivalent to warrants exercisable in the aggregate of up to 71,023 shares of our common stock. The services provided by Mass Harmony under the Mass Harmony Agreement include performing initial due diligence on the Company, preparing our business plan, and assisting in the corporate restructuring and financial documentation.
 
Pursuant to the First Amendment to the July 2008 Purchase Agreement dated as of July 31, 2008, we are required to list and trade our shares of common stock on the Nasdaq Capital Market, Nasdaq Global Market, American Stock Exchange or any successor market thereto within eighteen (18) months of July 18, 2008, or the Principal Shareholder, will be required to deliver to Blue Ridge Investments, LLC an aggregate of 250,000 shares of common stock.
 
The July 2008 Purchase Agreement also grants the following significant rights to Blue Ridge Investments, LLC and places the following significant restrictions and obligations on us:

·  
Subsequent financing participation. For two years after the date on which the initial registration statement to be filed by the Company under the Registration Rights Agreement described below is declared effective by the Securities and Exchange Commission (“SEC”), if Blue Ridge Investments, LLC continues to hold Series A Preferred Stock, it shall have the right to participate in any subsequent sale of securities by the Company in order to purchase up to its pro rata portion of the total amount of securities sold in the subsequent sale equal to the percentage of the total Series A Preferred Stock issued in the July 2008 Financing.

 
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·  
Consent for asset sale. We may not sell all or a substantial portion of our assets, except to a subsidiary, without the consent of the holders of a majority of the then-outstanding Series A Preferred Stock.

·  
Chief Financial Officer/Vice President of Investor Relations. As soon as possible after the Closing Date, we are required to use our best efforts to appoint an individual who is fluent in English and acceptable to Vision Opportunity China LP and to Blue Ridge Investments, LLC to serve as Chief Financial Officer and/or Vice President of Investor Relations.

·  
Investor relations fund. We must maintain an escrow account with $500,000 in connection with monies to be used for investor and public relations services. The escrow account was established through the Investor and Public Relations Escrow Agreement entered into by and between the Company, Vision Opportunity China LP and Sichenzia Ross Friedman Ference LLP, as escrow agent, dated as of June 10, 2008 and was funded on June 11, 2008. Out of this amount, $150,000 shall be released from escrow once we appoint a Chief Financial Officer or Vice President of Investor Relations. An additional $150,000 will be released to us after we engage a new independent registered accounting firm that is listed as one of the top 20 firms by stock market client number as calculated by Hemscott Group Limited, a division of Morningstar, Inc.  As of June 30, 2011, all of the $500,000 had been released back to the Company.

·  
U.S. visitation. For as long as Vision Opportunity China LP or Blue Ridge Investments, LLC holds at least 5% of the aggregate total number of shares of common stock and Shares (as defined in the Purchase Agreement) of the Company on a fully-diluted basis, the Company must provide for its management to visit the United States at least 4 times each year to meet with potential investors.

Securities Escrow Agreement

On July 18, 2008, we consummated a securities escrow agreement with Blue Ridge Investments, LLC, the Principal Shareholder, and Loeb & Loeb LLP, as escrow agent (the “July 2008 Securities Escrow Agreement”). In the Securities Escrow Agreement, as an inducement to Blue Ridge Investments, LLC to enter into the July 2008 Purchase Agreement, the Principal Shareholder agreed to deliver an aggregate of 1,971,842 shares of our common stock (the amount of common stock underlying the Series A Preferred Stock) (the “Blue Ridge Escrow Shares”) to the escrow agent for the benefit of Blue Ridge Investments, LLC, and to forfeit some or all of those shares to Blue Ridge Investments, LLC in the event we fail to achieve certain financial performance thresholds for the 12-month periods ending June 30, 2008 (“2008”) and June 30, 2009 (“2009”).


Pursuant to the First Amendment to the July 2008 Purchase Agreement and the First Amendment to the July 2008 Securities Escrow Agreement, both dated as of July 31, 2008, if we fail to list our common stock on the Nasdaq Capital Market, Nasdaq Global Market, American Stock Exchange or any successor market thereto within 18 months of July 18, 2008, 250,000 shares of common stock owned by Principal Shareholder will be distributed to Blue Ridge Investments, LLC.
 
As of June 30, 2011, pursuant to the terms of the Securities Escrow Agreement, all shares held in escrow had been released back to the Principal Shareholder.

Registration Rights Agreement

On July 18, 2008 we entered into and consummated a Registration Rights Agreement with Blue Ridge Investments, LLC (the “Blue Ridge RRA”), under which we agreed to prepare and file with the SEC and maintain the effectiveness of a “resale” registration statement pursuant to Rule 415 under the Securities Act (“Rule 415”) providing for the resale of: (i) all of the shares of common stock issuable on conversion of the Series A Preferred Stock, (ii) all of the shares of common stock issuable upon exercise of the Warrants, (iii) all of the Blue Ridge Escrow Shares delivered to Blue Ridge Investments, LLC under the July 2008 Securities Escrow Agreement described above, and (iv) all of the 250,000 shares of common stock that the Principal Shareholder will be required to deliver to Blue Ridge Investments, LLC in case the Company does not meet the deadline for listing on a national securities exchange.
 
Under the terms of the Blue Ridge RRA, we are required to have a registration statement filed with the SEC within 45 days after the date of the Closing Date, or September 1, 2008, and declared effective by the SEC not later than December 15, 2008.

We are required to pay liquidated damages to Blue Ridge Investments, LLC in an amount equal to 1% of Blue Ridge Investments, LLC initial acquisition of Series A Preferred Stock pursuant to the July 2008 Purchase Agreement for each month past the relevant deadline that the registration statement is not filed or not declared effective, for any period that we fail to keep the registration statement effective, or for any period that we cause our common stock to be delisted from the Over-the-Counter Bulletin Board (or other principal exchange on which it is traded), up to a maximum of 10% of the purchase amount of the Units. The number of shares of Series A Preferred Stock issuable pursuant to the liquidated damages provision is subject to reduction based on the maximum number of shares that can be registered under Rule 415.
   
 
13

 
The registration rights agreement also provides for additional demand registration rights in the event that Vision Opportunity China LP unable to register all of the registrable securities in the initial registration statement and grants holders of registrable securities customary piggy back rights during any time when there is not an effective registration statement providing for the resale of the registrable securities.

The terms of the Blue Ridge RRA are subject to the Vision RRA described in the section entitled “Private Placement (June 2008 Financing)” above. Under the terms of the Vision RRA, we granted registration rights to Vision Opportunity China LP on similar terms as Blue Ridge under the Registration Rights Agreement, except that we are required to file a registration statement within 45 days after June 30, 2008, and such registration statement must be declared effective by the SEC not later than November 27, 2008.

The terms of the Blue Ridge RRA are also subject to the Shareholder RRA. Under the terms of the Shareholder RRA, the Company granted registration rights to certain shareholders existing prior to the reverse merger transaction, by which the shareholders were granted registration rights for the registration of an aggregate of 1,304,750 shares of common stock, as described in more detail in the section entitled “Private Placement (June 2008 Financing)” above.

Warrant Amendment Agreement

On April 30, 2010, the Company entered into a Warrant Amendment agreement with each of the holders of the Warrants in the June 2008 Financing and July 2008 Financing, namely Vision Opportunity China, LP and Blue Ridge Investments, LLC, to amend their respective warrants so as to replace certain down-round anti-dilution protections with a provision to allow the Company to issue additional shares of common stock or common stock equivalents at a price less than the conversion price of the warrants with the consent of the majority holders of the warrants.

Recent Public Offerings

On November 19, 2010, we entered into an underwriting agreement with Maxim Group LLC and Global Hunter Securities, LLC relating to the issuance and sale in a public offering of 2,456,800 shares of the Company’s common stock, at a price of $5.5 per share for an aggregate gross purchase consideration of $13,512,400. The sale and purchase of the shares closed on November 24, 2010.

On December 17, 2010, we entered into another underwriting agreement with Maxim Group LLC and Global Hunter Securities, LLC relating to the issuance and sale in a public offering of 1,058,646 shares of the Company’s common stock, at a price of $5.5 per share for an aggregate gross purchase consideration of $5,822,553. The sale and purchase of the shares closed on December 22, 2010.

The offerings were made pursuant to a prospectus supplement and accompanying prospectus in connection with a takedown from the Company’s shelf registration statement on Form S-3 ((Registration No. 333-167276)  initially filed with the Securities and Exchange Commission on June 3, 2010 and amended on October 21, 2010. The registration statement was declared effective on October 25, 2010.

Subsidiaries

As a result of the Reverse Merger, Shen Kun and SK WFOE are our wholly-owned subsidiaries. Tianjin Shengkai, one of the entities through which we operate our business, currently has no subsidiaries, either wholly-owned or partially-owned.

On June 25, 2010, Shengkai (Tianjin) Trading Ltd., which is wholly owned by SK WFOE, was organized as a corporation under the laws of the PRC, with a total registered capital of RMB500,000. Shengkai (Tianjin) Trading Ltd. is primarily engaged in the international trading of non-valve products to better serve the Company’s international customers. Currently, Shengkai (Tianjin) Trading Ltd. has not started any operations.
 
Business Overview
 
We believe that the Company is one of the few ceramic valve manufacturers in the world with research and development, engineering, and production capacity for structural ceramics and is the only valve manufacturer in China who is able to produce large-sized ceramic valves with calibers of 150mm or more. Its product categories include a broad range of valves in all industries that are sold throughout China, to Europe, North America, United Arab Emirates and other countries in the Asia-Pacific region. Totaling over 200 customers, the Company became a supplier of China Petroleum & Chemical Corporation (“CPCC” or “Sinopec”) in 2005; it joined the supply network of China National Petroleum Corporation (“CNPC”) in 2006 and subsequently received a CNPC Certificate of Material Supplier for valve products in 2011. The Company is currently the only domestic ceramic valve manufacturer entering into the Sinopec and CNPC supply system, after a six-year application process.

The Company develops ceramic products with more than 770 types and specifications in 36 series, under 9 categories. Of these, 34 national patents have been obtained for its valve products. Our product won the title of “National Key New Product” four times from
 
 
14

 
1999-2003 and won a silver medal in the Shanghai International Industry Fair in 2002. In 2003, we obtained API authentication allowing export to North America and the Asia-Pacific region and CE authentication allowing export to EU in 2003.

Presently, the technology of most other domestic and overseas industrial ceramic valves manufacturers limits production to small-bore ball valves. In contrast, we produce a variety of ceramics in every category (gate valve, ball valve, back valve, adjustable valve, cut-off valve and special valve) and produce more than 770 specifications that sustain a maximum pressure level of 42MPa. The largest ceramic valve caliber that the Company is able to make is 1,000mm. Currently, we believe that most other manufacturers in the world primarily produce ceramic ball valves and ceramic adjustable valves with 150mm caliber or less.

Business History
 
Tianjin Shengkai was established in June 1994 with registered capital of RMB310,000 and an initial business scope covering the production and sales of spray mixtures and ceramic valves. The stock ownership was jointly held by eight shareholders including Wang Chen, the largest shareholder of the company.
 
In October 1995, Tianjin Shengkai increased its registered capital to RMB1 million through capital and equity increase; Wang Chen contributed RMB810,000 and the remaining shares were held by the other seven shareholders. In November 2000, the registered capital increased to RMB15 million and the company’s business scope was changed to the design, manufacturing and sales of ceramic valves, manufacturing and sales of high-tech ceramic material, technical consultation and service, and export of such products and related technologies.

Overview of Industrial Valve Industry
 
At present, the world industrial valve industry has been experiencing stable growth and development. According to statistical data in the Freedonia Group’s 2008 report titled “World Industrial Valves to 2011” (the “Freedonia Report”) (available at http://www.freedoniagroup.com/DocumentDetails.aspx?ReferrerId=FG-01&studyid=2297), world industrial valve demand has been growing steadily since 2006 with sales reaching $62.6 billion. The Freedonia Report indicates that world industrial demand for valves will reach $77.55 billion by 2011 and is expected to grow by an additional 23.3% through 2016 with world industrial valve sales reaching $95.65 billion.
 
The China market for industrial valves has been growing rapidly since 2001. According to the Freedonia Report, sales for Chinese industrial valves were $2.48 billion in 2001 and reached $5.75 billion as of the year end 2006 or a growth rate of 132.1% over this time period. As of the end of 2006, China was the second largest market for industrial valves on a worldwide basis behind the US with market shares of 9.2% and 22.2%, respectively.
 
The Freedonia Report indicates that Chinese industrial valve sales will reach $10.30 billion by year end 2011 with further growth expected through 2016 with sales reaching $15.75 billion or a growth rate of 52.9% over this time period. Due to the projected increased growth of the Chinese industrial valve market, by 2016 it is anticipated that China will gain significant market share from the US and will represent 16.5% of the overall industrial worldwide valve market versus 19.8% for the US.          
 
Operations of the Company
 
The Company designs, manufactures and distributes ceramic valves in 36 series under 9 categories, covering almost every general type of valve available for industrial use in the world. Our valve sizes range from 32mm to 1000mm and can withstand pressure up to 42MPa. The company provides a series of services related to industrial ceramic valves, including manufacture, installation and maintenance of general industrial ceramic valves, as well as the design and manufacture of various non-standard ceramic valves as required by customers’ special operating conditions.

Production is comprised of three processes: ceramic piece production, machine-work of ceramic and metal components, and assembly. Currently, the total area of the production plant is approximately 22,000 m2, with 168 sets of machine tools, of which 49 sets are for ceramics, and 119 sets of digitally controlled machine tools for metal components. Ceramic valve output in fiscal year 2011 was 23,298 sets.

Ceramics are friable and non-plastic and can be difficult to process. Additionally, we believe there is no special equipment available for ceramic processing in the world. Nevertheless, the Company has overcome these hurdles by applying the following features to its products:

·  
adding zirconia to alumina ceramics to increase toughness and resistance to corrosion;
·  
successfully using Martensite transformation toughening technology to increase toughness and reduce deformability; and
·  
applying nano-sized powder technology to improve toughness and other features.
·  
altering existing metal processors so as to enable us to apply cold-working techniques to its ceramic products.
 
The Company has developed a solid solution and agent that lowers firing temperature and enhances the homogeneous dispersion of ceramic pulp, applying the theories of solid solution, chemical dispersion and the rational sintering temperature curve. This technology
 
 
15

 
effectively controls the contraction ratio during the ceramic sintering process to greatly improve the success rate of finished products. Currently, the success rate of sintered finished goods of various calibers of our valve products has reached over 95%, and firing temperatures for our products are 80°C-120°C lower than the world standard in the industry.

The Company has also developed various technologies under various temperatures, so as to solve problems that arise from the combination of ceramics and metal with different coefficients of thermal expansion and to ensure that the valves produced are leak-proof. The Company mainly selects ceramic material of partially stabilized zirconia (PSZ), tetragonal zirconia polycrystal (TZP), zirconia-toughened alumina (ZTA) and zirconia toughened mullite (ZTM).
 
We believe that our ability to produce a comprehensive category of high-quality ceramic products, together with our self-developed ceramic processor, leak-proof valve sealing technology and strong technology development capacity, distinguish us from our domestic and international competitors.
 
The Company expensed all research and development costs as incurred.  Research and development expenses incurred for the years ended June 30, 2011 and 2010 were $885,694 and $865,098, respectively.

Products  
 
The Company mainly produces industrial ceramic valves with calibers primarily ranging from 150mm to 400mm and the largest up to 1,000mm in various types and in different combinations of ceramic and metal coefficients, depending on their use. Ceramic valves perform significantly better than metal valves due to higher wear resistance, corrosion resistance, and high temperature resistance. We estimate that the average service life of our ceramic valves is at least 10 times of that of comparably-sized metal valves currently in the market.
 
Customers and Suppliers
 
Customers
 
For the year ended June 30, 2011, the Company’s top 10 customers and sales amount were as follows:

Name
 
Amount (RMB)
Company A
 
 15,436,854
Company B
 
15,201,218
Company C
 
 15,192,477
Company D
 
 13,045,152
Company E
 
 11,580,546
Company F
 
10,227,483
Company G
 
9,958,916
Company H
 
8,904,200
Company I
 
8,187,930
Company J
 
8,061,286

Our top 10 customers contributed approximately 18.67% of total sales in the fiscal year ended June 30, 2011. No customer individually accounted for more than 2.5% of total sales.

Suppliers

For the year ended June 30, 2011, The Company’s top 10 suppliers and purchase amount were as follows:
  
Name
 
Amount (RMB)
Company K
 
       19,529,878
Company L
 
       18,280,829
Company M
 
       17,852,974
Company N
 
       16,260,701
Company O
 
       15,646,681
Company P
 
       15,167,910
Company Q
 
       15,016,554
Company R
 
       14,157,778
Company S
 
       13,781,855
Company T
 
       13,775,086

 
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Our top 10 suppliers accounted for approximately 51.69% of total purchases in the fiscal year ended June 30, 2011. No supplier individually accounted for more than 6.9% of total sales.

Marketing and Sales

Marketing and sales efforts have been and will be made to implement the following strategies to achieve our sales objectives:

Targeted marketing: Two marketing departments have been set up for domestic and overseas markets: Department No. 1 is responsible for domestic marketing and engaging in direct sales for regular customers and sales via agents for spot sales. Sales teams are divided by geographical region. Currently, the Company has set up regional distribution offices in Hunan, Jilin, Heilongjiang, Hebei, Jiangxi, Shandong, Hubei, Shanxi, Sichuan, Ningxia and Inner Mongolia and has a distribution network covering almost all provinces in China. Department No. 2 engages in international sales and utilizes foreign agents to conduct sales in international markets. We have obtained relevant approval and authentication to export to Europe, North America, and the Asia-Pacific region.

Strategic transition to new markets: In response to recent business disruptions and changes in the global ceramic valves industry, in the future, the Company will implement a strategic transition away from the low-end markets including the electric power markets, to the high-end oil and chemical markets, both domestically and abroad. The Company has gained qualification to supply to Sinopec and CNPC; In future, it will endeavor to obtain certifications to become supplier to those multinational companies in the global oil and chemical industries.

Sales training: Each member of sales personnel in the company is trained in grass-roots production before starting work, so as to become familiar with production flow and product characteristics. The HR department has prepared a training plan aimed at sales personnel to educate them in sales and product knowledge. To ensure the professionalism of our employees, all of our sales personnel must pass an exam following training before they may start work.


Value-added services: The Company is working to enhance the quality of our before-sales, during sales and after-sales service. Shengkai has developed before-sales technical design service to achieve a perfect connection of product with customer demand.
 
Competition
 
Competitive Environment
 
Currently, the world ceramic valve industry is still in its infancy. Ceramic valves represent a very small proportion in the industrial valve industry.
  
The Company’s main competitors are manufacturers of metal valves, which currently still represent the majority market share in the valve market. Although the unit price of metal valves is typically cheaper than the unit price of ceramic valves, ceramic valves are more durable than metal valves and as such are more cost-effective than metal valves. Primary Chinese metal valve competitors include Henan Kaifeng High Pressure Valve Co., Ltd., CNNC Sufa Technology Industry Co., Ltd, Neway Valve (Suzhou) Co., Ltd. and Lanzhou High-Pressure Valves Co., Ltd., etc.
 
Within the ceramic valve industry, the business of our primary ceramic valve competitors is briefly described below:
 
Cera System GmbH. Primary line of business: high quality ceramic ball valve and ceramic pipeline manufacture. Single equipment is used for structural ceramics production, resulting in few varieties, small caliber and high production cost of ceramic valves.

Fujikin of America, Inc. Primary line of business: semiconductor products and ceramic valves, particularly small ceramic adjustable ball valves. Fujikin specializes in the manufacture of control devices for valves, but it relies primarily on outsourcing for its ceramic valve cores.

Yantai Kingway Flow Control Co., Ltd. Primary line of business: KOWOV brand ceramic ball valves and control valves in addition to electric and pneumatic actuated metal valves.

Xiamen Shengzhong Ceramic Valve Technology Co., Ltd. Primary line of business: series of ceramic components as well as high-quality, small-sized ceramic ball valves, butterfly valves and gate valves.

Many of our international competitors, in particular, have longer operating histories and have more established relationships with customers and end users and are engaged in major markets of general industrial products and cutting edge technology fields. However, with respect to the niche market of ceramic valves manufacture, presently foreign valve manufacturers Cera System and Fujikin have mature production scales for ceramic valves, but they do not make industrial ceramics development and ceramic valve production their main line of business, and they rely on either single-use equipment or outsourcing for production of ceramic components. In China, aside from Shengkai,
 
 
17

 
there are small amount of ceramic valve manufacturers with limited sales volumes, most of which also mainly depend on outsourcing for ceramic pieces.

Our Competitive Advantages

At present, based on our experience in and knowledge of the ceramic valve industry in China, we believe that we are the leading producer of ceramic valves in China. Given our early entry into the ceramic valve market, we believe we enjoy a leading position in China because of our head start in ceramic material technology and valve assembly.

Presently, the technology of other domestic and overseas industrial ceramic valve manufacturers limits their production to small-bore ball valves. In contrast, the Company produces a variety of ceramic valves in every category (gate valve, ball valve, back valve, adjustable valve, cut-off valve and special valve, etc.) and produces more than 770 specifications that sustain a maximum pressure level of 42MPa. The largest ceramic valve caliber produced by the Company is able to make is 1,000mm; currently, we believe that most of other manufacturers in the world only produce ceramic ball valves and ceramic adjustable valves with 150mm caliber or less. We believe that our ability to produce a comprehensive category of high-quality ceramic products, together with our self-developed ceramic processor, leak-proof valve sealing technology and strong technology development capacity, set us apart from our domestic and international competitors.
 
Our Future Goals

We have the following near-term goals for our company:

·  
Develop new technology for the industry. We plan to increase investment in technology development and continue conducting research on engineering structural ceramics that will advance the ceramic industrial valve market.

·  
Lower production costs. We plan to digitalize our machinery and streamline our valve production so as to lower the production cost of ceramic valves and hasten their substitution for metal valves.

·  
Internationalization. We have started to gain brand awareness in the overseas valve market. As such, we will keep expanding market share in the international market.

·  
Strategic transition to new markets. In response to recent business disruptions and changes in the global ceramic valves industry, the Company will implement a strategic transition away from the low-end markets including the electric power markets, to the high-end oil and chemical markets, both domestically and abroad.

Our new manufacturing plant was substantially completed, and commercial production at this new facility officially began in September 2010. Our headquarters building was also completed in September 2010. The new facility increases our annual production capacity to 24,000 sets of ceramic valves based on one-shift operation. Construction funds for the new manufacturing facility was obtained from two private placement transactions in 2008 and from cash flows generated from operations. When we reached 100% production capacity at the new facility during the last two quarters of the fiscal year 2011, we had managed to further increase our production capacity by adding shifts for some of the production processes and also planned to acquire additional machines to support the additional capacity.
 
 
In recent months, because of the heightened suspicions on the integrity of Chinese companies, enquiries into the Company’s business and domestic customers mounted by certain shareholders and interested parties without the Company’s approval or endorsement have resulted in severely damaged relations with some of the Company’s important domestic customers. This has resulted in considerable loss of business since June 2011, and a higher turnover in the Company’s sales agents and representatives. Some of the Company’s other customers have seized this opportunity to demand price cuts from the Company. Meanwhile, some of the Company’s competitors also have seized this opportunity to take away our customers.

In response to this situation, management of the Company has decided to phase out its less profitable domestic market segments including the electric power market and focus on expanding its presence in the more profitable domestic and foreign oil and chemical industries where ceramic valve products typically command higher prices than the domestic Chinese market

The Company plans to substantially raise prices to match industry levels and to reflect its superior product quality. The Company also expects to streamline operations through headcount reduction and other cost-saving measures to conserve capital and reduce the impact of any revenue loss during this transition.

Finally, the Company plans to leverage its self-developed ceramic material technologies to continue in-house and joint research and development of innovative and superior-performance products for the international oil and chemical markets and commit its resources to expanding the acceptance of its products overseas.

 
18

 
Raw Materials and Equipment

Raw materials required for valve production includes metal materials and ceramic materials like aluminum oxide and zinc oxide; a large number of spare parts in various specifications are also purchased during production. Our supply contracts typically bear renewable one year terms. The company implements the ISO9001 quality system and as such is very strict with selection of equipment and material suppliers. Purchased machinery or kiln equipment in addition to raw materials are subsequently strictly inspected and examined by the quality control department, so as to prevent unqualified products from being put into the production flow.

Technology Development

The Company focuses its technology development on those product areas that have the highest demand, so as to expedite market share expansion of ceramic valves, lower the risks of product development and promotion, and improve the company’s input-output ratio. The Company has also increased investment in nano-ceramics performance enhancement via nano technology, so as to continue to increase the caliber, pressure and temperature scope of ceramic valves (and the displacement of metal valves in the market).

In its newly completed production facility completed in September 2010, the Company has introduced digital-control processing centers that will greatly enhance process precision and efficiency and will improve the overall quality of our valves. The digitalization has also reduced the need for a larger, highly skilled workforce.

Intellectual Property
 
The Company has certain intellectual property rights as listed below:
 
Patents

We have applied for and obtained 34 patents in the PRC for the following products:

No.
 
Utility Models
 
Utility Models No.
 
Designer
 
Application Date
 
Authorized Announce-
ment Date
 
Owner
 
 
 
 
 
 
 
 
 
 
 
 
 
1
 
High temperature and high Pressure ceramic check valves in power station
 
ZL 200420029890.0
 
Wang Chen
 
10/10/2004
 
2/1/2006
 
Tianjin Shengkai
2
 
Preventing slag at the bottom of the wedge and abrasion-resistant ceramic slag-off valves
 
ZL 200420029889.8
 
Wang Chen
 
10/10/2004
 
2/1/2006
 
Tianjin Shengkai
3
 
Anti-fouling ceramic seal discharge valves
 
ZL 200420029887.9
 
Wang Chen
 
10/10/2004
 
12/7/2005
 
Tianjin Shengkai
4
 
Reciprocating sliding dual- plate ceramic sealing valves
 
ZL 200420029886.4
 
Wang Chen
 
10/10/2004
 
2/1/2006
 
Tianjin Shengkai
5
 
New ceramic replica valves
 
ZL 200420029885.X
 
Wang Chen
 
10/10/2004
 
11/9/2005
 
Tianjin Shengkai
6
 
External composite armor plate for tank
 
ZL 2004 2 0029600.2
 
Wang Chen
 
8/24/2004
 
8/3/2005
 
Tianjin Shengkai
7
 
The new V-shaped channel spherical valves
 
ZL 2004 2 0029601.7
 
Wang Chen
 
8/3/2004
 
8/3/2005
 
Tianjin Shengkai
8
 
Cavitation and erosion-resistant high-pressure adjusting valves
 
ZL 2004 2 0029602.1
 
Wang Chen
 
8/24/2004
 
8/3/2005
 
Tianjin Shengkai
9
 
New ceramic three links valves
 
ZL 2004 2 0029603.6
 
Wang Chen
 
8/24/2004
 
8/3/2005
 
Tianjin Shengkai
10
 
Ceramic valves with purge devices
 
ZL 200820002560
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
11
 
Throttle ceramic valves
 
ZL 200820002561.5
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
12
 
Fast-opening ceramic adjusting valves
 
ZL 200820002565.3
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
13
 
Eccentric anti-seize abrasion-resistant spherical valves
 
ZL 200820002564.9
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
14
 
Spherical ceramic adjusting valves
 
ZL 200820002562.X
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
15
 
Ceramic butterfly valves
 
ZL 200820002563.4
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
16
 
Ceramic seal switching valves
 
ZL 200820002566.8
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
17
 
Fine-tuning ceramic adjusting valves
 
ZL 200820002567.2
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
 
 
19

 
18
 
Hemispherical ceramic adjusting valves
 
ZL 200820002559.8
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
19
 
Ceramic ball check valves
 
200920179548.1
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
20
 
Three links switching ceramic cut-off valves
 
200920179544.3
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
21
 
Pneumatic ceramic seal shut-off valve
 
200920179546.2
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
22
 
An enhanced ceramic sphere
 
200920179545.8
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
23
 
Ceramic ball cut-off valves
 
200920179547.7
 
Wang Chen
 
10/12/2009
 
9/28/2010
 
Tianjin Shengkai
24
 
High pressure ceramic flat gate valve
 
200920179550.9
 
Wang Chen
 
10/12/2009
 
9/10/2010
 
Tianjin Shengkai
25
 
Ceramic seal swing check valves
 
200920179549.6
 
Wang Chen
 
10/12/2009
 
5/11/2011
 
Tianjin Shengkai
26
 
Throttle ceramic cut-off valve
 
200920179551.3
 
Wang Chen
 
10/12/2009
 
6/22/2011
 
Tianjin Shengkai
27
 
Ceramic Liner
 
201020576395.7
 
Wang Chen
 
10/26/2010
 
5/11/2011
 
Tianjin Shengkai
28
 
High Temperature Ceramic Nozzle
 
201020576411.2
 
Wang Chen
 
10/26/2010
 
5/25/2011
 
Tianjin Shengkai
29
 
Ceramic Spray Nozzle
 
201020576415.0
 
Wang Chen
 
10/26/2010
 
5/11/2011
 
Tianjin Shengkai
30
 
Ceramic Piston Pump
 
201020576428.8
 
Wang Chen
 
10/26/2010
 
6/8/2011
 
Tianjin Shengkai
31
 
Ceramic Pump
 
201020576436.2
 
Wang Chen
 
10/26/2010
 
6/15/2011
 
Tianjin Shengkai
32
 
Ceramic Valv Stem
 
201020576439.6
 
Wang Chen
 
10/26/2010
 
5/4/2011
 
Tianjin Shengkai
33
 
Ceramic Plunger
 
201020576448.5
 
Wang Chen
 
10/26/2010
 
4/27/2011
 
Tianjin Shengkai
34
 
Thermocouple Protection
 
201020576462.5
 
Wang Chen
 
10/26/2010
 
6/8/2011
 
Tianjin Shengkai
 
Shengkai has patent applications pending for the following products:

Name
 
Patent No.
 
Application Date
Ceramic Butterfly Disc
 
201120264468.3
 
7/26/2011
Invisible Rod Knife-shape Ceramic Gate Valve
 
201120264469.8
 
7/26/2011
Ceramic Ball used in Corrosive Media
 
201120264470.0
 
7/26/2011
Flat Ceramic Gate Valve with Diversion Hole
 
201120265746.7
 
7/26/2011
Full-lined Sliding Gate
 
201120265747.1
 
7/26/2011
Large-diameter Ball Valve Structure
 
201120265748.6
 
7/26/2011
Coat Ceramic Ball
 
201120265749.0
 
7/26/2011
High Pressure Fixed Ceramic Ball Valve
 
201120265750.3
 
7/26/2011
High Pressure Valve in Coal-chemical System
 
201120265771.5
 
7/26/2011
Ceramic Plug Valve
 
201120265773.4
 
7/26/2011
Ceramic Valve Ball Machining Tooling
 
201120265774.9
 
7/26/2011
Ceramic Disc Grinding Cylindrical Fixture
 
201120265775.3
 
7/26/2011
Anti-body Deformation of the Large-diameter Gate Valve
 
201120265772.x
 
7/26/2011

Trademarks and Domain Names

Shengkai has registered seven trademarks for “SK” and “Shengkai” with the Trademark Bureau under the State of Administration for Industry & Commerce, all of which are effective:
 
20

 
Trademark
 
Certificate
No.
 
Category
 
Registrant
 
Valid Term
“SK”
 
No.1717597
 
No.6 :metal valves (parts of non-machinery), metallic pipe fittings, metallic pipe reinforcement material, metallic pipes fittings of compressed air pipes, metallic pipes, metallic pipes of air conditioning equipment, metallic drip valves, metallic sleeve, conduits and pipes of central heating equipments, metallic pipes of central heating
 
Tianjin Shengkai
 
2/21/2002 to 2/20/2012
 
No.4152529
 
No.2: black clear lacquer, chinaware silver lacquer, platinum glaze for brightening ceramic materials, ceramic coating, white dye or paint, non-viscous chemical coating, within and external walls of bright water-soluble spray plastic, metal anti-rust formulations, metal used protection formulations, ceramic materials with paint, antirust oil
 
Tianjin Shengkai
 
5/7/2007 to 5/6/2017
 
No.4152532
 
No.20: non-metallic valves, non-metallic ball valves, plastic water pipe valves, plastic drip valves
 
Tianjin Shengkai
 
5/7/2007 to 5/6/2017
 
No.4152527
 
No.7:   mud pumps for petroleum, power station boilers and auxiliary equipments, centrifugal pumps, pumps, valves, the flap valves, pressure valves and give up valves, hydraulic valves, control valves, engine nozzles, electrostatic industrial equipments, conveyor
 
Tianjin Shengkai
 
10/14/2006 to 10/13/2016
 
No.4152528
 
No.6:   Armored plates, metallic valves (non-machinery parts), metallic ceramics, metallic drip valves, metallic pipes, metallic water pipes, metallic spray-head, metallic nozzles, metallic piping elbows
 
Tianjin Shengkai
 
10/14/2006 to 10/13/2016
 
No.4152533
 
No.11: slag of furnace automatic transmission installations, valves steam heating equipments, taps, plumbing plugs, sewer equipments, plumbing modulator switches, water equipments, air purification equipments and machinery, gas purification devices, ionizing air handling equipments, flues, flues in chimney, air filtration equipments
 
Tianjin Shengkai
 
10/14/2006 to 10/13/2016
 

 
21

 
Shengkai has registered the following domain names:

Domain Name
 
Owner
 
Registration Date
 
Expiration Date
“Ceramicvalve.net”
 
Tianjin Shengkai
 
4/13/2007
 
4/13/2012 (extended from 4/13/2011)
“Shengkai.com”
 
Tianjin Shengkai
 
N/A
 
6/15/2014 (extended from 6/15/2010)
“Shengkaiinnovations.com”
 
Shengkai Innovations, Inc.
 
11/13/2009
 
11/23/2011
 
Tianjin Shengkai
 
4/13/2007
 
4/13/2012 (extended from 4/13/2011)
 
Tianjin Shengkai
 
4/16/2007
 
4/16/2012 (extended from 4/16/2011)
 
Tianjin Shengkai
 
4/13/2007
 
4/13/2012 (extended from 4/13/2011)
 
Tianjin Shengkai
 
4/13/2007
 
4/13/2012 (extended from 4/13/2011)
 
Tianjin Shengkai
 
4/13/2007
 
4/13/2012 (extended from 4/13/2011)
 
Tianjin Shengkai
 
4/13/2007
 
4/13/2012 (extended from 4/13/2011)

Employees

As of September 20, 2011, Shengkai had 186 employees, 85 of which possess a diploma over junior college level, representing 45.7% of the work force recruited. We currently have 8 senior-level professionals and 16 mid-level professionals with undergraduate or higher degrees.

Employee benefits include five state-mandated insurance plans:

·  
Old-age insurance: We withhold a portion of each employee’s average monthly salary from the prior year, as determined by the provincial government, generally 8%, and contribute an additional amount determined by law, up to approximately 20% of such average monthly salary.
·  
Medical insurance: We withhold approximately 2% of each employee’s average monthly salary from the prior year and contribute an additional amount totaling approximately 10% of such average monthly salary.
·  
Unemployment insurance: We withhold approximately 1% of each employee’s average monthly salary from the prior year, and contribute an additional amount totaling approximately 2% of such average monthly salary.
·  
Maternity insurance: We contribute an amount totaling approximately 0.8% of each employee’s average monthly salary from the prior year.
·  
Industrial injury insurance: we contribute an amount totaling approximately 0.5% of each employee’s average monthly salary from the prior year.

In the year ended June 30, 2011, our average compensation per employee per month was RMB4,000, or approximately $630. We also pay benefits in the form of social security insurance fees for employees required such insurance under PRC law.

We have a system of human resource performance review and incentive policies that allows personnel reviews to be carried out monthly or bi-monthly, depending on the length of service.
 
Government Regulation
 
          We are subject to a wide range of regulation covering every aspect of our business. The most significant of these regulations are set forth below. In each case, we have passed the most recent required inspections and have received appropriate and up-to-date licenses, certificates and authorizations, as set forth in the next subsection of this 10-K.
Regulations on Safety Supervision for Special Equipment

On March 11, 2003, the State Council issued Regulations on Safety Supervision for Special Equipment (“Special Equipment Regulations”) with came into effect on June 1, 2003 and was amended on January 24, 2009. According to Special Equipment Regulations, an enterprise, which manufactures elements for pressure pipeline, such as valves, is required to obtain the manufacture license of special equipment issued by competent special equipment safety supervision authorities before relevant business operations.

Foreign Investment in PRC Operating Companies

The Foreign Investment Industrial Catalogue jointly issued by the MOFCOM and the National Development and Reform Commission or the NDRC in 2007 classified various industries/businesses into three different categories: (i) encouraged for foreign investment; (ii) restricted to foreign investment; and (iii) prohibited from foreign investment. For any industry/business not covered by any of these three categories, they will be deemed industries/businesses permitted to have foreign investment. Except for those expressly provided restrictions,
 
 
22

 
encouraged and permitted industries/businesses are usually 100% open to foreign investment and ownership. With regard to those industries/businesses restricted to or prohibited from foreign investment, there is always a limitation on foreign investment and ownership. The PRC Subsidiary’s business does not fall under the industry categories that are restricted to, or prohibited from foreign investment and is not subject to limitation on foreign investment and ownership.

Regulation of Foreign Currency Exchange

Foreign currency exchange in the PRC is primarily governed by a series of regulations, including the Regulations on Exchange Control of the PRC (2008), and the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), as amended. Under these regulations, the Renminbi is freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans or investments in securities outside the PRC without the prior approval of the SAFE. Pursuant to the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), foreign invested enterprises (“FIEs”), such as SK WFOE, may purchase foreign exchange without the approval of the SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange, subject to a cap approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, the relevant PRC government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside the PRC are still subject to limitations and require approvals from the SAFE.

Regulation of FIEs’ Dividend Distribution
 
The principal laws and regulations in the PRC governing distribution of dividends by FIEs include:
 
 
(i)
The Sino-foreign Equity Joint Venture Law (1979), as amended, and the Regulations for the Implementation of the Sino-foreign Equity Joint Venture Law (1983), as amended;
 
 
(ii)
The Sino-foreign Cooperative Enterprise Law (1988), as amended, and the Detailed Rules for the Implementation of the Sino-foreign Cooperative Enterprise Law (1995), as amended;
 
 
(iii)
The Foreign Investment Enterprise Law (1986), as amended, and the Regulations of Implementation of the Foreign Investment Enterprise Law (1990), as amended.
 
 
(iv)
Regulations on Exchange Control of the PRC (2008)

 
(v)
Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996)

Under these regulations, FIE in the PRC may pay dividends only out of the FIE’s profits, if any, after the payment of its enterprise income tax and contributions to its reserve fund, employee bonus and welfare fund and enterprise development fund at percentages that are decided by its board of directors; and such net profits shall be distributed in proportion to the contributions to the registered capital of the parties to the venture. Moreover, the registered capital contribution of an FIE must be fully paid before any profit or dividend of the FIE is remitted abroad; where the registered capital contribution of an FIE is not been fully paid due to special circumstances, profits or dividends of the FIE can be remitted abroad only if approvals from competent authorities have been obtained; furthermore, an FIE may only remit profits or dividends abroad at authorized banks and must comply with certain procedural requirements, such as providing the Foreign Invested Enterprise Foreign Exchange Registration Certificate, the resolution of the board of directors for the distribution of profits, the capital verification report issued by certified public accountants, the audit report and the tax payment documentation, etc.
 
Regulation of a Foreign Currency’s Conversion into RMB and Investment by FIEs
 
On August 29, 2008, the SAFE issued a Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises or Notice 142, to further regulate the foreign exchange of FIEs. According to the Notice 142, FIEs shall obtain verification report from a local accounting firm before converting its registered capital of foreign currency into Renminbi. The Notice 142 provides that the Renminbi capital converted from foreign currency registered capital of a FIE may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC, unless it is provided for otherwise. In addition, on July 18, 2011, the SAFE issued a supplementary notice of Notice 142 to address further explanation on the related conducting rules of Notice 142, which became effective as of August 1, 2011.
 
Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions
 
On October 21, 2005, the SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Notice 75, which became effective as of November 1, 2005; and on May 20, 2011, the SAFE issued the specific conducting rules of Notice 75 namely Operating Rules for Fund-raising and Return Investment Activities of Domestic Residents through Special Purpose Companies, which became effective as of
 
 
23

 
July 1, 2011. SAFE Notice 75 states that PRC residents, whether natural or legal persons, must register with the relevant local SAFE branch prior to establishing or taking control of an offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by them. The term “PRC legal person residents” as used in SAFE Notice 75 refers to those entities with legal person status or other economic organizations established within the territory of the PRC. The term “PRC natural person residents” as used in SAFE Notice 75 includes all PRC citizens and all other natural persons, including foreigners, who habitually reside in the PRC for economic benefit.

PRC residents are required to complete amended registrations with the local SAFE branch upon: (i) injection of equity interests or assets of an onshore enterprise to the offshore entity, or (ii) subsequent overseas equity financing by such offshore entity. PRC residents are also required to complete amended registrations or filing with the local SAFE branch within 30 days of any material change in the shareholding or capital of the offshore entity, such as changes in share capital, share transfers and long-term equity or debt investments or, providing security, and these changes do not relate to return investment activities. PRC residents who have already organized or gained control of offshore entities that have made onshore investments in the PRC before SAFE Notice 75 was promulgated must register their shareholdings in the offshore entities with the local SAFE branch on or before March 31, 2006.
 
Under SAFE Notice 75, PRC residents are further required to repatriate into the PRC all of their dividends, profits or capital gains obtained from their shareholdings in the offshore entity within 180 days of their receipt of such dividends, profits or capital gains. The registration and filing procedures under SAFE Notice 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds, or the return of funds upon a capital reduction.

Government Regulations Relating to Taxation

On March 16, 2007, the National People’s Congress, approved and promulgated the EIT Law, which took effect on January 1, 2008. Under the EIT Law, FIEs and domestic companies are subject to a uniform tax rate of 25%. The EIT Law provides a five-year transition period starting from its effective date for those enterprises which were established before the promulgation date of the EIT Law and which were entitled to a preferential lower tax rate under the then-effective tax laws or regulations.
 
On December 26, 2007, the State Council of the PRC issued Circular 39, providing that the enterprises that had been approved to enjoy a low tax rate prior to the promulgation of the EIT Law will be eligible for a five-year transition period since January 1, 2008, during which time the tax rate will be increased step by step to the 25% unified tax rate set out in the EIT Law. From January 1, 2008, for the enterprises whose applicable tax rate was 15% before the promulgation of the EIT Law, the tax rate will be increased to 18% for year 2008, 20% for year 2009, 22% for year 2010, 24% for year 2011, and 25% for year 2012. For the enterprises whose applicable tax rate was 24%, the tax rate was changed to 25% beginning on January 1, 2008.

Under the EIT Law, enterprises are classified as “resident enterprise” and “non-resident enterprise” and an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. On December 6, 2007, the State Council promulgated the implementation rules to the EIT Law, which also became effective on January 1, 2008 and define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

On April 22, 2009, the State Administration of Taxation issued the Notice Regarding the Determination of PRC-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or SAT Circular 82. SAT Circular 82 provides certain specific criteria for determining whether the "de facto management body" of a PRC-controlled offshore-incorporated enterprise is located in the PRC. “PRC-controlled offshore enterprise” refers to an enterprise which is formed and registered abroad by an enterprise or enterprise group located in the PRC as the major controlling investor under the law of a foreign country (region).

According to the SAT Circular 82, a PRC-controlled offshore incorporated enterprise will be regarded as a PRC tax resident by virtue of having "de facto management body" in the PRC only if all of the following conditions set forth in the SAT Circular 82 are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise's financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise's primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.

Furthermore, a PRC-controlled enterprise may file a resident enterprise application to the competent tax authority of the place where its de facto management body or where the major PRC investor is located, and the competent tax authority shall, after the preliminary examination, report, level by level, its identity of resident enterprise to the State Administration of Taxation for confirmation. If an overseas PRC-controlled enterprise fails to file a resident enterprise application, the competent tax authority of the place where its major PRC investor is located may make a preliminary judgment about whether it is a PRC resident enterprise according to the information available to it, and report to the State Administration of Taxation for confirmation.

 
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Although SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those controlled by PRC individuals, the determining criteria set forth in the SAT Circular 82 may reflect the State Administration of Taxation's general position on how the "de facto management body" test may be applied in determining the tax resident status of offshore enterprises.

Currently, the tax resident status of an enterprise is subject to determination by the competent PRC tax authorities and uncertainties remain with respect to the interpretation of the term "de facto management body" as applicable to our offshore entities, we may be considered a resident enterprise. If the PRC tax authorities determine that we are “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. Firstly, we may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Secondly, dividends paid to us from our PRC Subsidiary may qualify as “tax-exempt income”, but we cannot guarantee that such dividends will not be subject to PRC withholding tax. In addition, it could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our non-PRC shareholders and gains derived by our non-PRC shareholders from transferring our shares, if such income is considered PRC-sourced income by the relevant PRC authorities.

According to Notice of the State Administration of Taxation on Issuing the Interim Measures for the Administration of Source-based Withholding of Enterprise Income Tax on Non-resident Enterprise (No. 3 [2009] of the State Administration of Taxation), the source-based withholding shall apply to the incomes from return on equity investment such as dividends and bonuses, interest, rents, royalties, income from assignment of property and other incomes subject to the enterprise income tax derived from the PRC by non-resident enterprise, and the entities or individuals which are directly liable to make the relevant payments to the non-resident enterprises under the relevant legal or contractual provisions shall be the withholding agents; where the withholding agent failed to withhold or cannot perform the withholding obligations, the non-resident enterprise shall, within seven days after the payment or payment due for the dividends, file enterprise incoming tax to the competent tax authorities; where both parties to an equity transfer transaction which is conducted outside the PRC are non-resident enterprise, the non-resident enterprise which obtains the income shall fine file a tax return to the competent tax authority of the enterprise whose equity interests are transferred. The enterprise whose equity interests are transferred shall assist the tax authority in taxing the non-resident enterprise; where the non-enterprise again fails to pay tax within a certain time limit under a tax authority’s warning notice, the competent tax authority has the right to collect the enterprise incoming tax and charge late-payment surcharges from the non-enterprise’s income from other project(s) and its payable person in China, and send a Notice of Tax-related Matters, other income projects and it payable person is liable for the payable tax and overdue fine.

In such event, we may be required to withhold a 10% PRC tax on any dividends paid to non-resident investors. In addition, non-resident investors may be responsible for paying PRC tax at a rate of 10% on any gain realized from the sale or transfer of our shares if such non-resident investors and the gain satisfy the requirements under the EIT Law and its implementing rules, and we would not have an obligation to withhold income tax in respect of such gains.

If the PRC tax authorities determine that we are non-resident enterprises, dividends paid to us from our PRC Subsidiary will be subject to PRC withholding tax. The EIT Law and the implementing rules of the EIT Law provide that (A) an income tax rate of 25% will normally be applicable to non-resident enterprises which (i) have establishments or premises of business inside the PRC, and (ii) the income in connection with their establishment or premises of business is sourced from the PRC or the income is earned outside the PRC but has actual connection with their establishments or places of business inside the PRC, and (B) an income tax rate of 10% will be applicable to non-resident enterprises which (i) do not have an establishment or place of business in the PRC or (ii) have an establishment or place of business in the PRC, but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC.

On December 10, 2009, the SAT issued the Notice on Strengthening Administration of Enterprise Income Tax for Equity Transfers by Non-PRC Resident Enterprises, or SAT Circular 698 with retroactive effect from January 1, 2008. Under SAT Circular 698, if a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly by disposition of the equity interests of an overseas holding company, or Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5%, or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the PRC competent tax authority of the PRC resident enterprise this Indirect Transfer. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding, or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. SAT Circular 698 also provides that, where a non-PRC resident enterprise transfers its equity interests in a PRC resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction. On March 28, 2011, the SAT released SAT Public Notice 24 to clarify several issues related to Circular 698. SAT Public Notice 24 became effective on April 1, 2011. According to SAT Public Notice 24, the term “effective tax” refers to the effective tax on the gain derived from disposition of the equity interests of an overseas holding company; and the term “does not impose income tax” refers to the cases where the gain derived from disposition of the equity interests of an overseas holding company is not subject to income tax in the country/region where the overseas holding company is a resident. There is uncertainty as to the application of SAT Circular 698. If SAT Circular 698 was determined by the tax authorities to be applicable to us and our non-resident investors, we and our non-resident investors may be required to expend valuable resources to comply with this circular or to establish that we or our non-resident investors should not be taxed under SAT Circular 698, which may adversely affect us or our non-resident investors.

 
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Regulations of Overseas Investments and Listings
 
On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the CSRC, the SASAC, the SAT, the SAIC and the SAFE, jointly amended and released the M&A Rules, which became effective on September 8, 2006. The M&A Rules are applicable to (i) foreign investors acquire equity interests or subscribe the capital increase of a PRC non-foreign investment company, or (ii) foreign investors establish a foreign investment company to acquire and operate assets of a PRC non-foreign investment company, or acquire assets of a PRC non-foreign investment company to establish a foreign investment company for operating such assets. The M&A Rules requires that, if an overseas company established or controlled by PRC domestic companies or citizens intends to acquire equity interests or assets of any other PRC domestic company affiliated with the PRC domestic companies or citizens, such acquisition must be submitted to the MOFCOM, rather than local regulators, for approval. The M&A Rules further address that the special purpose vehicle, or “SPV” refers to an offshore company directly or indirectly controlled by a PRC individual or company for the purpose of taking the interests of its domestic company to list on an overseas stock market and further regulate that listing and trading of a SPV on an overseas stock market whose shareholders intend to acquire a PRC company in consideration of the SPV’s equity (“cross-border equity swap” ) shall be subject to the examination and approval of CSRC..
 
On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by SPVs. Other than documents required to be submitted, no other details with respect to the timing, criteria and process for obtaining any required approval from CSRC have been specified. Therefore, it remains unclear how the M&A Rules or the CSRC procedures will be interpreted, amended and implemented by the relevant authorities.
 
Environmental Regulations
 
On December 26, 1989, the Standing Committee of the National People’s Congress issued the Environment Protection Law, setting forth the legal framework for environment protection in the PRC. The Environmental Protection Law requires the State Administration of Environmental Protection to implement uniform supervision and administration of environmental protection standards nationwide and to establish national waste discharge standards. Local environmental protection bureaus are responsible for environmental protection in their jurisdictions and may set stricter local standards which are required to be registered at the State Administration of Environmental Protection. Companies are required to comply with the stricter of the two standards. Enterprises producing environmental contamination and other public hazards must incorporate the relevant environmental protection standards into their planning and establish environmental protection systems. These companies must also adopt effective measures to prevent environmental contamination and hazardous emissions, such as waste gas, waste water, deposits, dusts, pungent gases and radioactive matters as well as noise, vibration and magnetic radiation. Companies discharging contaminated wastes in excess of the discharge standards prescribed by the State Administration of Environmental Protection must pay non-standard discharge fees in accordance with national regulations and be responsible for the applicable remediation. Government authorities may impose different penalties against persons or companies in violation of the environmental protection laws and regulations depending on individual circumstances. Such penalties may include warnings, fines, imposition of deadlines for remediation, orders to cease certain operations, orders to reinstall contamination prevention and remediation facilities that have been removed or left unused, imposition of administrative actions against the responsible persons or orders to close down the company. Where the violation is deemed serious, responsible persons may be required to pay damages, and may be subject to criminal liability.

Regulations Relating to Employee Share Options
 
In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, setting forth the respective requirements for foreign exchange transactions by individuals (both PRC or non−PRC citizens) under either the current account or the capital account. In January 2007, the SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions, such as a PRC citizen’s participation in employee stock ownership plans or share option plans of an overseas publicly listed company. On March 28, 2007, the SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas Listed Company, or the Stock Option Rules. The purpose of the Stock Option Rules is to regulate the foreign exchange administration of PRC domestic individuals who participate in employee stock holding plans and share option plans of overseas listed companies.

According to the Stock Option Rules, if a PRC domestic individual participates in any employee stock ownership plan or share option plan of an overseas listed company, a PRC domestic qualified agent or the PRC subsidiary of such overseas listed company must, among other things, file, on behalf of such individual, an application with the SAFE or its local counterpart to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with stock holding or share option exercises as PRC domestic individuals may not directly use overseas funds to purchase shares or exercise share options. Concurrent with the filing of such application with the SAFE or its local counterpart, the PRC domestic qualified agent or the PRC subsidiary shall obtain approval from the SAFE or its local counterpart to open a special foreign exchange account at a PRC domestic bank to hold the funds required in connection with the stock purchase or option exercise, any returned principal or profits upon sales of shares, any dividends issued on the stock and any other income or expenditures approved by the SAFE or its local counterpart. The PRC domestic qualified agent or the PRC subsidiary is also required to obtain approval from the SAFE or its local counterpart to open an overseas special foreign exchange account at an overseas trust bank with custody qualifications to hold overseas funds used in connection with any shares purchase.

 
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Many issues with respect to the Stock Option Rules require further interpretation. We and our PRC citizen employees who have been granted share options, or PRC optionees, will be subject to these rules when our company becomes an overseas publicly-listed company. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions. However, as these rules have only been recently promulgated, it is currently unclear as to how these rules will be interpreted and implemented.

Regulation on Intellectual Property Rights

 Patent Law

The National People’s Congress adopted the Patent Law of the People’s Republic of China in 1984, and amended it in 1992, 2000 and 2008, respectively. A patentable invention, utility model or design must meet three conditions: novelty, inventiveness and practical applicability. Patents cannot be granted for scientific discoveries, rules and methods for intellectual activities, methods used to diagnose or treat diseases, animal and plant breeds or substances obtained by means of nuclear transformation. The Patent Office under the State Council is responsible for receiving, examining and approving patent applications. A patent is valid for a twenty-year term in the case of an invention and a ten-year term in the case of a utility model or design, starting from the application date. A third-party user must obtain consent or a proper license from the patent owner to use the patent except for certain specific circumstances provided by law. Otherwise, the use will constitute an infringement of the patent rights.

Trademark Law

Both the PRC Trademark Law, adopted in 1982 and revised in 1993 and 2001, and the Implementation Regulation of the PRC Trademark Law adopted by the State Council in 2002, give protection to the holders of registered trademarks. The Trademark Office, under the authority of the State Administration for Industry and Commerce, handles trademark registrations and grants rights for a term of ten years for registered trademarks, which may be renewed by the Trademark Office. The PRC Trademark Law has adopted a “first-to-file” principle with respect to trademark registration. Where a trademark for which a registration has been made is identical or similar to another trademark which has already been registered or been subject to a preliminary examination and approval for use on the same kind of or similar commodities or services, the application for registration of such trademark may be rejected. Any person applying for the registration of a trademark may not prejudice the existing right first obtained by others, nor may any person register in advance a trademark that has already been used by another party and has already gained a “sufficient degree of reputation” through such party’s use. Trademark license agreements must be filed with the Trademark Office or its regional offices.

Regulation on Employment

On June 29, 2007, the National People’s Congress promulgated the Labor Contract Law of PRC, or the Labor Law, which became effective as of January 1, 2008. On September 18, 2008, the PRC State Council issued the PRC Labor Contract Law Implementation Rules, which became effective as of the date of issuance.

Pursuant to the PRC Labor Contract Law and its implementation rules, employers must execute written labor contracts with full-time employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required to establish a system for labor safety and sanitation, strictly abide by state rules and standards and provide employees with workplace safety training. Violations of the PRC Labor Contract Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for serious violations.

In addition, employers in the PRC are obliged to provide employees with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds.

Approvals, Licenses and Certificates

We require a number of approvals, licenses and certificates in order to operate our business. Our principal approvals, licenses and certificates are set forth below.

Tianjin Shengkai

·  
Business License (No. 120191000015144) by Tianjin Administration for Industry and Commerce, valid from June 7, 1994 through May 17, 2024.

·  
Organization Code Certificate issued by Tianjin Quality Supervision and Inspection Bureau (code No. 23967678-2, and registration No. Zu Dai Guan 120191-045813), valid from August 24, 2010 through August 23, 2014. The company has passed the 2011 annual inspection.

 
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·  
Taxation Registration Certificate (Jin Shui Zheng Zi No. 120115239676782) issued by the Tianjin Economic-Technological Development Area Branch of the State Administration of Taxation on October 30, 2010.

·  
Customs Declaration Registration Certificate for Consignees or Consignors of Import & Export of the PRC Customs (the Certificate code No.1207268124) issued by Tianjin Customs District of the PRC respectively on Aug 27, 2009. The valid terms are respectively three years.

·  
Self-declaration Units Registration Certificate (the Certificate No. 1200604101) issued by Tianjin Entry-Exit Inspection and Quarantine Bureau on September 21, 2006.

·  
The American Petroleum Institute issued to Shengkai Certificates of Authority to use the Official API Monogram (No.6D-0460) on June 9, 2006. The expiration date is June 09, 2012.

·  
Quality Certificate (ISO9001:2000)(No.0170-2003-AQ-RGC-RvA) issued by Det Norske Veritas Certification B.V. on December 6, 2002. The expiration date is December 6, 2011.

·  
Tianjin Finance Bureau, Tianjin State Taxation Bureau, Tianjin Local Taxation Bureau and Tianjin Scientific Technology Committee issued the Certificates of High Technology Enterprise (No.2003-011 and No.0612007B5003) to Tianjin Shengkai on June 8, 2009. The valid terms are three years and the expiration date is June 8, 2012.

·  
Manufacturer License of Special Equipment (TS2712014-2012) issued by Tianjin Bureau of Quality and Technical Supervision on October 15, 2008, valid through October 14, 2012.

·  
Manufacturer License of Special Equipment (TS2710P74-2013) issued by Tianjin Bureau of Quality and Technical Supervision on February 14, 2011, valid through September 29, 2013.

·  
CE (No.DGR-0036-QS-516-06) issued by TUV SUD Industrie Service GmbH on November 14, 2006. The expiration date is November 13, 2012.

·  
Registration Form for Operators of Foreign Trading (the code No. 00498476, and import & export enterprise code No.1200239676782) issued by Tianjin Commission of Commerce on December 5, 2007.

SK WOFE

·  
Business License (No. 120000400054373) by Tianjin Administration for Industry and Commerce, valid from April 9, 2008 through April 8, 2028.

·  
Certificate of Approval for Establishment of Enterprises with Foreign Investment in the PRC (No. of Issuance: 1200032322), approved by Tianjin City People’s Government on March 24, 2008.

·  
Taxation Registration Certificate (Jin Shui Zheng Zi No. 12011667149649X) issued by the Tianjin Economic-Technological Development Area Branch of the State Administration of Taxation on April 28, 2010.

·  
Organization Code Certificate issued by Tianjin Quality Supervision and Inspection Bureau (code No. 67149649-X, and registration No. Zu Dai Guan 120192-021898), valid from April 23, 2010 through April 22, 2014. The company has passed the 2011 annual inspection.

·  
Customs Declaration Registration Certificate for Consignees or Consignors of Import & Export of the PRC Customs (the Certificate code No.1210949067) issued by Tianjin Customs District of the PRC, valid through August 15, 2012.

·  
Registration Form for Operators of Foreign Trading (the code No. 01019766, and import & export enterprise code No.120067149649X) issued by Tianjin Commission of Commerce on June 21, 2011.

Shengkai (Tianjin) Trading Ltd.
 
·  
Business License (No. 120192000064551) by Tianjin Administration for Industry and Commerce, valid from June 25, 2010 through June 24, 2100.

·  
Organization Code Certificate issued by Tianjin Quality Supervision and Inspection Bureau (code No. 55653836-7, and registration No. Zu Dai Guan 120192-023438), valid from September 15, 2010 through September 14, 2014. The company has passed the 2011 annual inspection.

 
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·  
Taxation Registration Certificate (Jin Shui Zheng Zi No. 120116556538367) issued by the Tianjin Economic-Technological Development Area Branch of the State Administration of Taxation on September 19, 2010.

·  
Customs Declaration Registration Certificate for Consignees or Consignors of Import & Export of the PRC Customs (the Certificate code No.1207461833) issued by Tianjin Customs District of the PRC, valid through March 10, 2014.

·  
Registration Form for Operators of Foreign Trading (the code No. 01007534, and import & export enterprise code No.1200556538367) issued by Tianjin Commission of Commerce on September 21, 2010.

 
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information contained in this report before deciding to invest in our common stock.

Risks Related to Our Business and Industry
 
Our new organizational structure makes it difficult for us to evaluate our future business prospects.
 
Prior to May 30, 2008, our business was operated through Tianjin Shengkai. Under the present structure, although there is no change in personnel, we have agreements with Tianjin Shengkai pursuant to which we manage and derive the profit from Tianjin Shengkai’s business by providing the exclusive supporting services from SK WFOE to Tianjin Shengkai. It is possible that the change in our business structure may impair our ability to operate our business.

The PRC government may determine that the VIE Agreements are not in compliance with applicable PRC laws, rules and regulations.

We manage and operate Tianjin Shengkai, one of our operating entities, through SK WFOE pursuant to the rights its holds under the contractual agreements (the “VIE” Agreements”). By reason of the VIE Agreements, Tianjin Shengkai is a variable interest entity (“VIE”).  Almost all economic benefits and risks arising from Tianjin Shengkai’ s operations are transferred to SK WFOE under these agreements.  Details of the VIE Agreements are set out in the “PRC Restructuring” section.

There are risks involved with the operation of our business in reliance on the VIE Agreements, including the risk that the VIE Agreements may be determined by PRC regulators or courts to be unenforceable. Our PRC counsel, Beijing Deheng Law Offices, has advised us that the VIE Agreements are binding and enforceable under the PRC law, but has further advised that if the VIE Agreements were for any reason determined to be in breach of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:

·  
imposing economic penalties;
·  
discontinuing or restricting the operations of SK WFOE or Tianjin Shengkai;
·  
imposing conditions or requirements with respect to the VIE Agreements with which SK WFOE or Tianjin Shengkai may not be able to comply;
·  
requiring our company to restructure the relevant ownership structure or operations;
·  
taking other regulatory or enforcement actions that could adversely affect our company’s business; and
·  
revoking the business licenses and/or the licenses or certificates of SK WFOE, and/or voiding the VIE Agreements.

Any of these actions could adversely affect our ability to manage, operate and gain the financial benefits of Tianjin Shengkai, which would have a material adverse impact on our business, financial condition and results of operations. If we are unable to restructure our relationship with Tianjin Shengkai in such circumstances, our operations in the valve industries will be materially affected.
 
Our ability to manage and operate Tianjin Shengkai under the VIE Agreements may not be as effective as direct ownership.
 
We conduct our business in the PRC and generate substantially all of our revenues through the VIE Agreements. We depend on Tianjin Shengkai to hold and maintain contracts with our customers.  Our plans for future growth are based substantially on growing the operations of Tianjin Shengkai. However, the VIE Agreements may not be as effective in providing us with control over Tianjin Shengkai as direct ownership.

We do not have any ownership interest in Tianjin Shengkai. Although we have been advised by Beijing Deheng Law Offices, our PRC legal counsel, that each contract under SK WFOE’s contractual arrangements with Tianjin Shengkai is valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing us with control over Tianjin Shengkai as direct ownership of Tianjin Shengkai would be. In addition, Tianjin Shengkai may breach the contractual arrangements. For example, Tianjin Shengkai may decide not to make contractual payments to SK WFOE, and consequently to our company, in accordance with the existing
 
 
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contractual arrangements. In the event of any such breach, we may have to (i) incur substantial costs and resources to enforce such arrangements, and (ii) rely on legal remedies under PRC law, which we cannot be sure would be always effective in light of uncertainties in the PRC legal system.

Therefore, if we are unable to effectively control Tianjin Shengkai, it may have an adverse effect on our ability to achieve our business objectives and grow our revenues.

As the VIE Agreements are governed by PRC law, we would be required to rely on PRC law to enforce our rights and remedies under them; PRC law may not provide us with the same rights and remedies as are available in contractual disputes governed by the law of other jurisdictions.

The VIE Agreements are governed by the PRC law and provide for the resolution of disputes through legal proceedings pursuant to PRC law. If Tianjin Shengkai or its shareholders fail to perform the obligations under the VIE Agreements, we would be required to resort to legal remedies available under the PRC law, including seeking specific performance or injunctive relief, or claiming damages. We cannot be sure that such remedies would provide us with effective means of causing to meet its obligations, or recovering any losses or damages as a result of non-performance. Further, the legal environment in China is not as developed as in other jurisdictions. Uncertainties in the application of various laws, rules, regulations or policies in the PRC legal system could limit our ability to enforce the VIE Agreements and protect our interests.

SK WFOE’s contractual arrangements with Tianjin Shengkai and the payment arrangement thereunder may be challenged by the PRC tax authorities and may result in adverse tax consequences to us.

We generate our revenues through the payments we receive pursuant to the VIE Agreements. We could face adverse tax consequences if the PRC tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations. For example, PRC tax authorities may adjust WFOE’s and/or Tianjin Shengkai’s income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. A transfer pricing adjustment could result in a reduction, for the PRC tax purposes, of adjustments recorded by Tianjin Shengkai, which could adversely affect us by increasing Tianjin Shengkai’s tax liability without reducing SK WFOE’s tax liability, which could further result in late payment fees and other penalties to Tianjin Shengkai for underpaid taxes.
 
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may materially adversely affect us.
  
In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Round-Trip Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75. The policy announced in this notice required PRC residents to register with the relevant SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in May 2007 (known as Notice 106), expanded the reach of Circular 75. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
 
We believe we comply with the applicable regulations. Currently, Wang Chen, Guo Wei, Zhao Yanqiu, Ji Haihong, Zhang Ying, Miao Yang, Wu Yanping and Liu Naifan are PRC residents who, in accordance with Circular 75 and Notice 106, have each completed registration with the Tianjin branch of SAFE for the foreign exchange of overseas investment. We cannot however assure you that, if challenged by government agencies, the structure of our organization has fully complied with all applicable registrations or approvals required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. A failure by such PRC resident beneficial holders or future PRC resident shareholders to comply with Circular 75 and Notice 106, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
 
Our principal shareholder has the power to control our business.
 
Our principal shareholder, Long Sunny Limited, owns approximately 52.29% of our common stock as of September 20, 2011. As a result, Long Sunny Limited essentially has the ability to elect all of our directors and to approve any action requiring shareholder action, without the vote of any other shareholders.
 
 
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Because we may require additional financing to expand our operations, our failure to obtain necessary financing may impair our operations.

At June 30, 2011, we had working capital of approximately $70,016,487. Our capital requirements in connection with the development of our business are significant. During the fiscal year ended June 30, 2011, we spent approximately $43,974,587 for the purchase of raw materials and supplies and equipment and other fixed assets, of which $33,736,806 was used to purchase raw materials and supplies and $10,237,781 was used to purchase equipment and other fixed assets.
 
We cannot assure you that we will be able to get additional financing on any terms, and, if we are able to raise funds, it may be necessary for us to sell our securities at a price which is at a significant discount from the market price and on other terms which may be disadvantageous to us. In connection with any such financing, we may be required to provide registration rights to the investors and pay damages to the investor in the event that the registration statement is not filed or declared effective by specified dates. The price and terms of any financing which would be available to us could result in both the issuance of a significant number of shares and significant downward pressure on our stock price.

Because our products are marketed both in the domestic and international markets, we are subject to both domestic and international competition.
 
The Company faces two types of competitors: (i) manufacturers of metal valves, which currently still represent the majority market share in the entire valve market, competing with ceramic valves with its lower price; and (ii) Chinese and international companies that are better known and have greater financial resources than we have. Many of the international companies, in particular, have longer operating histories and have more established relationships with customers and end users. Some of our international competitors also may have a greater ability to attract and retain users than we do because they are engaged in major markets of general industrial products and cutting edge technology fields. If our competitors are successful in providing similar or better valve products or make their services easier to access, we could experience a decline in demand for our products.
 
An increase in the cost of raw materials will affect sales and revenues.
 
Raw materials required for valve production includes metal materials and ceramic materials like aluminum oxide and zinc oxide; a large number of spare parts in various specifications are also purchased during production. Any increase in the prices of these raw materials will affect the price at which we can sell our product. If we are not able to raise our prices to pass on increased costs, we would be unable to maintain our margins.
 
If we fail to effectively manage our growth when our business and operations experience rapid growth, our business and operating results could be harmed.
 
We had experienced rapid growth in our operations, which had placed significant demands on our management, operational and financial infrastructure. If in future our operations resume rapid growth and we do not effectively manage our growth, the quality of our products and services could suffer, which could negatively affect our operating results. To effectively manage this growth, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. These systems enhancements and improvements may require significant capital expenditures and management resources. Failure to implement these improvements could hurt our ability to manage our growth and our financial position.

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.
 
Our patents, trademarks, trade secrets, copyrights and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights as well as to our products and services. For example, effective intellectual property protection may not be available in China and other countries in which our products are sold. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results.
 
 Because we depend on third parties to market our products in the international market, any problems encountered by these third parties could affect our sales.
 
Although the market for valve products is international, most of our products are sold to companies in the PRC. We do not have any offices outside of the PRC, and we depend on other companies to market our products in the international market. As a result, we are dependent upon third parties, over which we have no control, to develop and implement an international marketing effort. Any problems encountered by these third parties, including potential violations of laws of the PRC or other countries, may affect their ability to sell our products which would, in turn, affect our net sales.
 
 
31

 
We rely on highly skilled personnel and the continuing efforts of our executive officers and, if we are unable to retain or motivate key personnel or hire qualified personnel, our business may be severely disrupted if we lose their services.
 
Our performance largely depends on the talents and efforts of highly skilled individuals and in particular, the technology and expertise held by our Chief Executive Officer, Wang Chen. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract new technology developers and to retain and motivate our existing contractors.

We do not maintain key man life insurance on any of our executive officers. If one or more of our executive officers are unable or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives joins a competitor or forms a competing company, we may lose some of our customers. Our chief executive officer is a party to contractual agreements as described elsewhere in this registration statement. However, if any disputes arise between our executive officer and us, we cannot assure you, in light of uncertainties associated with the PRC legal system, the extent to which any of these agreements could be enforced in China, where some of our executive officers reside and hold some of their assets.

Because we have inadequate insurance coverage in the PRC, we may not be protected from risks that are customarily covered by insurance in the United States.
 
We do not presently maintain product liability insurance, and our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties or claims filed against us.

We currently do not carry any product liability or other similar insurance. We cannot assure you that we would not face liability in the event of the failure of any of our products. This is particularly true given our plan to significantly expand our sales into international markets, like the United States, where product liability claims are more prevalent.

Except for automobile insurance, we do not have other insurance such as business liability or disruption insurance coverage for our operations in the PRC. We do not maintain a reserve fund for warranty or defective products claims. Our costs could substantially increase if we experience a significant number of warranty claims. We have not established any reserve funds for potential warranty claims since historically we have experienced few warranty claims for our products so that the costs associated with our warranty claims have been low. If we experience an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, it would have a material adverse effect on our financial condition and results of operations.

Certain key technology for our business is uninsured and inaccessible in the absence of key individuals.

The “recipe” to our unique method for creating structural ceramic valves is held by Wang Chen, our CEO, and his mother, Guo Chuanye. This technology is recorded but is uninsured and inaccessible by anyone but Mr. Wang, Guo Chuanye, and our director, Guo Wei. If either of these three key individuals were to lose the ability to recall this technology, either through death or incapacity, we would lose key technology that could have a material adverse effect on our financial condition and results of operations.

Our Chief Executive Officer controls us through his position and stock ownership and his interests may differ from other shareholders.

Since the exercise on August 5, 2009 of a call option agreement entered into on June 9, 2008 by and between Wang Chen and Li Shaoqing, our Chief Executive Officer, Mr. Wang, beneficially owns 52.29% of our common stock through his 100% holding in Long Sunny Limited. As a result, Mr. Wang will be able to influence the outcome of shareholder votes on various matters, including the election of directors and extraordinary corporate transactions such as business combinations. Mr. Wang’s interests may differ from that of other shareholders.
 

Additionally, Mr. Wang and our pending director, Guo Wei, are husband and wife and as such their interests may not be independent from one another.

Our operations may be adversely affected by the unilateral decisionmaking structure of Tianjin Shengkai, the entity through which substantially all of our business is conducted.

Mr. Wang Chen currently serves as executive director of Tianjin Shengkai. Tianjin Shengkai’s Articles of Association provides for its governance by an executive director, instead of a board of directors, to be appointed by Tianjin Shengkai’s shareholders. The PRC Company Act permits PRC companies with a smaller number of shareholders or registered capital to be governed by a sole executive director. Pursuant to Tianjin Shengkai’s Articles of Association, the executive director’s actions are overseen by a supervisor, Guo Chuanji, who holds no interest in the company. Notwithstanding such supervision, the governance of Tianjin Shengkai by a single executive director could result in inadequately vetted business decisions that could negatively affect the performance of our operations.

 
32

 
We rely on energy and transportation services or others in providing products and services to our users, and any failure or interruption in the services and products provided by these third parties could harm our ability to operate our business and damage our reputation.
 
Our systems are heavily reliant on the availability of electricity. If we were to experience a major power outage, we would have to rely on back-up generators. These back-up generators may not operate properly and their fuel supply could be inadequate during a major power outage. This could result in a disruption of our business.
 
If we fail to obtain all required licenses, permits, or approval, we may be unable to expand our operations.
 
Before we can develop certain products, we must obtain a variety of approvals from local and municipal governments. There no assurance that we will be able to obtain all required licenses, permits, or approvals from government authorities. If we fail to obtain all required licenses, permits or approvals, we may be unable to expand our operations.
 
If we make any acquisitions, they may disrupt or have a negative impact on our business.
 
Although we have no present plans for any acquisitions, in the event that we make acquisitions, we could have difficulty integrating the acquired companies’ personnel and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot predict the affect expansion may have on our core business. Regardless of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks described above, acquisitions are accompanied by a number of inherent risks, including, without limitation, the following:
 
·  
the difficulty of integrating acquired products, services or operations;
·  
the potential disruption of the ongoing businesses and distraction of our management and the management of acquired companies;
·  
the difficulty of incorporating acquired rights or products into our existing business;
·  
difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses in maintaining such facilities;
·  
difficulties in maintaining uniform standards, controls, procedures and policies;
·  
the potential impairment of relationships with employees and customers as a result of any integration of new management personnel;
·  
the potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing of the products to new and existing customers;
·  
the effect of any government regulations which relate to the business acquired;
·  
potential unknown liabilities associated with acquired businesses or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior to our acquisition.

Our business could be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations.

Because the holders of our warrants have cashless exercise rights, we may not receive proceeds from the exercise of the outstanding warrants if the underlying shares are not registered.
 
The holders of our warrants have cashless exercise rights, which provide them with the ability to receive common stock with a value equal to the appreciation in the stock price over the exercise price of the warrants being exercised. This right is not exercisable prior to December 10, 2009 (in the case of warrants issued in connection with our June 2008 financing) or January 18, 2010 (in the case of warrants issued in connection with our July 2008 financing). Thereafter the right is only exercisable if the underlying shares are not subject to an effective registration statement. To the extent that the holders exercise the cashless exercise rights, we will not receive any proceeds on exercise of warrants.
 
Risks Related to Doing Business in China

 Adverse changes in political and economic policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position. 
 
Our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including
 
·  
the amount of government involvement;
 
 
33

 
·  
the level of development;
·  
the growth rate;
·  
the control of foreign exchange; and
·  
the allocation of resources.
 
While the Chinese economy has grown significantly in the past 20 years, the growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to regulate its economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
 
The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business. The PRC government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the PRC government to slow the pace of growth of the Chinese economy could result in decreased capital expenditure by solar energy users, which in turn could reduce demand for our products.
 
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of renewable energy investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses.
 
 Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.
 
The change in value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of Renminbi against U.S. dollar, which is continuing. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. As a portion of our costs and expenses is denominated in Renminbi, the revaluation in July 2005 and potential future revaluation has and could further increase our costs. In addition, as we rely entirely on dividends paid to us by our operating subsidiaries, any significant revaluation of the Renminbi may have a material adverse effect on our revenues and financial condition, and the value of, and any of our dividends payable on our ordinary shares in foreign currency terms. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.
 
Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
 
All of our revenues and most of our expenses are denominated in Renminbi. If our revenues denominated in Renminbi increase or expenses denominated in Renminbi decrease in the future, we may need to convert a portion of our revenues into other currencies to meet our foreign currency obligations, including, among others, payment of dividends declared, if any, in respect of our ordinary shares. Under China’s existing foreign exchange regulations, we are able to pay dividends in foreign currencies, without prior approval from the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, we cannot assure you that that the Chinese government will not take further measures in the future to restrict access to foreign currencies for current account transactions.

Capital outflow policies in the PRC may hamper our ability to remit income to the United States.
 
The People’s Republic of China has adopted currency and capital transfer regulations. These regulations may require that we comply with complex regulations for the movement of capital and as a result we may not be able to remit all income earned and proceeds received in connection with our operations or from the sale of our operating subsidiary to the U.S. or to our shareholders.


Our operations and assets in the PRC are subject to significant political and economic uncertainties.
 
Government policies are subject to rapid change and the PRC government may adopt policies which have the effect of hindering private economic activity and greater economic decentralization. There is no assurance that the PRC government will not significantly alter its
 
 
34

 
policies from time to time without notice in a manner which reduces or eliminates any benefits from its present policies of economic reform. In addition, a substantial portion of productive assets in China remains government-owned. For instance, all lands are state owned and leased to business entities or individuals through governmental granting of state-owned land use rights. The granting process is typically based on government policies at the time of granting, which could be lengthy and complex. This process may adversely affect our business. The PRC government also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency and providing preferential treatment to particular industries or companies. Uncertainties may arise with changing of governmental policies and measures. In addition, changes in laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency, the nationalization or other expropriation of private enterprises, as well as adverse changes in the political, economic or social conditions in China, could have a material adverse effect on our business, results of operations and financial condition.
 
A downturn in the economy of China may slow our growth and profitability.
 
The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any downturn will not have a negative effect on our business.  
 
Because PRC law governs almost all of our material agreements, we may not be able to enforce our legal rights within China or elsewhere, which could result in a significant loss of business, business opportunities, or capital.  
 
PRC law governs almost all of our material agreements. We cannot assure you that we will be able to enforce any of our material agreements or that remedies will be available outside of China. The system of laws and the enforcement of existing laws in China may not be as certain in implementation and interpretation as in the United States. The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital.
 
It will be extremely difficult to acquire jurisdiction and enforce liabilities against our officers, directors and assets based in China.  
 
Substantially all of our assets will be located in the PRC and our officers and our present directors reside outside of the United States.  As a result, it may not be possible for United States investors to enforce their legal rights, to effect service of process upon our directors or officers or to enforce judgments of United States courts predicated upon civil liabilities and criminal penalties of our directors and officers under Federal securities laws. Moreover, we have been advised that China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States. Further, it is unclear if extradition treaties now in effect between the United States and China would permit effective enforcement of criminal penalties of the Federal securities laws.  
 
We may have difficulty establishing adequate management, legal and financial controls in China, which could impair our planning processes and make it difficult to provide accurate reports of our operating results.   
 
China historically has not followed Western style management and financial reporting concepts and practices, and its access to modern banking, computer and other control systems has been limited.  Although we will be required to implement internal controls, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in China in these areas. As a result of these factors, we may experience difficulty in establishing the required controls and instituting business practices that meet Western standards, making it difficult for management to forecast its needs and to present the results of our operations accurately at all times. If we are unable to establish the required controls, market makers may be reluctant to make a market in our stock and investors may be reluctant to purchase our stock, which would make it difficult for you to sell any shares of common stock that you may own or acquire.
 
Because our funds are held in banks which do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.
 
Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. As a result, in the event of a bank failure, we may not have access to funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
 
Imposition of trade barriers and taxes may reduce our ability to do business internationally, and the resulting loss of revenue could harm our profitability.    
 
We may experience barriers to conducting business and trade in our targeted emerging markets in the form of delayed customs clearances, customs duties and tariffs. In addition, we may be subject to repatriation taxes levied upon the exchange of income from local currency into foreign currency, substantial taxes of profits, revenues, assets and payroll, as well as value-added tax. The markets in which we plan to operate may impose onerous and unpredictable duties, tariffs and taxes on our business and products, and there can be no assurance that this will not reduce the level of sales that we achieve in such markets, which would reduce our revenues and profits.

 
35

 

Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
 
We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC. We can make no assurance, however, that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
 
Risks Related to Ownership of our Common Stock
 
The trading price for our common stock has been and may continue to be volatile.
 
The market price of our common stock has experienced fluctuations and may continue to fluctuate significantly. The market price of our common shares may be adversely affected by various factors, including enforcement of existing laws, innovation and technological changes, the emergence of new competitors, the perception of desirability of investing in Chinese companies, quarterly variations in revenue and results of operations, speculation in the press or analyst community and general market conditions or market conditions specific to particular industries.

The rights of the holders of common stock may be impaired by the potential issuance of preferred stock.
 
We have been required to amend our articles of incorporation to provide for a class of preferred stock. As a result, the board of directors may, without shareholder approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights that could adversely affect the voting power and equity interest of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention to issue any additional shares of preferred stock or to create any new series of preferred stock and the certificate of designation relating to the Series A Preferred Stock restricts our ability to issue additional series of preferred stock, we may issue such shares in the future. Without the consent of the holders of 75% of the outstanding Series A Preferred Stock, we may not alter or change adversely the rights of the holders of the Series A Preferred Stock or increase the number of authorized shares of Series A Preferred Stock, create a class of stock which is senior to or on a parity with the Series A Preferred Stock, amend our articles of incorporation in breach of these provisions or agree to any of the foregoing.
 
The issuance of shares through our stock compensation plans may dilute the value of existing shareholders and may affect the market price of our stock.
 
We have used, and in the future we may further use stock options, stock grants and other equity-based incentives, either pursuant to the 2010 and 2011 Incentive Stock Plans or outside of the 2010 and 2011 Incentive Stock Plans, to provide motivation and compensation to our officers, employees and key independent consultants. The award of any such incentives will result in an immediate and potentially substantial dilution to our existing shareholders and could result in a decline in the value of our stock price. The exercise of these options and the sale of the underlying shares of common stock and the sale of stock issued pursuant to stock grants may have an adverse effect upon the price of our stock.

We will continue to incur significant costs as a result of operating as a public company, and management will be required to devote substantial time to new compliance requirements.  If we fail to comply in a timely manner, our business could be harmed and our stock price could decline.

As a public company, we incur significant legal, accounting and other expenses under the Sarbanes-Oxley Act of 2002, together with rules implemented by the SEC and applicable market regulators. These rules impose various requirements on public companies, including requiring certain corporate governance practices. Management and other personnel will need to devote a substantial amount of time to these new compliance requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of U.S. public companies’ internal control over financial reporting, and attestation of this assessment by their independent registered public accountants. While the Dodd-Frank Wall Street Reform and Consumer Protection Act exempts smaller reporting companies with respect to the attestation by their independent registered public accountants as to our financial controls, this exception does not affect the requirement that we include a report of management on our internal controls over financial reporting and will not affect the requirement to include the auditor's attestation if our public float exceeds $75 million and we cease to be smaller reporting company. Existing standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. As of June 30, 2011, management has concluded that our controls and procedures were
 
 
36

 
effective.  However, we cannot guarantee the implementation of controls and procedures in future years to be without any significant deficiency or material weakness.

The issuance and sale of the common stock issuable upon conversion of the Series A Preferred Stock and exercise of warrants could result in a change of control.
 
If we issue all of the shares of common stock issuable upon conversion of the Series A Preferred Stock and exercise of warrants, the 12,765,997 shares of common stock so issuable would constitute approximately 27.7% of our then outstanding common stock. The percentage would increase to the extent that we are required to issue any additional shares of common stock become upon conversion of the Series A Preferred Stock pursuant to the anti-dilution and adjustment provisions and pursuant to the liquidated damages provisions of the registration rights agreements executed in connection with the Series A Preferred Stock. Any sale of all or a significant percentage of those shares to a person or group could result in a change of control.

We have not and do not anticipate paying any dividends on our common stock.
 
                We have paid no dividends on our common stock to date and it is not anticipated that any dividends will be paid to holders of our common stock in the foreseeable future. While our future dividend policy will be based on the operating results and capital needs of the business, it is currently anticipated that any earnings will be retained to finance our future expansion and for the implementation of our business plan. As an investor, you should take note of the fact that a lack of a dividend can further affect the market value of our stock, and could significantly affect the value of any investment in our Company.

 
Not Applicable.
 
 
           Our main office and our manufacturing facilities are located in Tianjin, China, on a plot of land of approximately 43,566.3 square meters in size. We have been issued a Land Use Right Certificate for the land until January 23, 2059 by the municipal government of Tianjin, which may be renewed. The construction of our new manufacturing facility and office building on this land has been substantially completed and we are in the process of applying for the title certificate from the local government. We currently own five buildings and lease one premise as listed below. We believe that our existing facilities are well maintained and in good operating condition.

Our land use rights are set forth below:

Land Use Rights through Grants from Land Management Authority

    Plot A  
Plot B
 
 
Land No.
No. 01-17-(3)-8
No. 1201104020180020001
 
 
Land Use Right Certificate No.
Jin Nan Dan Guo Yong (2001) Geng 2 Zi No.045
Bao Dan Guo Yong (2009) No. 022
 
 
User of the Land
Tianjin Shengkai
SK WFOE
 
 
Location
Wang Gang Road, Shuangang, Jinnan Economic & Technology Development Area, Tianjin
No. 106 Zhonghuan South Road, Economic Zone, Airport Industrial Park, Tianjin
 
 
Usage
Commercial Services
Commercial Services
 
 
Area ( m2 )
10,023.0
43,566.3
 
 
Form of Acquisition
Grant from related Land Management Authority
Grant from related Land Management Authority
 
 
Expiration Date
September 21, 2048
January 23, 2059
 
 
Encumbrances
None
None
 


We currently own the following buildings, as set forth below:

 
37

 
Owned Premises

 
Part 1
 
Part 2
 
Part 3
 
Part 4
 
Part 5
 
Certificate No.
No. 11230902147
 
Owner
Shengkai
 
Location
Wang Gang Road, Shuangang, Jinnan Economic& Technology Development Area, Tianjin
 
Category
Private
 
Area ()
931.06
 
1192.90
 
493.64
 
824.74
 
2691.41
 
Usage of Design
Industry
 
Industry
 
Industry
 
Industry
 
Industry
 
Structure
Mixture
 
Mixture
 
Mixture
 
Mixture
 
Mixture
 
Encumbrances
None
 

We currently lease the following premise.

Leased Premises

No.
 
Lessor
 
Location
 
Term
 
Rent per Year
(USD)
 
1
 
Tianjin Development Zone Binhai Investment Service Co., Ltd.
 
Room 325, Part I, 122 Dongting Road, Tianjin Development Zone
 
August 17, 2011 to August 16, 2012
   
$    617.78
 
 
 
 We know of no material, active, pending or threatened proceeding against us or our subsidiaries, nor are we, or any subsidiary, involved as a plaintiff or defendant in any material proceeding or pending litigation.
 
 
  
 
 
Market Information
 
The Company’s common stock has been quoted on NASDAQ Stock Market LLC under the symbol “VALV” since May 25, 2010.  Its common stock previously traded on the NYSE Amex under the symbol “SHE” between December 23, 2009 and May 24, 2010, and was quoted on the Over-the-Counter Bulletin Board (“OTCBB”) under the symbol “SKII”, “SOSA,” and “SSAU” prior to December 23, 2009.
 
The range of high and low prices for the quarters of the last two years ended June 30, 2011 is listed below. The prices are taken from the OTCBB and NASDAQ. The high and low bid prices when the Company was quoted on the OTCBB reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
 
 
Fiscal Quarter
 
Low Price
 
High Price
 
2010 First Quarter  
   
4.00
   
2.85
 
2010 Second Quarter
   
5.70
   
3.60
 
2010 Third Quarter
   
10.56
   
5.27
 
2010 Fourth Quarter
   
9.00
   
7.27
 
2011 First Quarter  
   
8.50
   
5.90
 
2011 Second Quarter
   
7.60
   
5.50
 
2011 Third Quarter
   
6.09
   
3.38
 
2011 Fourth Quarter
   
3.91
   
1.28
 

As of September 20, 2011, we had approximately 2,200 shareholders of record of our common stock, including the shares held in street name by brokerage firms. The holders of common stock are entitled to one vote for each share held of record on all matters submitted to a vote of shareholders. Holders of the common stock have no preemptive rights and no right to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock.

 
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Dividends

We have not paid dividends on our common stock and do not anticipate paying such dividends in the foreseeable future. We will rely on dividends from SK WFOE for our funds and PRC regulations may limit the amount of funds distributed to us from SK WFOE, which will affect our ability to declare any dividends.

Securities Authorized for Issuance under Equity Compensation Plans
 
The following table gives information about the Company’s common stock that may be issued upon the exercise of options granted to employees, directors and consultants under its 2010 and 2011 Incentive Stock Plans as of June 30, 2011. On February 8, 2010, the Company’s board of directors and a majority of the Company’s holders of common stock approved establishment of the 2010 Incentive Stock Plan.  On March 4, 2011, the Company’s board of directors and a majority of the Company’s holders of common stock approved establishment of the 2011 Incentive Stock Plan.
 
Equity Compensation Plan Information
   
Plan category
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
     
Weighted-average
exercise price of
outstanding options,
warrants and rights
 
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a)
   
                   
 
(a)
     
(b)
 
(c)
   
Equity compensation plans approved by security holders
2,211,250
(1   
$
7.29
 
661
 (2 
                     
Equity compensation plans not approved by security holders
                   
                     
Total
2,211,250
     
$
7.29
 
661
   

(1) This number only includes shares to be issued upon exercise of outstanding options under the 2010 Incentive Stock Plan and does not include the 2,670,000 shares of common stock awarded to the Company's employees under the 2011 Incentive Stock Plan.

(2) Up to 2,670,661 shares of common stock are authorized to be issued under the 2011 Incentive Stock Plan. As of June 30, 2011, 661 shares of common stock remain available for future issuance under this plan.


Recent Sales of Unregistered Securities
 
None. 


The following selected statement of operations data contains statement of operations data and balance sheet data of the Company for the fiscal years ended June 30, 2011, 2010 and 2009. The statement of operations data and balance sheet data were derived from the audited financial statements. Such financial data should be read in conjunction with the financial statements and the notes to the financial statements starting on page F-1 and with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.
 
Statements of Operation Data
 
      Twelve months ended June 30,
      2011        2010        2009   
Net revenues
  $ 93,451,373     $ 54,148,954     $ 39,297,235  
Cost of sales
    (40,327,502 )     (21,916,944 )     (15,267,244 )
                         
Gross profit
  $ 53,123,871     $ 32,232,010     $ 24,029,991  
Other miscellaneous income
  $ -     $ -     $ 112,758  
Operating expenses:
                       
Selling
    (8,340,307 )     (5,093,859 )     (3,760,970 )
General and administrative
  (15,197,301 )     (22,502,796 )     (2,474,872 )

 
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Operating income
  $ 29,586,263     $ 4,635,355     $ 17,906,907  
Other income, net
    318,701       205,498       -  
Interest income, net
    259,871       387,675       193,149  
Changes in fair value of instruments – gain/(loss)
    69,692,778       (56,910,599 )     -  
 
         
 
         
Income (loss) before income taxes
  $ 99,857,613     $ (51,682,071 )   $ 18,100,056  
Income taxes
    (6,386,854 )     (4,703,494 )     (4,522,362 )
 
         
 
         
Net income (loss)
  $ 93,470,759     $ (56,385,565 )   $ 13,577,694  
 
Balance Sheet Data

   
As at June 30,
 
   
2011
   
2010
   
2009
 
Cash and cash equivalents
 
$
59,870,108
   
$
20,995,182
   
$
38,988,958
 
Working capital
   
70,016,487
     
23,613,693
     
40,990,996
 
Total assets
   
141,452,732
     
84,605,949
     
60,253,034
 
Total liabilities
   
15,561,410
     
86,887,128
     
4,746,447
 
Total shareholders’ equity
   
125,891,322
     
(2,281,179
   
55,506,587
 
 
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of the financial condition and results of operation of the Company for the fiscal years ended June 30, 2011 and 2010 should be read in conjunction with the selected financial data, the financial statements and the notes to those statements that are included elsewhere in this registration statement. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Cautionary Notice Regarding Forward-Looking Statements and Business sections in this registration statement. We use terms such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements.

General

SK WFOE and Tianjin Shengkai, the entities through which we run our operations, are prominent ceramic valve manufacturers. We have more than 17 years of experience and possess a unique method for creating ceramic valves.

We believe that the Company is one of the few ceramic valve manufacturers in the world with research and development, engineering, and production capacity for structural ceramics and is able to produce large-sized ceramic valves with calibers of 6" (150mm) or more. The Company's product portfolio includes a broad range of valves that are sold throughout the PRC, to Europe, North America, Middle East and other countries in the Asia-Pacific region. The Company has over 200 customers, and is the only ceramic valve supplier qualified to supply SINOPEC. The Company joined the supply network of China National Petroleum Corporation (“CNPC”) in 2006 and subsequently received a CNPC Certificate of Material Supplier for valve products in 2011.
 
Results of Operations
 
Comparison of the Years Ended June 30, 2011 and 2010
 
Revenue

Revenue for the fiscal year ended June 30, 2011 was $93,451,373, an increase of $39,302,419 or 72.6% from $54,148,954 for the fiscal year ended June 30, 2010. The increase was primarily attributable to our continuous marketing efforts, increased customer demand and expanded production capacity during the fiscal year ended June 30, 2011. The expansion in production capacity was due to the increase in our equipment and more operation shifts at the old facility and commencement of operations at our new manufacturing facility in mid-September 2010, offset by disruptions caused by the relocation of our production facility from the old plant to the new plant in September 2010. The new facility increased our total production capacity to 24,000 sets of ceramic valves per year based on a one-shift operation schedule. During the second half of the fiscal year ended June 30, 2011, we added additional shifts to increase our capacity output. Total ceramic valves output for the fiscal year ended June 30, 2011 reached 23,298 sets, compared with only 14,376 sets for the fiscal year ended June 30, 2010.
 
 
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Ceramic valve is a relatively new technology with a very low market penetration rate compared with traditional metal valves which are currently prevalent in market. Demand for the Company’s ceramic valves had been growing because of the durability and reasonable pricing of our products. Approximately 91.1% of our source of revenue came from customers in the electric power, petrochemical and chemical industries for the fiscal year ended June 30, 2011, compared with 94.5% for the fiscal year ended June 30, 2010. The electric power industry still contributes significantly to our revenue, accounting for approximately 61.7% of total revenue for the fiscal year ended June 30, 2011, compared with 65.2% for the fiscal year ended June 30, 2010.

Revenue from the electric power industry was $57,670,510 for the fiscal year ended June 30, 2011, an increase of approximately $22,378,980 or 63.4% from $35,291,530 for the fiscal year ended June 30, 2010. The increase was primarily attributable to the broadening of our customer base and repeated orders from existing customers. Approximately 20% of revenue from the electric power industry for the 2011 fiscal year was generated from 28 new customer accounts.
 
Revenue from the petrochemical and chemical industry, our biggest potential market, accounted for approximately 29.4% of total revenue for the fiscal year ended June 30, 2011, compared with 29.3% for the fiscal year ended June 30, 2010. The revenue from the petrochemical and chemical industry was $27,505,265 for the fiscal year ended June 30, 2011, an increase of $11,618,727 or 73.1% from $15,886,538 for the fiscal year ended June 30, 2010. The increase was primarily due to our continuous efforts to market our products to the petrochemical and chemical industry. We focused more marketing efforts on the petrochemical and chemical industries because most of their production and supply processes involve highly corrosive and abrasive media or other severe conditions, and therefore we believe that our ceramic valves are a good fit for these sectors because of their superior durability. Approximately 25% of revenue from the petrochemical and chemical industry for the year was generated from twenty new customer accounts.
 
Revenue from other industries, including the aluminum and metallurgy industries, accounted for approximately 8.9% of total revenue for the fiscal year ended June 30, 2011, compared with 5.5% for the fiscal year ended June 30, 2010. The revenue for other industries was $8,275,598 for the fiscal year ended June 30, 2011, an increase of $5,304,712 or 178.6% from approximately $2,970,886 for the fiscal year ended June 30, 2010. The rapid growth in revenue from the other industries was primarily due to the mandatory application of dry dedust technique, as mandated in the Environmental Protection Guide for Developing Circular Economy in Iron and Steel promulgated by the Ministry of Environment Protection of PRC in March 2009 to replace the traditional wet technique, used in blast furnace gas cleaning in the iron and steel industry. Iron and steel mills introduced new blast furnace gas cleaning systems, which create a highly abrasive working environment for the valves. Accordingly, there was a greater need to replace their old valves with more durable ones. Approximately 37% of revenue from the other industries for the year was generated from eleven new customer accounts.

In recent months, because of the heightened suspicions on the integrity of PRC companies, enquiries into the Company’s business and domestic customers mounted by certain shareholders and interested parties without the Company’s approval or endorsement have resulted in severely damaged relations with some of the Company’s important domestic customers. This has resulted in considerable loss of business since June 2011, and a higher turnover in the Company’s sales agents and representatives. Some of the Company’s other customers have seized this opportunity to demand price cuts from the Company. Meanwhile, some of the Company’s competitors also have seized this opportunity to take away its customers. In response to this situation, management of the Company has decided to phase out its less profitable domestic market segments including the electric power market and focus on expanding its presence in the more profitable domestic and foreign oil and chemical industries where ceramic valve products typically command higher prices than the domestic PRC market.

In the immediate future, we expect revenues for the quarter ended September 30, 2011 to fall by as much as 60% compared with the quarter ended June 30, 2011.

Gross Profit

Gross profit for the fiscal year ended June 30, 2011 was $53,123,871, an increase of $20,891,861 or 64.8% compared to $32,232,010 for the fiscal year ended June 30, 2010. The increase was primarily attributable to the revenue increase. The gross profit margin for the fiscal year ended June 30, 2011 was 56.8%, compared to 59.5% for the fiscal year ended June 30, 2010. Included in total sales for the fiscal 2011 were approximately $3.2 million in sales of ceramic valve components and some metal valves , which had a gross margin closer to the industry norm in PRC and much lower than our higher value-added ceramic valve products, dragging down the average gross margin in the year. These orders for valve components and metal valves were made together with orders for ceramic valves as a package deal from a few customers. Such a large quantity of valve component and metal valves sales is not expected to recur on a regular basis in future. The decrease in gross margin between the two comparison periods was also attributed to increase in depreciation expenses and material costs. For the fiscal year ended June 30, 2011, new fixed assets of approximately $49.3 million was added to plant and equipment. The corresponding new depreciation expenses recorded in cost of goods sold was approximately $1.2 million for the year. In the fourth quarter of fiscal 2011, prices for steel raw materials and steel die-casting components had increased by approximately 13% compared with previous quarters.

Due to the anticipated drop in sales revenue as discussed above, we estimate that our gross margin for the quarter ended September 30, 2011 would continue to drop to around 45% because of the fixed nature of depreciation and other expenses and loss of bulk discount in procurement.

 
41

 
Selling Expenses

Selling expenses for the fiscal year ended June 30, 2011 was $8,340,307, an increase of $3,246,448 or 63.7%, from $5,093,859 for the fiscal year ended June 30, 2010. The major component of selling expenses was commissions paid to agents for introducing new sales, which were approximately $7.5 million for the fiscal year ended June 30, 2011, an increase of approximately $3.1 million or 72.7% from approximately $4.4 million for the fiscal year ended June 30, 2010. Selling expenses as a percentage of total sales revenue decreased to 8.9% for the fiscal year ended June 30, 2011 from 9.4% for the fiscal year ended June 30, 2010, primarily attributable to the revenue increase and that most of other selling expenses are relatively fixed in nature. Since commission, the major component of selling expenses, is a fixed percentage of revenue, we expect selling expenses for the future quarters would basically decrease proportionately with the downturn in business.

General and Administrative Expenses

General and administrative (“G&A”) expenses for the fiscal year ended June 30, 2011 were $15,197,301, a decrease of $7,305,495 or 32.5% compared to $22,502,796 for the fiscal year ended June 30, 2010. The decrease was primarily attributable to the inclusion of a non-cash stock compensation expense of approximately $16.0 million in the G&A expenses for the fiscal year ended June 30, 2010, resulting from the return of shares of common stock to the Company's chief executive officer and principal shareholder, because the Company achieved the financial performance thresholds for the fiscal years ended June 30, 2009 and 2008, pursuant to the Securities Escrow Agreements in the June 2008 and July 2008 Financings and amendments thereto. Included in G&A expenses for the fiscal year ended June 30, 2011 was a non-cash charge of $9,674,402, which was the share-based compensation costs on i) the options to an advisor and to independent directors, management and key employees issued on March 31, 2010 and June 22, 2010, under the Company’s 2010 Incentive Stock Plan, and ii) the stock awards to management, key employees and consultants issued in March and June, 2011, under the Company’s 2011 Incentive Stock Plan. The non-cash share-based compensation costs included in the G&A expenses for the fiscal year ended June 30, 2010 was $3,054,332. G&A expenses (excluding the non-cash items) for the fiscal year ended June 30, 2011 were $5,522,899, an increase of $2,046,355 or 58.9% compared to $3,476,544 for the fiscal year ended June 30, 2010. The increase in G&A (excluding the non-cash items) expenses for the fiscal year June 30, 2011 over the fiscal year ended June 30, 2010 was attributable to the increase in depreciation costs from $67,634 to $305,744 as a result of the construction of the new headquarters, traveling expenses, cash compensation to independent directors and management staff due to new appointments and hirings, as well as expenses incurred in our U.S. capital market-related activities, such as Nasdaq listing fees and costs for participation in investment conferences. The amortization of land use rights and other intangible assets for the fiscal year ended June 30, 2011 was $1,005,537, an increase of $88,153 or 9.6% compared to $917,384 for the fiscal year ended June 30, 2010.

Changes in Fair Value of Instruments
 
For the fiscal year ended June 30, 2011, the Company incurred non-cash gain in an aggregate amount of approximately $69.7 million related to its issuance of Series A warrants and Series A convertible preferred stock in the Private Placements in June and July, 2008, as well as issuance of warrants to underwriters in the public offerings in November and December 2010, pursuant to provision of FASB ASC Topic 815, “Derivative and Hedging” (“ASC 815”). The accounting treatment of the warrants resulted from the difference between the Company's functional currency in Renminbi and the denominated currency of the strike price of the warrants in U.S. dollars. The accounting treatment of the preferred stock resulted from a down-round provision providing anti-dilution protection to the preferred stockholders. Both warrants and the embedded conversion option of Series A convertible preferred stock are recorded as liabilities measured at fair value with changes in their fair value recognized in earnings for the fiscal year ended June 30, 2011. Fair value of the instruments was primarily a function of the price of our common stock. A decrease in our stock price over the year resulted in a decrease in fair value of the instruments, which are liabilities; hence a gain was recognized for the reporting period.
 
For the fiscal year ended June 30, 2010, however, the Company recognized a non-cash loss of approximately $56.9 million, due to the increase in our stock price over that year, resulting in an increase in fair value of the instruments.

Provision for Income Taxes

Provision for income tax for the fiscal year ended June 30, 2011 was $6,386,854, an increase of $1,683,360 or 35.8% from $4,703,494 for the fiscal year ended June 30, 2010. Excluding the approximately $9.7 million share-based compensation cost and the approximately $69.7 million gain from changes in fair value of instruments, adjusted income before taxes was approximately $39.8 million for the fiscal year ended June 30, 2011 compared with approximately $24.3 million for the fiscal year ended June 30, 2010, after adjusting for the approximately $16.0 million stock compensation expense, approximately $3.1 million share-based compensation cost, and approximately $56.9 million loss from changes in fair value of instruments. The increase in provision for income taxes was not proportional to the growth in the adjusted income before taxes, attributable to the new preferential income tax rate in calendar 2010. In April 2010, Tianjin Shengkai, the Company’s operating entity in Tianjin, PRC, was newly awarded the status of “high technology” enterprise for the calendar years 2009 through 2011. Hence Tianjin Shengkai enjoys a preferential enterprise income tax rate of 15% starting from January 1, 2010 through December 31, 2011, and will receive a 10% refund for the income taxes paid at the standard 25% tax rate for the calendar year 2009. The applicable income tax rate was 25% for the period from July 1, 2009 through December 31, 2009.
 
 
42

 
Liquidity and Capital Resources

Cash and Cash Equivalent
 
Our cash and cash equivalents at the beginning of the fiscal year ended June 30, 2011 was $20,995,182 and increased to $59,870,108 by the end of the period, an increase of $38,874,926 or 185.2%. The increase was primarily attributable to the net proceeds from the public offering closed by the end of the calendar year 2010 and internal cash flows generated from operations, offset by progressive payments made for our recently completed new manufacturing facility and headquarters building.
 
We believe that after taking into account of our current cash position and cash generated from operating activities, we have adequate operating funds to sustain working capital, capital expenditures and milestone payments for the next twelve months. From time to time, we may identify new expansion opportunities, research and development projects and significant marketing initiatives for which there will be a need to use cash.
 
We manage our cash based on thorough consideration of our corporate strategy, business environment as well as the macro economic situation. Factors we take into account when managing our cash include interest rates, foreign currency fluctuation as well as the flexibility in executing our corporate strategy.
 
Net cash provided by operating activities
 
Net cash provided by operating activities was $28,581,818 for the fiscal year ended June 30, 2011, an increase of $7,305,880 or 34.3% from $21,275,938 for the comparable period in fiscal 2010. The adjusted net income, after deducting the non-cash gain from changes in fair value of instruments and adding back the non-cash share-based compensation cost, was $33,452,383 for the fiscal year ended June 30, 2011, an increase of $13,901,097 or 71.1% from $19,551,286 for the fiscal year ended June 30, 2010. The increase in net cash inflow from operations was primarily attributable to the higher adjusted net income, in spite of larger working capital used between the two comparable periods in fiscal 2011 and fiscal 2010, as reflected by increased cash used in accounts receivable, notes receivable and other receivables, notes payable and advances from customers over the fiscal years ended June 30, 2011 and 2010, respectively.

Net cash used in investing activities
  
Net cash used in investing activities was $9,290,312 for the fiscal year ended June 30, 2011, compared to $39,490,349 for the fiscal year ended June 30, 2010, a decrease of $30,200,037 or 76.5%. The change was primarily attributable to less capital expenditures incurred during the fiscal year ended June 30, 2011 compared to the fiscal year ended June 30, 2010.

Net cash provided by financing activities

Net cash provided by financing activities was $17,466,689 for the fiscal year ended June 30, 2011, attributable to the proceeds from issuance of common stock in the public offering during the year, net of offering costs. For the fiscal year ended June 30, 2010, the fund of $89,799 was proceeds from exercise of warrants in the year.

Capital Expenditures
 
In October 2008, we successfully won a bid on a land use right over a plot of land of approximately 43,566.3 square meters in size. The land is located in Tianjin, PRC and the bid price was approximately $1.9 million (RMB12.6 million). The formal contract was signed with the government on January 23, 2009, with the Company due to pay the bid price in full by March 25, 2009. The land was purchased to construct corporate headquarters and to build a new manufacturing facility to expand our production capacity. Expenditures committed under related construction contracts totaled $34,794,225 (RMB224,909,871), of which $32,217,011 (RMB208,250,759) had been paid as of June 30, 2011. The remaining balance of $2,577,214 (RMB16,659,112)  will substantially be settled after completion of inspection and final acceptance of the construction project by relevant government authorities, with certain amount to be held from payment as warranty deposit till approximately one year after such final acceptance. Certain equipment and machinery contracts for the above-mentioned newly completed manufacturing facility have also been executed, total amount of which was approximately $16,178,759 (RMB104,579,500), of which $15,192,489 (RMB98,204,250) had been paid as of June 30, 2011. The remaining balance of $986,270 (RMB6,375,250) primarily represented the amount held as warranty deposit till approximately one year after installation. Expenditures committed under certain utility installation and related auxiliary engineering projects totaled $3,723,091 (RMB24,066,062), which had been fully paid as of June 30, 2011.
 
Trends

In response to the recent business disruptions and changes in the global ceramic valves industry as described above, management of the Company has decided to phase out its less profitable domestic market segments including the electric power market and focus on expanding its presence in the more profitable domestic and foreign oil and chemical industries where ceramic valve products typically command higher prices than the domestic Chinese market. The Company plans to substantially raise prices to match industry levels and to reflect its superior product quality. The Company also expects to streamline operations through headcount reduction and other cost-saving measures to conserve capital and reduce the impact of any revenue loss during this transition. Finally, the Company plans to leverage its self-developed ceramic material technologies to continue in-house and joint research and development of innovative and superior-performance products for the international oil and chemical markets and commit its resources to expanding the acceptance of its products overseas.

 
43

 
As such, we expect that in the immediately following quarter ended September 30, 2011, revenue from the electric power industry would significantly drop, and major contribution to our sales would be from the petrochemical and chemical industry. We estimate that for the quarter ended September 30, 2011, total revenue would fall by as much as 60% sequentially compared with the quarter ended June 30, 2011, and gross margin would drop to around 45%. We expect the Company to run with positive but significantly reduced cash flow from operations. Such decrease may persist until our marketing and sales efforts to some new customers and projects pay off, and the expansion in the international market picks up meaningfully. Successful penetration into international oil and chemical markets would also require the Company to obtain various certifications, including but not limited to ISO14000 and OHSAS 18000 and other firm-specific supplier qualifications, which will take time to go through various application procedures, efforts in new product development and investment in additional or different equipment.

Inflation

We believe that inflation has not had a material or significant impact on our revenue or our results of operations.

Contractual Obligations
 
We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our financial position, results of operations, and cash flows.
 
The following table summarizes our contractual obligations as of June 30, 2011, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.
 
   
Totals
   
Less Than
1 Year
   
1 to 3
Years
   
Thereafter
 
                         
Capital expenditures (1)
  $ 3,563,484     $ 3,563,484     $ -          
 
(1) Capital expenditure is commitment for the construction of a new manufacturing facility and for the purchase of new equipment and machinery. See Note 16 - Commitment and Contingency in the notes to the financial statements, included elsewhere in this report. The Company entered into certain construction contracts for building a new manufacturing facility and a headquarters building. The total amount of executed contracts was $34,794,225 (RMB224,909,871), of which $32,217,011 (RMB208,250,759)  had been paid as of June 30, 2011. The construction of both the manufacturing facility and the headquarters building were substantially completed in September 2010. The Company has also executed certain equipment and machinery contracts totaling $16,178,759 (RMB104,579,500), of which $15,192,489 (RMB98,204,250) had been paid as of June 30, 2011.

Credit Facility

On December 10, 2009, Shengkai and Industrial Bank Co., Ltd., Tianjin Branch (“Industrial Bank”) entered into a line of credit loan agreement (“LOC Agreement”) with a valid period of December 10, 2009 to October 22, 2010. The maximum amount Shengkai may draw down on the line of credit is RMB 1,500,000 in the form of a short-term cash flow loan at an interest rate of no lower than 110% of the base interest rate or in the form of a bank acceptance draft. Industrial Bank may unilaterally change the maximum amount available under the line of credit and the term of the line of credit.

The line of credit loan is secured by properties owned by Shengkai and the personal properties and income of Wang Chen and Guo Wei through a mortgage agreement and two personal guarantees, described in more detail below.

In conjunction with the LOC Agreement, Shengkai entered into a mortgage agreement for a maximum of RMB 8,682,000 with the Industrial Bank to secure repayment of the LOC Agreement on December 10, 2009. The collateral covered by the agreement is certain real property owned by Shengkai, valued at RMB17,540,000 and located at Wanggang Road, Shuanggang Economic Development Zone, Jinnan District, Tianjin, PRC. The mortgage agreement is valid from December 10, 2009 until all the principal, interest, and other expenses under the LOC Agreement are paid in full.

 
44

 
In connection with the LOC Agreement, Wang Chen, our CEO and director, and Guo Wei, our director, (each, a “Guarantor”) each made an irrevocable personal guarantee of the LOC Agreement on November 5, 2009 and on November 9, 2009, respectively, valid for two years from the date the loan becomes payable. Each Guarantor is jointly and severally liable for the payment of the loan principal, interest, damages and the expenses incurred relating to the collection of the payment and guarantees the repayment of the loan by all his/her personal property and income.

As of June 30, 2011 the Company has no outstanding balance under the LOC Agreement. The Company has no continuing obligations under the above mortgage agreement. Neither Mr. Wang Chen nor Ms. Guo Wei has any obligations under their respective personal guarantee.

Off Balance Sheet Arrangements

None.

Critical accounting policies and estimates
 
The financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. However, actual results could differ materially from those estimates (See Note 2 in the Notes to Financial Statements).
 
Revenue recognition

Revenue represents the invoiced value of goods sold and is recognized upon the delivery of goods to customers, net of value added tax (“VAT”). Revenue is recognized when the following four criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured.
 
Intangible assets

Intangible assets represent land use rights, patent rights and other assets (such as use of software) in the PRC. Land use rights are carried at cost and amortized on a straight-line basis over the period of rights of 50 years commencing from the date of acquisition of equitable interest. Patent rights are carried at cost and amortized on a straight-line basis over the period of rights of 10 years commencing from the date of acquisition of equitable interest. Others are software costs which are carried at cost and amortized on a straight-line basis over the period from 3 to 10 years.

Foreign currency translation

The accompanying consolidated financial statements are presented in United States dollars (“US$” or “$”), while the functional currency of the Company is Renminbi (“RMB”), as determined based on the criteria of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) ASC 830 “Foreign Currency Matters”.  The consolidated financial statements are translated into United States dollars from RMB at year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses.  Capital accounts are translated at their historical exchange rates when the capital transactions occurred.  The resulting transaction adjustments are recorded as a component of other comprehensive income with in shareholders’ equity. Gains and losses from foreign currency transactions are included in net income.
 
New Financial Accounting Pronouncements
 
In July 2010, the FASB issued ASU 2010-20 an accounting update to provide guidance to enhance disclosures related to the credit quality of a company's financing receivables portfolio and the associated allowance for credit losses (“FASB ASC Topic 310”). Pursuant to this accounting update, a company is required to provide a greater level of disaggregated information about its allowance for credit loss with the objective of facilitating users' evaluation of the nature of credit risk inherent in the company's portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. The revised disclosures as of the end of the reporting period are effective for the Company beginning in the second quarter of fiscal 2011, and the revised discourses related to activities during the reporting period are effective for the Company beginning in the third quarter of fiscal 2011. The adoption of such standard did not have a material impact on the Company's consolidated financial statements and disclosures.

In December 2010, the FASB issued ASU 2010-28 an accounting pronouncement related to intangibles – goodwill and other (“FASB ASC Topic 350”), which requires a company to consider whether there are any adverse qualitative factors indicating that an impairment may exist in performing step 2 of the impairment test for reporting units with zero or negative carrying amounts. The provisions for this pronouncement are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010, with no early adoption. We will adopt this pronouncement for our fiscal year beginning July 1, 2011. The adoption of this pronouncement is not expected to have a material impact on our consolidated financial statements.

 
45

 
In December 2010, the FASB issued ASU 2010-29 an accounting pronouncement related to business combinations (“FASB ASC Topic 815”), which specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. It also expands the supplemental pro forma disclosures under Topic 805 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. Early adoption is permitted. The adoption of this pronouncement is not expected to have a material impact on our consolidated financial statements.

In January 2011, the FASB issued ASU 2011-01 an accounting pronouncement related to receivables (“FASB ASC Topic 310”). The amendments in this update temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. The adoption of this pronouncement is not expected to have a material impact on our consolidated financial statements.

The FASB has issued Accounting Standards Update (ASU) No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The FASB believes the guidance in this ASU will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings.
 
The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings.

In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. The amendments to FASB Accounting Standards Codification™ (Codification) Topic 310, Receivables, clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties.
 
For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. For nonpublic entities, the amendments to the Codification in the ASU are effective for annual periods ending on or after December 15, 2012, including interim periods within those annual periods. Early application is permitted.

The FASB has issued Accounting Standards Update (ASU) No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.
 
In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. FASB Accounting Standards Codification™ (Codification) Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets.

The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted.

The FASB has issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs.

 
46

 
The amendments to the FASB Accounting Standards Codification™ (Codification) in this ASU 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 ASU 2011-04 early, but no earlier than for interim periods beginning after December 15, 2011.

The FASB has issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the FASB Accounting Standards CodificationTM (Codification) to allow an entity 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. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.

ASU 2011-05 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.

The FASB has issued Accounting Standards Update (ASU) No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits 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 for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%.

ASU 2011-08 is 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.

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

Not Applicable.


Item 8.  Financial Statements and Supplementary Data.
 
 
47

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES

 
 
 
 

 
Report of Independent Registered Public Accounting Firm

ALBERT WONG & CO.
CERTIFIED PUBLIC ACCOUNTANTS
7th Floor, Nan Dao Commercial Building
359-361 Queen’s Road Central
Hong Kong
Tel : 2851 7954
Fax: 2545 4086
 
ALBERT WONG
B.Soc., Sc., ACA., LL.B., C.P.A.(Practising)

 
To:
The board of directors and stockholders of
 
Shengkai Innovations, Inc.
 
Report of Independent Registered Public Accounting Firm
 
We have audited the accompanying consolidated balance sheet of Shengkai Innovations, Inc. and subsidiaries as of June 30, 2011 and the related consolidated statements of income, stockholders' equity and cash flow for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
 
We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
We were not engaged to examine management’s assertion about the effectiveness of the Company’s internal control over financial reporting as of June 30, 2011 included in the Company’s Item 9A “Controls and Procedures” in the Annual Report on Form 10-K and, accordingly, we do not express an opinion thereon.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Shengkai Innovations, Inc. and subsidiaries as of June 30, 2011 and the results of its operations and its cash flow for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 

 
Hong Kong, China
/s/ Albert Wong & Co.
   
September 26, 2011
Certified Public Accountants
 
 
F-2

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Stated in US Dollars)

         
June 30,
 
   
Note
   
2011
   
2010
 
                   
ASSETS
 
 
 
 
 
 
 
Current Assets
 
 
 
 
 
 
 
Cash and cash equivalents
 
 
    $ 59,870,108     $ 20,995,182  
Restricted cash
          1,386,873       1,849,958  
Accounts receivable, net
 
 
      12,623,359       6,490,110  
Notes receivable
 
 
      217,502       73,437  
Other receivables
    4       2,722,300       325,183  
Advances to suppliers
 
 
      274,814       408,110  
Inventories
    5       2,532,485       2,556,166  
Total Current Assets
 
 
      79,627,441       32,698,146  
Plant and equipment, net
    6       53,921,084       6,120,056  
Construction in progress
            -       25,185,643  
Land use rights, net
    7       2,534,059       2,480,929  
Other intangible assets, net
    8       5,370,148       6,001,411  
Advances to suppliers for purchase of equipment and construction
 
 
      -       12,119,764  
TOTAL ASSETS
 
 
    $ 141,452,732     $ 84,605,949  
 
 
 
   
 
   
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
   
 
   
 
 
Current Liabilities
 
 
   
 
   
 
 
Notes payable
    9       1,386,873       2,652,095  
Accounts payable
 
 
      3,829,491       2,848,600  
Advances from customers
 
 
      227,451       1,256,777  
Other payables and accrued expenses
    10       2,350,144       1,265,198  
Income tax payable
 
 
      1,816,995       1,061,783  
Total Current Liabilities
 
 
      9,610,954       9,084,453  
Warrant liabilities
 
 
      168,442       37,424,035  
Preferred (conversion option) liabilities
 
 
      5,782,014       40,378,640  
TOTAL LIABILITIES
 
 
    $ 15,561,410     $ 86,887,128  
   
 
   
 
   
 
 
Commitments and Contingencies
    16     $ -     $ -  
 
See accompanying notes to consolidated financial statements

 
F-3

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
 (Stated in US Dollars)

         
June 30,
 
   
Note
   
2011
   
2010
 
               
STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
Preferred stock – $0.001 par value 15,000,000 share authorized; 5,987,368 and 6,987,368 issued and outstanding as of June 30, 2011 and 2010 respectively.
    12     $ 5,987     $ 6,987  
Common stock - $0.001 par value 100,000,000 shares authorized; 29,776,611 and 23,191,165 shares issued and outstanding as of June 30, 2011 and 2010 respectively.
            29,777       23,192  
Additional paid-in capital
            63,554,251       34,259,304  
Statutory reserves
 
 
      11,196,604       7,081,706  
Retained earnings/(accumulated losses)
 
 
      42,669,590       (46,686,271 )
Accumulated other comprehensive income
 
 
      8,435,113       3,033,903  
TOTAL STOCKHOLDERS EQUITY
 
 
      125,891,322       (2,281,179 )
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
    $ 141,452,732     $ 84,605,949  


See accompanying notes to consolidated financial statements

 
F-4

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Stated in US Dollars)

         
Year Ended June 30,
 
   
Note
   
2011
   
2010
 
               
Revenues
 
 
    $ 93,451,373     $ 54,148,954  
Cost of sales
 
 
      (40,327,502 )     (21,916,944 )
Gross profit
 
 
      53,123,871       32,232,010  
Operating expenses:
 
 
   
 
   
 
 
Selling expenses
 
 
      (8,340,307 )     (5,093,859 )
General and administrative expenses
 
 
      (15,197,301 )     (22,502,796 )
Total operating expenses
          (23,537,608 )     (27,596,655 )
Income from operations
 
 
      29,586,263       4,635,355  
Other income, net
 
 
      318,701       205,498  
Interest income, net
 
 
      259,871       387,675  
Changes in fair value of instruments - gain/(loss)
 
 
      69,692,778       (56,910,599 )
Income (loss) before income taxes
 
 
      99,857,613       (51,682,071 )
Income taxes
    12       (6,386,854 )     (4,703,494 )
Net income (loss)
 
 
      93,470,759       (56,385,565 )
Foreign currency translation adjustment
 
 
      5,401,210       373,824  
Comprehensive income (loss)
 
 
      98,871,969       (56,011,741 )
   
 
   
 
   
 
 
Basic earnings (loss) per share
    13     $ 3.653     $ (2.483 )
   
 
   
 
   
 
 
Diluted earnings (loss) per share
    13     $ 2.668     $ (2.483 )
   
 
   
 
   
 
 
Basic weighted average shares outstanding
    13       25,587,094       22,704,492  
   
 
   
 
   
 
 
Diluted weighted average shares outstanding
    13       35,030,074       22,704,492  

See accompanying notes to consolidated financial statements

 
F-5

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY
 (Stated in US Dollars)
 
         
Preferred
                     
Accumulated
       
   
Common stock
   
Stock
   
Additional
               
other
       
   
Number
         
Number
         
paid-in
   
Statutory
   
Retained earnings
   
comprehensive
       
   
of shares
   
Amount
   
of shares
   
Amount
   
capital
   
reserves
   
(Accumulated losses)
   
Income
   
Total
 
                                                       
Balance, June 30, 2009
    22,112,500     $ 22,113       7,887,368     $ 7,887     $ 30,666,631     $ 4,693,020     $ 17,456,857     $ 2,660,079     $ 55,506,587  
Net loss
    -  
 
  -    
 
      -       -       -       (56,385,565 )     -       (56,385,565 )
Conversion from preferred stock to common stock
    900,000  
 
  900       (900,000 )     (900 )     -       -               -       -  
Appropriation of surplus reserve
    -  
 
  -    
 
      -       -       2,388,686       (2,388,686 )     -       -  
Issuance of stock options
    -  
 
  -    
 
      -       3,054,332       -               -       3,054,332  
Exercise of warrants
    178,665  
 
  179    
 
      -       1,206,446       -               -       1,206,625  
Reclassification of warrants and preferred stock to liabilities
    -  
 
  -    
 
      -       (16,640,025 )     -       (5,368,877 )     -       (22,008,902 )
Stock compensation expense
                                    15,971,920                               15,971,920  
Foreign currency translation adjustment
    -  
 
  -    
 
      -       -       -       -       373,824       373,824  
Balance, June 30, 2010
    23,191,165  
 
$ 23,192    
6,987,368 
    $ 6,987     $ 34,259,304     $ 7,081,706     $ (46,686,271 )   $ 3,033,903     $ (2,281,179 )
 
See accompanying notes to consolidated financial statements

 
F-6

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY (Continued)
(Stated in US Dollars)

         
Preferred
                     
Accumulated
       
   
Common stock
   
Stock
   
Additional
               
other
       
   
Number
         
Number
         
paid-in
   
Statutory
   
Retained earnings
   
comprehensive
       
   
of shares
   
Amount
   
of shares
   
Amount
   
capital
   
reserves
   
(Accumulated losses)
   
Income
   
Total
 
                                                       
Balance, June 30, 2010
    23,191,165     $ 23,192    
6,987,368 
    $ 6,987     $ 34,259,304     $ 7,081,706     $ (46,686,271 )   $ 3,033,903     $ (2,281,179 )
Net income
                                                  93,470,759               93,470,759  
Conversion from preferred stock to common stock
    1,000,000       1,000       (1,000,000 )     (1,000 )     2,877,831                               2,877,831  
Appropriation of surplus reserve
                                            4,114,898       (4,114,898 )             -  
Proceeds from shares issued in public offering
    2,456,800       2,457                       12,132,279                               12,134,736  
Proceeds from shares issued in public offering
    1,058,646       1,058                       5,330,895                               5,331,953  
Issuance of incentive stocks to employees
    600,000       600                       3,053,400                               3,054,000  
Issuance of incentive stocks to employees
    1,470,000       1,470                       2,291,730                               2,293,200  
Warrants issued to underwriter
    -       -                       (718,390 )                             (718,390 )
stock option expense
    -       -                       4,327,202                               4,327,202  
Currency difference
    -       -                                               5,401,210       5,401,210  
Balance, June 30, 2011
    29,776,611       29,777       5,987,368       5,987       63,554,251       11,196,604       42,669,590       8,435,113       125,891,322  
 
See accompanying notes to consolidated financial statements

 
F-7

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Stated in US Dollars)
   
Year Ended June 30,
 
   
2011
   
2010
 
Cash flows from operating activities
 
 
 
 
Net income (loss)
  $ 93,470,759     $ (56,385,565 )
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
   
 
 
Depreciation
    1,870,404       508,023  
Amortization
    1,005,537       917,384  
Provision for doubtful accounts
    171,298       -  
(Gain)/loss on disposal of property, plant and equipment
    (2,807 )     1,849  
Changes in fair value of instruments – (gain)/loss
    (69,692,778 )     56,910,599  
Stock based compensation
    9,674,402       3,054,332  
Stock compensation expense - escrowed shares
 
-
      15,971,920  
Changes in operating assets and liabilities:
 
 
   
 
 
(Increase) decrease in assets:
 
 
   
 
 
Accounts receivable
    (5,808,002 )     (2,396,926 )
Notes receivable
    (136,504 )     219,405  
Other receivables
    (2,317,873 )     (300,842 )
Deposits and prepaid expenses
 
-
      194,766  
Advances to suppliers
    150,479       (77,279 )
Inventories
    155,791       (1,636,793 )
Increase (decrease) in liabilities:
 
 
   
 
 
Notes payable
    (1,370,014 )     1,655,474  
Accounts payable
    807,463       1,714,386  
Advances from customers
    (1,067,806 )     1,008,342  
Other payables
    749,210       444,030  
Accruals
    241,823       (111,461 )
Income tax payable
    680,434       (415,706 )
Net cash provided by operating activities
    28,581,816       21,275,938  
Cash flows from investing activities
 
 
   
 
 
Proceeds from disposition of property, plant and equipment
    821       3,291  
Purchase of property, plant and equipment
    (63,816 )     (26,510,913 )
Payment of construction in progress
    (10,173,965 )     -  
Purchase of intangible assets
    (2,009 )     (11,465 )
Decrease/(increase) in advances to suppliers for purchase of equipment and construction
    401,562       (12,070,002 )
Decrease/(increase) in restricted cash
    547,095       (901,260 )
Net cash used in investing activities
    (9,290,312 )     (39,490,349 )
Cash flows from financing activities
 
 
   
 
 
Proceeds from exercise of warrants
  $ -     $ 89,799  
Proceeds from stock issued, net of transaction costs of $1,868,264
    17,466,689       -  
Net cash provided by financing activities
  $ 17,466,689     $ 89,799  
 
See accompanying notes to consolidated financial statements

 
F-8

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
 (Stated in US Dollars)

   
Year Ended June 30,
 
   
2011
   
2010
 
         
Net increase (decrease) in cash and cash equivalents
  $ 36,758,193     $ (18,124,612 )
   
 
   
 
 
Effect of exchange rate changes on cash and cash equivalents
    2,116,733       130,836  
   
 
   
 
 
Cash and cash equivalents–beginning of year
    20,995,182       38,988,958  
   
 
   
 
 
Cash and cash equivalents–end of year
  $ 59,870,108     $ 20,995,182  
 
 
 
   
 
 
Supplementary cash flow information:
 
 
   
 
 
   
 
   
 
 
Interest received
  $ 259,873     $ 387,675  
   
 
   
 
 
Taxes paid
  $ 5,706,420     $ 5,119,200  
                 
Non-cash transaction:
               
Preferred stock conversion to common stock
  $ 1,000     $ 900  
Cashless exercise of warrants
  $ -     $ 1,016,536  
 
See accompanying notes to consolidated financial statements

 
F-9

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

1.
ORGANIZATION AND PRINCIPAL ACTIVITIES

Shengkai Innovations, Inc. (“SKII”) was incorporated in the State of Florida on December 8, 2004. Prior to June 9, 2008, SKII has only nominal operations and assets. On October 23, 2008, SKII changed its name from Southern Sauce Company, Inc. to Shengkai Innovations, Inc.

On June 9, 2008, SKII executed a reverse-merger with Shen Kun International Limited (“Shen Kun”) by an exchange of shares whereby SKII issued 20,550,000 shares of common stock at $0.001 par value in exchange for all Shen Kun shares. Immediately after the closing of the reverse-merger, SKII had a total of 22,112,500 shares of common stock outstanding, with the Shen Kun shareholders (and their assignees) owning approximately 92.9% of the outstanding common stock on a non-diluted basis. Shen Kun became a wholly-owned subsidiary of SKII.

The exchange transaction was accounted for as a reverse acquisition in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations” (formerly included under Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations). For financial reporting purposes, this transaction is classified as a recapitalization of SKII and Shen Kun. The accompanying consolidated financial statements were retroactively adjusted to reflect the effects of the recapitalization of the financial statements of SKII and the historical financial statements of Shen Kun. The 1,562,500 shares of Shengkai Innovations, Inc. outstanding prior to this stock exchange transaction were accounted for at the net book value at the time of the transaction, which was a deficit of $62,206. The consolidated statements of operations include the results of operations of Tianjin Shengkai Industrial Technology Development Co., Ltd. and Shengkai (Tianjin) Limited for the years ended June 30, 2011 and 2010.

Shen Kun formed Sheng Kai (Tianjin) Ceramic Valves Co., Ltd., which was renamed to Shengkai (Tianjin) Limited in April 2010 (“SK” or “WFOE”), which entered into a series of agreements with Tianjin Shengkai Industrial Technology Development Co., Ltd (“Shengkai”) including but not limited to consigned management, technology service, loan, exclusive purchase option, equity pledge, etc. The agreements were entered on May 30, 2008. As a result of entering the abovementioned agreements, WFOE deem to control Shengkai as a variable interest entity as required by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810-10 (formerly FASB Interpretation No. 46 (revised March 2003) Consolidation of Variable Interest Entities -- an Interpretation of ARB No. 51).

Shengkai (Tianjin) Trading Ltd., which is wholly-owned by WFOE, was organized as a corporation under the laws of the People’s Republic of China (“PRC”) on June 25, 2010 with a total registered capital of RMB500,000. Shengkai (Tianjin) Trading Ltd. is primarily engaged in the international trading of non-valve products to better serve the Company’s international customers. It has not started operations as of June 30, 2011.

In connection with the reverse merger transaction, on June 11, 2008, SKII sold 5,915,526 Units for aggregate gross proceeds of $15,000,000, at a price of $2.5357 per Unit. Each Unit consists of one share of Southern Sauce Series A Convertible Preferred Stock, par value $0.001 per share (the “Preferred Shares”), convertible into one share of common stock, par value $0.001 per share (the “Common Stock”), and one Series A Warrant to purchase Common Stock equal to 120% of the number of shares of Common Stock issuable upon conversion of the Preferred Shares (“Warrant”). Additionally, on July 18, 2008, SKII sold 1,971,842 Units for aggregate gross proceeds of $5,000,000, at a price of $2.5357 per Unit. Each Unit consists of one Preferred Share, convertible into one share of Common Stock, par value $0.001 per share, and one Warrant to purchase Common Stock equal to 120% of the number of shares of Common Stock issuable upon conversion of the Preferred Shares.
 
 
F-10

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

1.
ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

SKII, through its subsidiaries is now in the business of manufacturing and sale of industrial ceramic valves and components.

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)  
Basis of presentation and method of accounting

The consolidated financial statements of Shengkai innovations, Inc. and subsidiaries (collectively the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).

The Company maintains its general ledger and journals with the accrual method accounting for financial reporting purposes. The financial statements and notes are representations of management.  Accounting policies adopted by the Company conform to U.S. GAAP and have been consistently applied in the presentation of financial statements.
 
(b)   
Principles of consolidation

The Company’s consolidated financial statements are compiled in accordance with U.S. GAAP. All significant inter-company accounts and transactions have been eliminated. The consolidated financial statements include 100% of assets, liabilities, and net income or loss of those subsidiaries.

The Company includes four subsidiaries since its reverse-merger on June 9, 2008. The detailed identities of the consolidating subsidiaries are as follows:

Name of Company
Place of
incorporation
 
Attributable
interest
 
         
Shen Kun International Limited
British
Virgin
Islands
   
100
%
           
Shengkai (Tianjin) Limited, formerly Sheng Kai (Tianjin) Ceramic Valves Co., Ltd
PRC
   
100
%
           
*Tianjin Shengkai Industrial Technology Development Co., Ltd.
PRC
   
 100
           
Shengkai (Tianjin) Trading Ltd.
PRC
   
 100
%
           
*Deemed variable interest entity member
         
 
(c)   
Use of estimates

The preparation of the financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.
 
 
F-11

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(d)
Economic and political risks

The Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.

The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.

 
(e)
Restricted Cash

Restricted cash represents amounts held by a bank as security for bank acceptance notes and therefore is not available for the Company’s use. The restricted cash is expected to be released within the next six months.

 
(f)
Accounts receivable

Accounts receivable are carried at net realizable value. The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of accounts receivable. A considerable amount of judgment is required in assessing the amount of the allowance. The Company considers the historical level of credit losses and applies percentages to aged receivable categories. The Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future. For the year ended June 30, 2011, the management established the general provisioning policy to make allowance equivalent to 100% of accounts receivable aged over 1 year. Additional specific provision is made against accounts receivable to the extent which they are considered to be doubtful.

Bad debts are written off when identified after exhaustive efforts at collection. The Company does not accrue interest on accounts receivable.  If accounts receivable are provided for, they would be recognized in the consolidated statement of operations within operating expenses. 

The Company sells its products to both agents/distributors and end-users. Normally the Company requires payment on delivery for agents/distributors. Usual credit term to end-user customers is about 1 to 3 months after receipt and acceptance of goods by customers. 5%-10% of total contract price may be retained from payment until the warranty (usually up to 1.5 years) expires.
 
 
F-12

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(g)
Property, plant and equipment

Property, plant and equipment are carried at cost less accumulated depreciation.  Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of the property, plant and equipment are as follows:

Buildings
20 – 40 years
Machinery and equipment
3 – 20 years
Office equipment
3 – 10 years
Motor vehicles
10 years

The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of operations. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.

 
(h)
Construction in progress

Construction in progress represents direct costs of construction incurred. Capitalization of these costs ceases and the construction in progress is transferred to plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. No depreciation is provided until it is completed and ready for intended use.

 
(i)
Land use rights

According to PRC laws, the government owns all the land in the PRC. Companies or individuals are authorized to possess and use the land only through land use rights granted by the PRC government. Land use rights are being amortized using the straight-line method over the term of rights of 50 years commencing from the date of acquisition.

 
(j)
Other intangible assets

Other intangible assets include patent rights and software costs which are stated at acquisition cost less accumulated amortization. Amortization expense is recognized using the straight-line method over the estimated useful life. Patent rights are carried at cost and amortized on a straight-line basis over the period of rights of 10 years commencing from the date of acquisition of equitable interest.  Software costs are carried at cost and amortized on a straight-line basis over the period from 3 to 10 years.

 
F-13

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(k)
Accounting for the impairment of long-lived assets

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, pursuant to the guidelines established in Statement of Financial Accounting Standards (“SFAS”) No. 144 (now known as "ASC 360"). 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. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose.

During the reporting periods, there was no impairment loss.

 
(l)
Inventories

Inventories are stated at lower of cost or net realizable value.  Cost is determined by the weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale and putting them in a saleable condition.  In case of manufacturing inventories and work in progress, cost includes an appropriate share of production overheads based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business less any applicable selling expenses. The Company has no reserve for inventories for the years ended June 30, 2011 and 2010.

 
(m)
Cash and cash equivalents

Cash and cash equivalents consist of cash on hand and bank deposits with original maturities of nine months or less, which are unrestricted as to withdrawal and use. The Company maintains bank accounts in the U.S.A., mainland China and Hong Kong.

   
June 30,
   
June 30,
 
   
2011
   
2010
 
Cash on hand
  $ 1,814     $ 5,348  
Bank deposits:
 
 
         
Bank of China
    50,578       889,600  
Industrial and Commercial Bank of China
    961,417       307,818  
Industrial Bank Co. Ltd.
    447,773       1,326,844  
Shanghai Pudong Development Bank
    57,770,717       18,043,632  
The Hong Kong and Shanghai Banking Corporation Limited
    20,840       15,483  
JPMorgan Chase Bank
    461,992       406,457  
China Construction Bank
    154,977       -  
    $ 59,870,108     $ 20,995,182  
 
 
F-14

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(n)
Fair value of financial instruments

FASB ASC 820 (formerly SFAS No. 157 Fair Value Measurements) establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market

These tiers include:

 
Level 1—defined as observable inputs such as quoted prices in active markets;

 
Level 2—defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

 
Level 3—defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, accounts receivable, notes receivable, other receivables, advances to suppliers, accounts payable, notes payable, other payables and accrued expenses and advances from customers, approximate their fair values because of the short maturity of these instruments.

Accounting guidance on fair value measurement and disclosures permits entities to choose to measure many financial instruments and certain other items at fair value. It was effective for fiscal year beginning July 1, 2009. Upon its adoption and at this time, we do not intend to reflect any of our current financial instruments at fair value (except that we are required to carry our derivative financial instruments at fair value). However, we will consider the appropriateness of recognizing financial instruments at fair value on a case by case basis in future periods.

The summary of fair values of financial instruments as of June 30, 2011 and 2010 are as follows:

June 30, 2011
Instrument
 
Fair Value
   
Carrying Value
   
Level
 
 Valuation
Methodology
Derivative warrant liabilities
 
$
      168,442
   
$
      168,442
     
3
 
Black-Scholes
Embedded conversion liability
 
$
5,782,014
   
$
5,782,014
     
3
   

June 30, 2010
Instrument
 
Fair Value
   
Carrying Value
   
Level
 
 Valuation
Methodology
Derivative warrant liabilities
 
$
37,424,035
   
$
37,424,035
     
3
 
Black-Scholes
Embedded conversion liability
 
$
40,378,640
   
$
40,378,640
     
3
   
 
 
F-15

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(n)
Fair value of financial instruments (continued)

The following represents a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended June 30, 2011 and 2010:

   
For the Years Ended June 30,
 
   
2011
   
2010
 
Beginning balance: Derivative liabilities
  $ 77,802,675     $ 24,199,716  
Issuance of derivative warrants
    718,390       -  
Conversion from preferred to common
    (2,877,831 )     (2,190,814 )
Conversion from warrants to common
    -       (1,116,826 )
Changes in fair value
    (69,692,778 )     56,910,599  
Ending balance: Derivative liabilities
  $ (5,950,456 )   $ 77,802,675  

 
(o)
Revenue recognition

Revenue represents the invoiced value of goods sold and is recognized upon the delivery of goods to customers. Revenue is recognized when all of the following criteria are met:

- Persuasive evidence of an arrangement exists;
- Delivery has occurred or services have been rendered;
- The seller’s price to the buyer is fixed or determinable, and
- Collection is reasonably assured.

There were no sales returns and allowances for the years ended June 30, 2011 and 2010. The Company does not provide unconditional right of return, price protection or any other concessions to its customers.

 
(p)
Costs of sales

Cost of sales consists primarily of direct material costs, direct labor cost, direct depreciation and related direct expenses attributable to the production of products.  Write-down of inventory to lower of cost or market is also reflected in cost of revenues.

 
(q)
Advertising

The Company expensed all advertising costs as incurred.  Advertising expenses included in the selling expenses for the years ended June 30, 2011 and 2010 were $13,260 and $82,913.

 
F-16

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(r)
Warranty expense

The Company generally provides one year warranty to most customers, or in some cases up to one and a half years. Historically warranty expense has been maintained at a very low percentage of sales revenue; therefore the Company does not accrue, but expenses all warranty expenses as incurred under selling expenses. The Company is closely monitoring warranty expense and will start to accrue it as soon as we identify that warranty expense regularly reaches certain percentage of total revenue. Warranty expenses for the years ended June 30, 2011 and 2010 were $201,421 and $149,153, respectively.

 
(s)
Research and development costs

The Company expensed all research and development costs as incurred.  Research and development expenses included in the general and administrative expenses for the years ended June 30, 2011 and 2010 were $885,694 and $865,098, respectively.

 
(t)
Retirement benefit plans

The employees of the Company are members of a state-managed retirement benefit plan operated by the government of the PRC.  The Company is required to contribute a specified percentage of payroll costs to the retirement benefit scheme to fund the benefits.  The only obligation of the Company with respect to the retirement benefit plan is to make the specified contributions.

Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the statements of operations as incurred. The retirement benefit expenses included in general and administrative expenses for the years ended June 30, 2011 and 2010 were $224,606 and $142,568, respectively.

 
(u)
Share-based compensation

Share-based compensation includes 1) stock options and common stock awards granted to employees and directors for services, and are accounted for under FASB ASC 718 "Compensation - Stock Compensation", and 2) warrants and common stock awards granted to consultants which are accounted for under FASB ASC 505-50 "Equity-Based Payment to Non-employees".

All grants of common stock awards and stock options/warrants to employees, directors and consultants are recognized in the financial statements based on their grant date fair values. The Company has elected to recognize compensation expense using the straight-line method for all common stock awards and stock options/warrants granted with service conditions that have a graded vesting schedule, with a corresponding charge to additional paid-in capital.

The Company estimates fair value of common stock awards based on the number of shares granted and the quoted price of the Company's common stock on the date of grant.
 
 
F-17

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(u)
Share-based compensation (continued)

The fair value of stock options is estimated using the Black-Scholes model. The Company's expected volatility assumption is based on the historical volatility of the Company's stock as well as historical volatility of comparable public companies, due to its relatively short trading history. The expected life assumption is presumed to be the mid-point between the vesting date and the end of the contractual term, as is permitted for "plain vanilla" employee stock options. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
 
 
FASB ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent period if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and are adjusted to reflect future change in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expenses were recorded only for those stock options and common stock awards that are expected to vest.

 
(v)
Income tax

Deferred tax assets and liabilities are recognized for the future tax consequence attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to reverse.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date.  A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain.

The Company uses FASB ASC 740 (formerly FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”)). – AN INTERPRETATION OF FASB STATEMENT NO. 109, ACCOUNTING FOR INCOME TAXES.  The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under FASB ASC 740, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.  FASB ASC 740 also provides guidance on recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.  At June 30, 2011 and 2010, the Company did not have a liability for unrecognized tax benefits.

 
F-18

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(w)
Value-added tax (“VAT”)

Enterprises or individuals, who sell commodities, engage in repair and maintenance or import or export goods in the PRC are subject to a value-added tax in accordance with the PRC laws.  The standard value-added tax rate is 17% of the gross sales price and the Company records its revenue net of VAT.  A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on the sales of the finished products. Therefore, the amounts of VAT recoverable included in other receivables on the balance sheets represent the excess of VAT paid on purchases over the VAT due on sales at June 30, 2011 and 2010, respectively, which can be used to offset future VAT that is due on sales.

 
(x)
Foreign currency translation

The accompanying consolidated financial statements are presented in United States dollars (“US$” or “$”), while the functional currency of the Company is Renminbi (“RMB”), as determined based on the criteria of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) ASC 830 “Foreign Currency Matters”.  The consolidated financial statements are translated into United States dollars from RMB at year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses.  Capital accounts are translated at their historical exchange rates when the capital transactions occurred.  The resulting transaction adjustments are recorded as a component of other comprehensive income with in shareholders’ equity.  Gains and losses from foreign currency transactions are included in net income.

The exchange rates used to translate amounts in RMB into USD for the purposes of preparing the consolidated financial statements were as follows:

June 30, 2011
 
Balance sheet
RMB 6.46400 to US$1.00
Statement of operations and comprehensive income
RMB 6.63665 to US$1.00
   
June 30, 2010
 
Balance sheet
RMB 6.80860 to US$1.00
Statement of operations and comprehensive income
RMB 6.83667 to US$1.00

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.  No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.

 
(y)
Cash and concentration of risk

Cash includes cash on hand and demand deposits in bank accounts.  Total cash in the banks at June 30, 2011 and 2010 amounted to $59,870,108 and $20,995,182, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to significant financial institution risks on its cash in bank accounts. Also see Note 3 for credit risk details.

 
F-19

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(z)
Statutory reserves

As stipulated by the PRC’s Company Law and as provided in SK and Shengkai’s Articles of Association, SK and Shengkai’s net income after taxation can only be distributed as dividends after appropriation has been made for the following:

 
(i)
Making up cumulative prior years’ losses, if any;
 
(ii)
Allocations to the “Statutory surplus reserve” of at least 10% of income after tax, as determined under PRC accounting rules and regulations, until the fund amounts to 50% of the Company's registered capital, which is restricted for set off against losses, expansion of production and operation or increase in registered capital;
 
(iii)
Allocations of 5-10% of income after tax, as determined under PRC accounting rules and regulations, to the Company's “Statutory common welfare fund”, which is restricted for capital expenditure for the collective benefits of the Company's employees; and
 
(iv)
Allocations to the discretionary surplus reserve, if approved in the shareholders’ general meeting.

On December 31, 2003, Shengkai established a statutory surplus reserve as well as a statutory common welfare fund and commenced to appropriate 10% and 5%, respectively of the PRC net income after taxation to these reserves. The amounts included in the statutory reserves were surplus reserve of $11,196,604 and $7,081,706 as at June 30, 2011 and 2010, respectively.

 
(aa)
Comprehensive income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners.  Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements.  The Company’s current component of other comprehensive income is the foreign currency translation adjustment.

 
(ab)
Recent accounting pronouncements
 
In July 2010, the FASB issued ASU 2010-20 an accounting update to provide guidance to enhance disclosures related to the credit quality of a company's financing receivables portfolio and the associated allowance for credit losses (“FASB ASC Topic 310”). Pursuant to this accounting update, a company is required to provide a greater level of disaggregated information about its allowance for credit loss with the objective of facilitating users' evaluation of the nature of credit risk inherent in the company's portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. The revised disclosures as of the end of the reporting period are effective for the Company beginning in the second quarter of fiscal 2011, and the revised discourses related to activities during the reporting period are effective for the Company beginning in the third quarter of fiscal 2011. The adoption of such standard did not have a material impact on the Company's consolidated financial statements and disclosures.
 
 
F-20

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(ab)
Recent accounting pronouncements (continued)
 
In December 2010, the FASB issued ASU 2010-28 an accounting pronouncement related to intangibles – goodwill and other (“FASB ASC Topic 350”), which requires a company to consider whether there are any adverse qualitative factors indicating that an impairment may exist in performing step 2 of the impairment test for reporting units with zero or negative carrying amounts. The provisions for this pronouncement are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010, with no early adoption. We will adopt this pronouncement for our fiscal year beginning July 1, 2011. The adoption of this pronouncement is not expected to have a material impact on our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29 an accounting pronouncement related to business combinations (“FASB ASC Topic 815”), which specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. It also expands the supplemental pro forma disclosures under Topic 805 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. Early adoption is permitted. The adoption of this pronouncement is not expected to have a material impact on our consolidated financial statements.

In January 2011, the FASB issued ASU 2011-01 an accounting pronouncement related to receivables (“FASB ASC Topic 310”). The amendments in this update temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. The adoption of this pronouncement is not expected to have a material impact on our consolidated financial statements.

The FASB has issued Accounting Standards Update (ASU) No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The FASB believes the guidance in this ASU will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings.

The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings.

 
F-21

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(ab)
Recent accounting pronouncements (continued)

In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. The amendments to FASB Accounting Standards Codification™ (Codification) Topic 310, Receivables, clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties.

For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. For nonpublic entities, the amendments to the Codification in the ASU are effective for annual periods ending on or after December 15, 2012, including interim periods within those annual periods. Early application is permitted.

The FASB has issued Accounting Standards Update (ASU) No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.

In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. FASB Accounting Standards Codification™ (Codification) Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets.

The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted.

The FASB has issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs.

The amendments to the FASB Accounting Standards Codification™ (Codification) in this ASU 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 ASU 2011-04 early, but no earlier than for interim periods beginning after December 15, 2011.
 
 
F-22

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 
(ab)
Recent accounting pronouncements (continued)

The FASB has issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the FASB Accounting Standards CodificationTM (Codification) to allow an entity 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. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.

ASU 2011-05 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.

The FASB has issued Accounting Standards Update (ASU) No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits 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 for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%.

ASU 2011-08 is 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.

 
F-23

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

3.
CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS

Financial instruments which potentially expose the Company to concentrations of credit risk, consists of cash and accounts receivable as of June 30, 2011 and 2010. The Company performs ongoing evaluations of its cash position and credit evaluations to ensure sound collections and minimize credit losses exposure.

As of June 30, 2011 and 2010, almost all the Company’s bank deposits were placed with banks in the PRC where there is currently no rule or regulation mandated on obligatory insurance of bank accounts. Relatively small bank deposits were maintained with the banks in the U.S.A and Hong Kong.

For the years ended June 30, 2011 and 2010, more than 90% of the Company’s sales were generated from the PRC. In addition, nearly all accounts receivable as of June 30, 2011 and 2010 also arose in the PRC.

The maximum amount of loss exposure due to credit risk that the Company would bear if the counterparties of the financial instruments fail to perform represents the carrying amount of each financial asset in the balance sheet.

Normally the Company does not require collateral from customers or debtors.

For the years ended June 30, 2011 and 2010, there was no single customer who accounts for 10% or more of the Company’s revenue. As at June 30, 2011 and 2010, there was no customer who accounts for 10% or more of the Company’s accounts receivable.

For the years ended June 30, 2011 and 2010, there was no single supplier who accounts for 10% or more of the Company’s purchase. As at June 30, 2011 and 2010, there was no supplier who accounts for 10% or more of the Company’s accounts payable.

4.
OTHER RECEIVABLES

Other receivables consist of the followings:

   
June 30, 2011
   
June 30, 2010
 
   
 
   
 
 
Advance to employees
 
$
159,783
   
$
24,935
 
Tender deposits
   
71,003
     
37,304
 
Sundry
   
1,582
     
32,656
 
VAT recoverable
   
2,489,932
     
230,288
 
   
$
2,722,300
   
$
325,183
 

5.
INVENTORIES

Inventories consist of the followings:

  
 
June 30, 2011
   
June 30, 2010
 
   
 
   
 
 
Finished goods
 
$
794,972
   
$
592,034
 
Work in process
   
80,750
     
-
 
Raw materials
   
1,656,763
     
1,964,132
 
   
$
2,532,485
   
$
2,556,166
 
 
 
F-24

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

6.
PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the followings:

   
June 30, 2011
   
June 30, 2010
 
At cost
       
 
 
Buildings
  $ 37,585,092     $ 2,119,449  
Machinery and equipment
    18,699,955       4,598,723  
Office equipment
    309,558       175,507  
Motor vehicles
    486,302       507,346  
      57,080,907       7,401,025  
Less: accumulated depreciation
               
Buildings
    (1,265,064 )   (338,732 )
Machinery and equipment
    (1,607,358 )     (666,345 )
Office equipment
    (118,135 )     (132,066 )
Motor vehicles
    (169,266 )     (143,826 )
      (3,159,823 )     (1,280,969 )
Property, plant and equipment, net
  $ 53,921,084     $ 6,120,056  

Depreciation expenses included in the cost of sales for the years ended June 30, 2011 and 2010 were $1,513,606 and $357,931, respectively. Depreciation expenses included in the general and administrative expenses for the years ended June 30, 2011 and 2010 were $356,798 and $150,092, respectively.

7.
LAND USE RIGHTS

   
June 30, 2011
   
June 30, 2010
 
         
 
 
Cost of land use rights
 
$
2,952,634
   
$
2,803,194
 
Less: Accumulated amortization
   
(418,575)
     
(322,265
)
Land use rights, net
 
$
2,534,059
   
$
2,480,929
 

Amortization expenses for land use rights for the years ended June 30, 2011 and 2010 were $77,071 and $19,551, respectively.

Amortization expense for the next five fiscal years and thereafter is as follows:

2012
  $ 79,130  
2013
    79,130  
2014
    79,130  
2015
    79,130  
2016
    79,130  
Thereafter
    2,138,409  
    $ 2,534,059  
 
 
F-25

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

8.
OTHER INTANGIBLE ASSETS

   
June 30, 2011
   
June 30, 2010
 
At cost:
       
 
 
Patent rights
  $ 7,889,851     $ 7,490,527  
Software
    1,621,198       1,537,921  
      9,511,049       9,028,448  
Less: Accumulated amortization
               
Patent rights
    (3,786,354 )     (2,858,219
Software
    (354,547 )     (168,818 )
      (4,140,901 )     (3,027,037 )
Other intangible assets, net
  $ 5,370,148     $ 6,001,411  

Amortization expenses for other intangible assets for the years ended June 30, 2011 and 2010 were $928,466 and $914,456 respectively.

Amortization expense for the next five fiscal years and thereafter is as follows:

2012
  $ 953,265  
2013
    953,265  
2014
    953,265  
2015
    953,109  
2016
    950,982  
Thereafter
    606,262  
    $ 5,370,148  
 
 
F-26

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

9.
NOTES PAYABLE

 
June 30,
2011
   
June 30,
2010
 
Due November 6, 2011
    45,792       -  
Due September 30, 2011
    154,702       -  
Due September 30, 2011
    162,400       -  
Due August 31, 2011, subsequently repaid on due dates 
    17,172       -  
Due August 21, 2011, subsequently repaid on due dates 
    719,987       -  
Due August 12, 2011, subsequently repaid on due dates 
    114,171       -  
Due July 25, 2011, subsequently repaid on due dates 
    172,649       -  
Due December 30, 2010, subsequently repaid on due dates 
    -       130,423  
Due December 30, 2010, subsequently repaid on due dates 
    -       53,939  
Due December 30, 2010, subsequently repaid on due dates 
    -       144,055  
Due December 28, 2010, subsequently repaid on due dates 
    -       549,188  
Due December 3, 2010, subsequently repaid on due dates 
    -       25,115  
Due December 3, 2010, subsequently repaid on due dates 
    -       56,840  
Due December 3, 2010, subsequently repaid on due dates 
    -       247,628  
Due November 28, 2010, subsequently repaid on due dates 
    -       29,375  
Due November 28, 2010, subsequently repaid on due dates 
    -       14,687  
Due November 28, 2010, subsequently repaid on due dates 
    -       8,812  
Due November 28, 2010, subsequently repaid on due dates 
    -       20,562  
Due November 28, 2010, subsequently repaid on due dates 
    -       8,812  
Due November 28, 2010, subsequently repaid on due dates 
    -       29,375  
Due November 28, 2010, subsequently repaid on due dates 
    -       28,200  
Due October 15, 2010, subsequently repaid on due dates 
    -       123,814  
Due October 14, 2010, subsequently repaid on due dates 
    -       204,888  
Due October 6, 2010, subsequently repaid on due dates 
    -       19,916  
Due October 2, 2010, subsequently repaid on due dates 
    -       18,653  
Due September 15, 2010, subsequently repaid on due dates 
    -       69,265  
Due September 9, 2010, subsequently repaid on due dates
    -       2,910  
 
 
 
F-27

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

9.
NOTES PAYABLE (CONTINUED)

 
June 30,
2011
   
June 30,
2010
 
Due September 9, 2010, subsequently repaid on due dates
    -       14,687  
Due September 9, 2010, subsequently repaid on due dates
    -       10,046  
Due September 9, 2010, subsequently repaid on due dates
    -       1,702  
Due September 9, 2010, subsequently repaid on due dates
    -       1,692  
Due September 3, 2010, subsequently repaid on due dates
    -       569,103  
Due August 3, 2010, subsequently repaid on due dates
    -       1,908  
Due August 3, 2010, subsequently repaid on due dates
    -       2,127  
Due August 3, 2010, subsequently repaid on due dates
    -       1,654  
Due July 20, 2010, subsequently repaid on due dates
    -       204,888  
Due July 4, 2010, subsequently repaid on due dates
    -       57,831  
Total
  $ 1,386,877     $ 2,652,095  

All the notes payable are subject to bank charges of 0.05% of the face value on each transaction.  Bank charges for notes payable for the years ended June 30, 2011 and 2010 were $1,452 and $2,780 respectively.
 
The interest-free notes payable are secured by $1,386,873 and $1,849,958 restricted cash as of June 30, 2011 and 2010, respectively.

10.
OTHER PAYABLES AND ACCRUED EXPENSES

   
June 30, 2011
   
June 30, 2010
 
   
 
   
 
 
Commission payables
 
$
727,372
   
$
441,860
 
Expense payables
   
181,846
     
-
 
Deposit for project
   
-
     
266,134
 
Sundry PRC taxes payables
   
983,292
     
379,588
 
Sundry
   
187,907
     
29,282
 
Accrual
   
269,727
     
127,975
 
   
$
2,350,144
   
$
1,244,839
 

11.
PUBLIC OFFERINGS AND WARRANTS ISSUED IN 2010

On November 24, 2010, the Company closed a public offering of 2,456,800 shares of common stock at $5.50 per share, resulting in approximately $13.5 million in gross proceeds. On December 22, 2010, the Company closed a public offering of 1,058,646 shares of common stock at $5.50 per share, resulting in approximately $5.8 million in gross proceeds. Global Hunter Securities, LLC and Maxim Group LLC (collectively the “Underwriters”) acted as the joint book runners for both offerings.

 
F-28

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

11.
PUBLIC OFFERINGS AND WARRANTS ISSUED IN 2010 (CONTINUED)

In connection with the public offerings, the Company issued to the Underwriters warrants (the “Underwriters’ Warrants”) to purchase 122,840 and 40,946 shares, respectively, of Common Stock of the Company according to the Underwriting Agreement dated November 19, 2010 and December 17, 2010, respectively. The Underwriters’ Warrants are exercisable in whole or in part at any time and from time to time. The exercise price, expiration date and total number of shares eligible to be purchased with the Underwriters’ Warrants are summarized in the following table:

Number of shares
   
Exercise price
   
Contractual term
             
163,786
   
$
6.875
   
3.0 years
 
 
The Company’s functional currency is RMB, which is different from the strike price of the Underwriters’ Warrants denominated in US dollars. According to ASC 815-40-15-7I, if the denominated currency of an equity-linked financial instrument’s strike price is different from the entity’s functional currency, an equity-linked financial instrument is not indexed to the entity’s own stock. ASC 815-40-55-36 illustrates the implementation of the above standard. Therefore, the Company determined that the Underwriters’ Warrants shall not be considered indexed to the entity’s own stock and accordingly records such Underwriters’ Warrants as a liability measured at fair value with changes in fair value recognized in earnings for each reporting period. See Note 2(n).

No Underwriters’ Warrants have been exercised, forfeited or expired since issuance.

12.
PREFERRED STOCK AND WARRANTS ISSUED IN 2008 FINANCING

On June 11, 2008, the Company sold 5,915,526 Preferred Shares and stock purchase warrants for cash consideration totaling $15 million dollars (the “June 2008 Financing”). The exercise price, expiration date and number of shares eligible to be purchased with the warrants are summarized in the following table:

Series of warrant
 
Number of shares
   
Exercise price
   
Contractual term
                 
Series A
   
7,098,632
   
$
3.52
   
5.0 years

 
F-29

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

12.
PREFERRED STOCK AND WARRANTS ISSUED IN 2008 FINANCING (CONTINUED)

The Preferred Shares have liquidation rights senior to common stock and to any other class or series of stock issued by the Company not designated as ranking senior to or pari passu with the Preferred Shares.  In the event of a liquidation of the Company, holders of Preferred Shares are entitled to receive a distribution equal to $2.5357 per share of Preferred Shares prior to any distribution to the holders of common stock or any other stock that ranks junior to the Preferred Shares. The Preferred Shareholders are not entitled to dividends unless paid to Common Shareholders. Any dividend paid will have the same record and payment date and terms as the dividend payable to the Common Stock. The Preferred Shares will participate based on their respective as-if conversion rates if the Company declares any dividends. Holders of Preferred Shares also have voting rights required by applicable law and the relevant number of votes shall be equal to the number of shares of Common Stock issuable upon conversion of Preferred Shares. At any time, each Preferred Share is convertible into 1 share of Common Stock adjusted from time to time to the Conversion Rate. The Conversion Rate is computed as the Liquidation Preference Amount ($2.5357 per share) divided by the Conversion Price. The Conversion Price is initially $2.5357 per share but can adjust for anti-dilution. The holder can also void the conversion or exercise its Buy-in Rights. The Buy-in-Rights entitle the holder to be protected in the case that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party. The Preferred Shares have registration rights that the Company is required to have a registration statement filed with the SEC within 45 days after the earlier of the date of the Second Closing or June 30, 2008, and declared effective by the SEC not later than November 27, 2008. We filed the initial registration statement on August 7, 2008, and it was declared effective by the SEC on August 21, 2008.

The Warrants were issued at an exercise price of $3.52 per share. The exercise price can adjust for dilutive events. The Warrants are immediately exercisable. However, if after exercise the holder would become a holder of greater than 9.9% of common stock they cannot exercise without filing a waiver with the company.  The waiver is required to be filed 61 days prior to exercise and by filing the waiver the restriction is removed. (Since the company is required to accept the waiver this restriction is not considered significant in valuing the warrant.) The Warrants expire 5 years from the date of issuance. The Warrants are freely transferable upon registration. The Warrants are subject to the same Registration Rights Agreement as that of the Preferred Shares. If a registration statement providing for the resale of the Common Stock issued upon exercise of the Warrant is not declared effective after 180 days after the issuance date, the Warrants can be cashless exercised. Also, the Warrants have Buy-in Rights similar to those of the Preferred Shares.

The gross proceeds of the transaction were $15 million. The proceeds from the transaction were originally allocated to the Preferred Shares, Warrants and beneficial conversion feature based on the relative fair value of the securities. The Company evaluated whether a relative fair value approach or residual fair value approach was more appropriate given the terms and accounting treatment related to the financial instruments involved. Given that the Warrants were not originally classified as a liability, the relative fair value method was used. The Warrants were first valued using the Black-Scholes valuation model. The Company valued the Warrants at issuance at $1.84 per warrant with the following assumptions: common stock fair market value of $2.55, expected life of 5 year, volatility of 100% and an interest rate of 4.5%.

 
F-30

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

12.
PREFERRED STOCK AND WARRANTS ISSUED IN 2008 FINANCING (CONTINUED)

The Company originally recognized a beneficial conversion feature discount on the Preferred Shares at their intrinsic value, which was the fair value of the common stock at the commitment date for the Preferred Shares investment, less the effective conversion price but limited to the $15 million of proceeds received from the sale. The Company originally recognized the $7.8 million beneficial conversion feature in the equity as a transfer from retained earnings to additional paid in capital as dividends in the accompanying consolidated financial statements on the date of issuance of the Preferred Shares since the Preferred Shares were convertible at the issuance date. The accounting treatment for such preferred stock and warrants were re-evaluated and adjustments were made during the year ended June 30, 2010.

On July 18, 2008 the Company sold 1,971,842 shares of Preferred Shares and stock purchase warrants for cash consideration totaling $5 million dollars (the “July 2008 Financing”). The exercise price, expiration date and number of shares eligible to be purchased with the Warrants are summarized in the following table:

Series of warrant
 
Number of shares
   
Exercise price
   
Contractual term
                 
Series A
   
2,366,211
   
$
3.52
   
5.0 years

The Preferred Shares have liquidation rights senior to common stock and to any other class or series of stock issued by the Company not designated as ranking senior to or pari passu with the Preferred Shares.  In the event of a liquidation of the Company, holders of Preferred Shares are entitled to receive a distribution equal to $2.5357 per share of Preferred Shares prior to any distribution to the holders of common stock or any other stock that ranks junior to the Preferred Shares. The Preferred Shareholders are not entitled to dividends unless paid to Common Shareholders. Any dividend paid will have the same record and payment date and terms as the dividend payable to the Common Stock. The Preferred Shares will participate based on their respective as-if conversion rates if the Company declares any dividends.  Holders of Preferred Shares also have voting rights required by applicable law and the relevant number of votes shall be equal to the number of shares of Common Stock issuable upon conversion of Preferred Shares. At any time, each Preferred Share is convertible into 1 share of Common Stock adjusted from time to time to the Conversion Rate. The Conversion Rate is computed as the Liquidation Preference Amount ($2.5357 per share) divided by the Conversion Price. The Conversion Price is initially $2.5357 per share but can adjust for anti-dilution. The holder can also void the conversion or exercise its Buy-in Rights. The Buy-in-Rights entitle the holder to be protected in the case that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party. The Preferred Shares have registration rights that the Company is required to have a registration statement filed with the SEC within 45 days after the date of the Closing Date, or September 1, 2008, and declared effective by the SEC not later than December 15, 2008. We filed the initial registration statement on August 7, 2008, and it was declared effective by the SEC on August 21, 2008.

 
F-31

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

12.
PREFERRED STOCK AND WARRANTS ISSUED IN 2008 FINANCING (CONTINUED)

The Warrants were issued at an exercise price of $3.52 per share. The exercise price can adjust for dilutive events.  The Warrants are immediately exercisable. However, if after exercise the holder would become a holder of greater than 9.9% of common stock they cannot exercise without filing a waiver with the company.  The waiver is required to be filed 61 days prior to exercise and by filing the waiver the restriction is removed. (Since the company is required to accept the waiver this restriction is not considered significant in valuing the warrant.) The Warrants expire 5 years from the date of issuance. The Warrants are freely transferable upon registration. The Warrants are subject to the same Registration Rights Agreement as that of the Preferred Shares. If a registration statement providing for the resale of the Common Stock issued upon exercise of the Warrant is not declared effective after 180 days after the issuance date, the Warrants can be cashless exercised. Also, the Warrants have Buy-in Rights similar to those of the Preferred Shares.

The gross proceeds of the transaction were $5 million. The proceeds from the transaction were originally allocated to the Preferred Shares, Warrants and beneficial conversion feature based on the relative fair value of the securities. The Company evaluated whether a relative fair value approach or residual fair value approach was more appropriate given the terms and accounting treatment related to the financial instruments involved. Given that the Warrants were not originally classified as a liability, the relative fair value method was used. The Warrants were first valued using the Black-Scholes valuation model. The Company valued the Warrants at issuance at $1.84 per warrant with the following assumptions:  common stock fair market value of $2.55, expected life of 5 year, volatility of 100% and an interest rate of 4.5%.

The Company originally recognized a beneficial conversion feature discount on the Preferred Shares at its intrinsic value, which was the fair value of the common stock at the commitment date for the Preferred Shares investment, less the effective conversion price but limited to the $5 million of proceeds received from the sale. The Company originally recognized the $2.6 million beneficial conversion feature in the equity as a transfer from retained earnings to additional paid in capital as dividends in the accompanying consolidated financial statements on the date of issuance of the Series A preferred shares since the Preferred Shares were convertible at the issuance date. The accounting treatment for such preferred stock and warrants were re-evaluated and adjustments were made during the year ended June 30, 2010.

In connection with the June 2008 Financing and the July 2008 Financing, in the event of the Company’s failure to timely convert, additional damages would become due.  In the event the Company does not have sufficient shares or is prohibited by law or regulation, then the holder can require cash redemption. The redemption price would equal 130% of the Liquidation Preference Amount plus additional amounts based on the difference between the bid prices on the conversion date and the date the Company has sufficient shares. The holder can also void the conversion or exercise its Buy-in Rights. The Buy-in-Rights entitle the holder to be protected in the case that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party. In addition, in the event of a merger, consolidation or similar capital reorganization (prior to conversion) the holders can request to be redeemed at 110% of liquidation value.

On April 30, 2010, the Company entered into a Warrant Amendment agreement with each of the holders of the Warrants in the June 2008 Financing and July 2008 Financing, namely Vision Opportunity China, LP and Blue Ridge Investments, LLC, to amend their respective warrants.  In particular, the parties have agreed to delete Sections 4(d), (e) and (f) of their Warrants and replace Section 4(d) with a provision to allow the Company to issue additional shares of common stock or common stock equivalents at a price less than the conversion price of the warrants with the consent of the majority holders of the warrants.


 
 
F-32

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

12.
PREFERRED STOCK AND WARRANTS ISSUED IN 2008 FINANCING (CONTINUED)

During the course of internal evaluation, the Company re-evaluated its accounting treatment as of July 1, 2009 for the warrants issued in June 2008 Financing and July 2008 Financing, the denominated currency of the strike price of which is different from the entity’s functional currency.  According to ASC 815-40-15-7I, if the denominated currency of an equity-linked financial instrument’s strike price is different from the entity’s functional currency, an equity-linked financial instrument is not indexed to the entity’s own stock. ASC 815-40-55-36 illustrates the implementation of the above standard. The Company’s primary operations are conducted in the PRC through its subsidiaries, SK and Shengkai, and the operating incomes and expenses are transacted in Renminbi (RMB), which is different from the strike price of the warrants, which are denominated in US dollars. Therefore, the Company determined that  warrants shall not be considered indexed to the entity’s own stock and hence adjusted the classification of the Warrants effective from the beginning of fiscal year 2010, i.e. July 1, 2009, on which date ASC 815 should have been adopted, by recording the warrants as a liability measured at fair value with changes in fair value recognized in earnings for each reporting period and recording a cumulative-effect adjustment to the opening balance of retained earnings. See Note 2(n).

During the course of internal evaluation, the Company re-evaluated its accounting treatment as of July 1, 2009 for the Preferred Shares issued in the June 2008 Financing and July 2008 Financing.  The Certificate of Designations of the Preferred Shares includes a down-round provision pursuant to which, if the Company issues any additional shares of common stock at a per share price of less than $2.5357, the conversion ratio will be adjusted downward to reflect such lesser issued price. The down-round provision changed for the period commencing on the two (2) year anniversary of the Original Issue Date as set forth in Section 5 (e)(i) and 5(e)(ii) thereof. Although the adjustment under the Section 5(e)(ii) is different from the Section 5(e)(i), the nature of the down-round provision is not changed under both sections. The Company performed a complete assessment of the preferred stock and concluded that the Preferred Shares issued in the June and July 2008 Private Placements is within the scope of ASC 815-40-55-33 due to the down-round provisions included in the terms of the agreements.  Pursuant to ASC 815-40-55-33, the down-round provision precludes the embedded conversion option of the Preferred Shares from being considered indexed to the entity’s own stock. Accordingly, the Company adjusted its accounting effective from the beginning of fiscal year 2010, i.e. July 1, 2009, on which date ASC 815 should have been adopted, by bifurcating the embedded conversion option of the Preferred Shares which should be recorded as a liability measured at fair value with changes in fair value recognized in earnings for each reporting period and recording a cumulative-effect adjustment to the opening balance of retained earnings. See Note 2(n).

No Series A Warrants have been exercised, forfeited or expired since issuance.

13.
SHARE-BASED COMPENSATION

The Company’s 2010 Incentive Stock Plan (the “2010 Plan”) adopted by our Board of Directors and approved by our shareholders, permits the grant of incentive stock options, non-statutory stock options, stock awards or restricted stock purchase offer, to our officers, employees, consultants and non-employee directors. The 2010 Plan provides for the issuance of up to 2,211,250 shares of common stock (subject to adjustment for stock split and similar events). Option awards generally vest in three to four equal installments and have 5 year contractual terms. The Company’s general policy is to issue new shares of common stock to satisfy stock option exercises or grants of unvested shares.

 
F-33

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

13.
SHARE-BASED COMPENSATION (CONTINUED)

On March 31, 2010, the Company granted 1,651,125 shares of non-statutory stock options to key employees and 310,000 shares to independent directors as compensation, these options have a 5 year contractual term. The options granted to key employees vest in three equal annual installments of 33.3%, with exercise price of $7.97 per share.  Options granted to independent directors vest in three equal annual installments of 33.3% or in four equal annual installments of 25%, with exercise price of $3 per share. On June 22, 2010, the Company issued 150,000 shares of non-statutory stock options to Mr. Chen Wang, CEO, and 100,125 shares of options to Ms. Wei Guo, VP International Sales of Shengkai. These options have a 5 year contractual term, vest in three equal annual installments of 33.3%, with exercise price of $8.13 per share.

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. That cost is recognized in the consolidated statement of operations over the requisite service period of the grants. Total compensation expense related to the stock options for the years ended June 30, 2011 and 2010 were $4,077,512 and $3,054,332, respectively, and were recorded as general and administrative expense.  As of June 30, 2011, there was $5,305,871 of unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the 2010 Plan.  That cost is expected to be recognized over a weighted average period of 1.5 years.  1,200,417 options have vested up to June 30, 2011, out of which 723,750 options vested during the year then ended.

The fair value of the stock options granted was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: volatility of 100%, the risk-free interest rate of 1.6%, expected dividend yield of 0% and expected life of 3.5 to 4 years.

Expected volatilities utilized in the model are based on the historic volatility of the Company’s stock price as well as volatility of comparable companies.  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 Staff Accounting Bulletin No. 107 with the continued use of this method extended under the provisions of Staff Accounting Bulletin No. 110. With the vesting period forms the lower bound of the estimate of expected term and the life of the option forming the upper bound.

The above assumptions were used to determine the weighted average grant date fair value of stock options of $5.63 per share for the options granted on March 31, 2010 and June 22, 2010.

A summary of the Company’s stock option activity as of June 30, 2011 and 2010, and changes during the years then ended are presented in the following table:

 
F-34

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

13.
SHARE-BASED COMPENSATION (CONTINUED)
 
   
Options
   
Weighted-Average Exercise
Price
 
             
Outstanding at July 1, 2009
   
-
   
$
-
 
Granted
   
2,211,250
     
7.29
 
Exercised
   
-
     
-
 
Forfeited or Expired
   
-
     
-
 
Outstanding at June 30, 2010
   
2,211,250
   
$
7.29
 
                 
Outstanding at July 1, 2010
   
2,211,250
   
$
7.29
 
Granted
   
-
     
-
 
Exercised
   
-
     
-
 
Forfeited or Expired
   
-
     
-
 
Outstanding at June 30, 2011
   
2,211,250
   
$
7.29
 
                 
Vested at June 30, 2011
   
1,200,417
   
$
7.61
 

The following table summarizes information about stock options outstanding at June 30, 2011:

 
   
Options Outstanding
   
Options Exercisable
 
Exercise Price
   
Number
Outstanding
   
Weighted Average
Remaining Contractual
Life (years)
   
Weighted Average
Exercise Price
   
Number
Exercisable
   
Weighted
Average
Exercise
Price
 
                                             
$ 8.13      
250,125
     
3.98
   
$
8.13
     
83,375
   
$
8.13
 
$ 3.00      
310,000
     
3.75
   
$
3.00
     
90,000
   
$
3.00
 
$ 7.97      
1,651,125
     
3.75
   
$
7.97
     
1,027,042
   
$
7.97
 
         
2,211,250
     
3.78
   
$
7.29
     
1,200,417
   
$
7.61
 
 

 
 
F-35

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

13.
SHARE-BASED COMPENSATION (CONTINUED)

A summary of the status of the Company’s nonvested shares as of June 30, 2011 and 2011, and changes during the years then ended, are presented below:

Nonvested Shares
 
Shares
   
Weighted Average
Grant Date 
Fair Value
 
   
 
   
 
 
Nonvested at July 1, 2009
   
-
   
$
-
 
Granted
   
2,211,250
     
5.63
 
Vested
   
476,667
     
5.37
 
Forfeited
   
-
     
-
 
Nonvested at June 30, 2010
   
1,734,583
   
$
5.70
 
                 
Nonvested at July 1, 2010
   
1,734,583
   
$
5.70
 
Granted
   
-
     
-
 
Vested
   
723,750
     
5.61
 
Forfeited
   
-
     
-
 
Nonvested at June 30, 2011
   
1,010,833
   
$
5.76
 

The Company’s 2011 Incentive Stock Plan (the “2011 Plan”) adopted by our Board of Directors and ratified and approved by our shareholders on March 4, 2011, permits the grant of incentive stock options, non-statutory stock options, stock awards or restricted stock purchase offers, to our officers, employees, consultants and non-employee directors. The 2011 Plan provides for the issuance of up to 2,670,661 shares of common stock (subject to adjustment for stock split and similar events). The Company’s general policy is to issue new shares of common stock to satisfy stock option exercises or grants of unvested shares.

On March 18, 2011 and June 22, 2011, our Board of Directors approved to grant an aggregate of 1,200,000 and 1,470,000 shares, respectively, of the Company’s common stock as stock awards under the 2011 Plan to certain key employees in order to incentivize them and retain their valued services with the Company. 2,070,000 of the approved stock awards have been issued during the fiscal year ended June 30, 2011 and the remaining 600,000 shares have been issued during the quarter ended September 30, 2011.

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. The Company estimates fair value of common stock awards based on the number of shares issued and the quoted price of the Company's common stock on the date of issuance. That cost is fully recognized in the consolidated statement of operations. Total compensation expense related to the common stock awards for the years ended June 30, 2011 and 2010 was $5,347,200 and $-0-, respectively, and were recorded as general and administrative expense.

 
F-36

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

13.
SHARE-BASED COMPENSATION (CONTINUED)

On October 11, 2010 the Company issued to an advisor warrants to purchase 50,000 shares of Common Stock of the Company according to the advisor service agreement dated April 13, 2010. The exercise price, expiration date and number of shares eligible to be purchased with the warrants are summarized in the following table:

Number of shares
   
Exercise price
   
Contractual term
             
 
50,000
   
$
6.31
   
5.0 years

The fair value of the warrants was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: volatility of 111.7%, the risk-free interest rate of 0.57%, expected dividend yield of 0% and expected life of 5 years. The Company accounts for share-based compensation to nonemployee in accordance with ASC 505-50. Accordingly, the Company expenses the fair value of the warrants and amortize over the one-year service period from the date of service agreement. Total compensation expense related for the year ended June 30, 2011 was $249,689, and was recorded as general and administrative expense.

14.
INCOME TAXES

SKII is registered in the State of Florida whereas its subsidiary, Shen Kun being incorporated in the British Virgin Islands, is not subject to any income tax and conducts all of its business through its PRC subsidiaries, SK, Shengkai and Shengkai (Tianjin) Trading Ltd. (see Note 1).

SK, Shengkai and Shengkai (Tianjin) Trading Ltd., being registered in the PRC, are subject to PRC’s Enterprise Income Tax. On March 16, 2007, the National People’s Congress of China approved the new Corporate Income Tax Law of the People’s Republic of China (the “New CIT Law”), which is effective from January 1, 2008.  Prior to January 1, 2008, the CIT rate applicable to our subsidiaries in the PRC was 33%.  After January 1, 2008, under the New CIT Law, the corporate income tax rate applicable to our Chinese subsidiaries is 25%.

In accordance with the New CIT Law, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises and subject to the PRC income tax at the rate of 25% on worldwide income.  The definition of “place of effective management" refers to an establishment that exercises, in substance, overall management and control over the production and business process, personnel, accounting and properties of an enterprise.  As of June 30, 2011, no detailed interpretation or guidance has been issued to define “place of effective management”.  Furthermore, as of June 30, 2011, the administrative practice associated with interpreting and applying the concept of “place of effective management” is unclear.  If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the New CIT Law.  The Company has analyzed the applicability of this law, and has not accrued for PRC tax on such basis as of June 30, 2011.  The Company will continue to monitor changes in the interpretation or guidance of this law. 

The New CIT Law also imposes a 10% withholding income tax, subject to reduction based on tax treaty where applicable, for dividends distributed by a foreign invested enterprise to its immediate holding company outside China.  Such dividends were exempted from PRC tax under the previous income tax law and regulations.  A foreign invested enterprise is subject to the withholding tax starting from January 1, 2008.  There was no such dividends distributed in the years ended June 30, 2011 or 2010.
 
 
F-37

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

14.
INCOME TAXES (CONTINUED)

In April 2010, Shengkai was awarded the status of “high technology” enterprise for the calendar years 2009 through 2011, of which Shengkai enjoys a preferential enterprise income tax rate of 15%.  However, for the year ended June 30, 2009, we already used income tax rate of 25% to provide and pay for income taxes.  For the period from July 1, 2009 to December 31, 2009, we used income tax rate of 25% to provide and pay for income taxed. After January 1, 2010, we used the preferential income tax rate of 15% to provide and pay for income tax expenses.  We did not record any tax refund receivable as of June 30, 2011 as we are not sure whether the refund of the overpaid income tax expenses during the calendar year 2009 would be approved by the local tax bureau. Income taxes payable was $1,816,995 and $1,061,783 at June 30, 2011 and 2010, respectively.

Income tax expenses consist of the following:

   
For the Years Ended June 30,
 
   
2011
   
2010
 
Current
  $ 6,386,854     $ 4,703,494  
Deferred
    -       -  
Total
  $ 6,386,854     $ 4,703,494  

Reconciliation from the expected income tax expenses calculated with reference to the statutory tax rate in the PRC of 25% for years ended June 30, 2011 and 2010 is as follows:

   
For the Years Ended June 30,
 
   
2011
   
2010
 
             
Income (loss) before income taxes
 
$
99,857,613
   
$
(51,682,071)
 
Income (loss) before income taxes from non-Chinese headquarters and subsidiaries
   
57,569,888
     
(75,922,632)
 
Income before income taxes from Chinese subsidiaries
   
42,287,725
     
24,240,561
 
                 
Income tax expenses for Chinese subsidiaries computed at the PRC statutory rate of 25%
   
10,571,932
     
6,060,140
 
Preferential tax rate effect of 10% on Shengkai for the period ended June 30
   
(4,228,773)
     
(1,356,646)
 
Permanent difference
   
43,695
     
-
 
   
$
6,386,854
   
$
4,703,494
 

 
F-38

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

15.
EARNINGS (LOSS) PER SHARE

Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Potentially dilutive shares of common stock consist of the common stock issuable upon the conversion of convertible debt, preferred stock, stock options and warrants. The Company uses the if-converted method to calculate the dilutive preferred stock and the treasury stock method to calculate the dilutive shares issuable upon exercise of warrants and stock options.

The calculation of the basic and diluted earnings (loss) per share attributable to the common stockholders is based on the following data:
 
   
For the Years Ended
 
   
June 30,
 
   
2011
   
2010
 
Earnings:
           
Net income (loss)
  $ 93,470,759     $ (56,385,565 )
Non-cash dividends on convertible preferred stock
  -     -  
             
Earnings (loss) for the purpose of basic earnings (loss) per share
  $ 93,470,759     $ (56,385,565 )
             
Effect of dilutive potential common stock
  -     -  
             
Earnings (loss) for the purpose of dilutive earnings (loss) per share
  $ 93,470,759     $ (56,385,565 )
             
Number of shares:
           
Weighted average number of common stock for the purpose of basic earnings (loss) per share
  25,587,094     22,704,492  
Effect of dilutive potential common stock
           
-Conversion of Series A convertible preferred stock
  5,987,368     -  
-Exercise of A Warrants
  3,317,219     -  
-Exercise of options
  138,393     -  
             
Weighted average number of common stock for the purpose of dilutive earnings (loss) per share
  35,030,074     22,704,492  
             
Earnings (loss) per share:
           
Basic earnings (loss) per share
  $ 3.65     $ (2.48 )
                 
Dilutive earnings (loss) per share
  $ 2.67     $ (2.48 )
 
 
F-39

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 2011 AND 2010
(Stated in US Dollars)

16.
COMMITMENTS AND CONTINGENCY

The newly completed manufacturing facility and a headquarters’ building are on a plot of land in Tianjin, China which was obtained in October, 2008. Certain construction contracts were executed. The total amount of executed contracts was $34,794,225 (RMB224,909,871), of which $32,217,011 (RMB208,250,759) had been paid as of June 30, 2011. The remaining balance of $2,577,214 (RMB16,659,112) will substantially be settled after completion of inspection and final acceptance of the construction project by relevant government authorities, with certain amount to be held from payment as warranty deposit till approximately one year after such final acceptance.

Certain equipment and machinery contracts for the above-mentioned newly completed manufacturing facility were executed. The total amount of executed contracts was $16,178,759 (RMB104,579,500), of which $15,192,489 (RMB98,204,250) had been paid as of June 30, 2011. The remaining balance of $986,270 (RMB6,375,250) primarily represented the amount held from payment as warranty deposit till approximately one year after installation.

17.
SEGMENT INFORMATION

The Company is principally engaged in one segment of the manufacturing and selling of ceramic valves in the PRC. Nearly all revenues are generated in the PRC and substantially all identifiable assets of the Company are located in the PRC. Accordingly, no segmental analysis is presented.

A breakdown of the Company's revenues for the years ended June 30, 2011 and 2010 in terms of customers' industry classification is as follows:

   
For the Years Ended June 30,
 
Customer industry
 
2011
   
2010
 
Electric power
  $ 57,670,510     $ 35,291,530  
Petrochemical and chemical
     27,505,265        15,886,538  
Aluminum, metallurgy and others
     8,275,598       2,970,886  
Total Sales
  $ 93,451,373     $ 54,148,954  

18.
AMENDMENT TO ARTICLES OF INCORPORATION

On September 30, 2010, the Board of the Company approved an amendment to the Company’s Articles of Incorporation to increase the total number of authorized shares of Common Stock of the Company from 50,000,000 to 100,000,000 shares (the “Amendment”). The Amendment was ratified on September 30, 2010 by the holder of a majority of the Company’s outstanding shares of Common Stock. The Amendment was effective on November 2, 2010, the date on which it was filed with the State of Florida.

19.
SUBSEQUENT EVENTS

On July 7th and 15th, 2011, the holder of Preferred Shares under the “June 2008 Financing” requested conversion of 2,000,000 and 900,000 Preferred Shares, respectively, into the Company’s Common Stock for the same amount.
 
 
F-40

 
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
          
Previous Independent Accountants
 
On August 4, 2011, BDO China Li Xin Da Hua CPA Co., Ltd. (“BDO”) resigned as our registered independent public accounting firm ("Resignation").

The audit report of BDO on our financial statements for the fiscal year ended June 30, 2010 contained no adverse opinions or disclaimers of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles.

During our fiscal year ended June 30, 2010, and through the date of Resignation, we have had no disagreements with BDO on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of BDO, would have caused it to make reference to the subject matter of such disagreements in its report on our financial statements for such periods.

During our fiscal year ended June 30, 2010, and through the date of Resignation, there have been no reportable events as defined under Item 304(a)(1)(v) of Regulation S-K adopted by the SEC.

We provided BDO with a copy of this disclosure before its filing with the SEC. We requested that BDO provide us with a letter addressed to the SEC stating whether or not it agrees with the above statements, and we received a letter from BDO stating that it agrees with the above statements.

New Independent Accountants
 
On August 4, 2011, our Audit Committee of the Board of Directors approved the appointment of Albert Wong & Co. (“AW”) as our new independent registered public accounting firm.

AW was previously engaged as the independent registered public accounting firm for the Company for the years ended June 30, 2008 and 2009, and resigned on June 28, 2010.  During that period, as disclosed in the Company's Form 8-K, filed on June 28, 2010,  (i) there were no disagreements between the Company and AW on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to AW's satisfaction, would have caused AW to make reference in connection with its opinion to the subject matter of the disagreement, and (ii) there were no "reportable events," as that term is described in Item 304(a)(1)(v) of Regulation S-K.

During the period commencing June 28, 2010 through the reengagement of AW as the Company's independent registered public accounting firm, neither the Company nor anyone on its behalf consulted AW with respect to any accounting or auditing issues involving the Company.  There was no discussion between AW and the Company regarding the application of accounting principles to a specified transaction, the type of audit opinion that might be rendered on the financial statements, or any matter that was either the subject of a disagreement, as described in Item 304 of Regulation S-K, with AW, or a "reportable event" as described in Item 304(a)(1)(v) of Regulation S-K.

Item 9A. Controls and Procedures.

(a)  
Evaluation of Disclosure Controls and Procedures

Based on an evaluation under the supervision and with the participation of the Company’s management, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act were effective as of June 30, 2011 to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

(b)  
Management’s Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 
49

 
1.  
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
2.  
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are made only in accordance with authorization of our management and directors; and
3.  
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of our assets that could have a material effect on the financial statements.

Under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of its internal control over financial reporting as of June 30, 2011. The framework on which such evaluation was based is contained in the report entitled “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”). Based on that evaluation and the criteria set forth in the COSO Report, management concluded that its internal control over financial reporting was effective as of June 30, 2011 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles.

Although the management of our Company, including the Chief Executive Officer and the Chief Financial Officer, believes that our disclosure controls and internal controls currently provide reasonable assurance that our desired control objectives have been met, management does not expect that our disclosure controls or internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

This annual report does not include an attestation report of the Company’s registered accounting firm regarding internal control over the financial reporting. The management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission.

 Changes in Internal Control over Financial Reporting

Other than as disclosed above, there were no changes in our internal controls over financial reporting during the fiscal year ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Item 9B. Other Information.

None.

 
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PART III

Item 10.  Directors, Executive Officers and Corporate Governance
 
Directors and Executive Officers of Shengkai Innovations, Inc.
 
The following table sets forth certain information concerning our directors and executive officers:
 
Directors and Executive Officers
 
Position/Title
 
Age
         
Wang Chen
 
Chief Executive Officer, Chairman
 
47
David Ming He
 
Chief Financial Officer
 
41
Wei Guo
 
Director
 
45
Michael Marks
 
Director
 
39
Jun Leng
 
Director
 
41
Ruizhu Mu
 
Director
 
39

The following is a summary of the biographical information of our directors and officers:

Mr. Wang Chen was appointed chief executive officer and chairman of the board of the Company on June 9, 2008.  Mr. Wang founded Shengkai in June 1994 and has been serving as Chief Executive Officer and Chief Technology Officer of Shengkai since then. Prior to founding Shengkai, he worked at Tianjin Dagang Power Plant from September 1987 to July 1992. Mr. Wang has an MBA from Renmin University of China. Mr. Wang is husband to Ms. Guo Wei, whose information is described in more details below.

Mr. David Ming He was appointed chief financial officer of the Company on March 1, 2010.  Mr. He previously served as chief financial officer of Equicap, Inc. (EQPI.OB) between January 2007 and February 2010. From October 2004 until January 2007, Mr. He served as the Senior Manager of SORL Auto Parts, Inc. (Nasdaq: SORL) in charge of capital market, investor relations, SEC filings and corporate internal controls. In his two years with SORL, Mr. He guided SORL’s progress in US capital market from an Over-the-Counter Bulletin Board company to a NASDAQ Global Market listed company, and completed a $36 million US public offering in November 2006. From 1994 to 2001, Mr. He was a senior manager in corporate banking with Credit Agricole Indosuez (now Calyon) in Shanghai. Currently Mr. He also serves as an independent director and chairperson of the Audit Committee of China Gengsheng Minerals, Inc. (NYSE Amex: CHGS). Mr. He holds designations of Chartered Financial Analyst and Illinois Certified Public Accountant. He received his Master of Science degree in Accountancy in 2004 and Master of Business Administration degree in Finance in 2003 from University of Illinois at Urbana-Champaign. He also received his Bachelor of Arts degree from Shanghai Institute of Foreign Trade in 1992.

Ms. Wei Guo was appointed director of the Company on June 24, 2008.  Ms. Guo has worked for Shengkai since 2005. She was appointed Chief Financial Officer of Shengkai in January 2007. Prior to working at Shengkai, Ms. Guo served as a purchasing specialist at Honeywell International Inc. (China) from August 1998 through August 2005. Ms. Guo has advanced English communication and translation skills and rich work experience in the field of joint ventures and financial management. Ms. Guo is the wife of Mr. Wang Chen, whose information is described in more details above.

Mr. Michael Marks was appointed director of the Company on November 5, 2009. Mr. Marks founded the China practice of Sonnenblick Goldman, a New York-headquartered investment bank, in January 2003, and until December 2007 he served as China managing director and regional principal of the firm.  In September 2002, Mr. Marks founded the Shanghai office of Horwath Asia Pacific, an advisory firm affiliated with Horwath International, and served as its director and Shanghai representative until December 2005. Mr. Marks also currently serves as a director of China Yida Holding, Co. (CNYD: NASDAQ), China Housing and Land Development, Inc. (CHLN: NASDAQ), and Yanglin Soybean Inc. (YSYB: OTCBB).  From January 1995 to January 1998, Mr. Marks worked in the audit, corporate finance and advisory divisions of PricewaterhouseCoopers.  Mr. Marks graduated with a Bachelor of Commerce and Masters of Commerce from the University of the Witwatersrand in Johannesburg, South Africa in 1994 and 1997, respectively, and in 1998 graduated with a Bachelor of Arts in psychology from the University of South Africa.  In 1995, Mr. Marks completed his qualifying examinations of the Chartered Institute of Management Accountants in the United Kingdom.  In 1997, Mr. Marks qualified as a Chartered Accountant in South Africa, and in 1999 as a Fellow of the Association of International Accountants in the United Kingdom.

 
51

 
Mr. Jun Leng was appointed director of the Company on November 5, 2009.  Mr. Leng has served as the Principal of Equity Investment, an affiliate of Bank of China since 2011. Before which he served as Director of Ping An Capital Investment in 2010, and the Vice President of J.P. Morgan Asia Consulting (Beijing) Ltd. from August 2008 till 2009.  Prior to that, he served as Vice President of Asia Investment Consulting Ltd., an affiliate of Bank of America, from December 2004 to August 2008.  Mr. Leng received a bachelor’s degree in engineering from Tsinghua University in Beijing, China, and a master’s degree in business administration from Guanghua Management School at Peking University.

Dr. Ruizhu Mu was appointed director of the Company on November 5, 2009. Dr. Mu has been an Associate Professor of the College of Chemistry and Chemical Engineering at Southwest University in China since September 2007 and from September 2005 to July 22006.  From September 2006 through July 2007, Dr. Mu was a post-doctorate associate under the supervision of Professor Yu Liu at NanKai University.   Dr. Mu received her bachelor’s degree in chemistry and PhD in synthetic organic chemistry from Lanzhou University, China.

All of our directors hold their positions on the board until our next annual meeting of the shareholders and until their successors have been qualified after being elected or appointed.  Officers serve at the discretion of the board of directors.

Our director, Guo Wei, is the wife of our director and Chief Executive Officer, Wang Chen. There are no other family relationships among our directors and executive officers. There is no arrangement or understanding between or among our executive officers and directors pursuant to which any director or officer was or is to be selected as a director or officer, and there is no arrangement, plan or understanding as to whether non-management shareholders will exercise their voting rights to continue to elect the current board of directors.

Director Qualifications
 
Directors are responsible for overseeing the Company’s business consistent with their fiduciary duty to stockholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The board believes that there are general requirements for service on the Company’s board of directors that are applicable to all directors and that there are other skills and experience that should be represented on the board as a whole but not necessarily by each director. The board and the Nominating Committee consider the qualifications of director and director candidates individually and in the broader context of the board’s overall composition and the Company’s current and future needs.
 
Qualifications for All Directors
 
In its assessment of each potential candidate, including those recommended by stockholders, the Nominating Committee considers the nominee’s judgment, integrity, experience, independence, understanding of the Company’s business or other related industries and such other factors the Nominating Committee determines are pertinent in light of the current needs of the board. The Nominating Committee also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.
 
The board and the Nominating Committee require that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board conducts interviews of potential director candidates to assess intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially. The board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
 
Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole
 
The board has identified particular qualifications, attributes, skills and experience that are important to be represented on the board as a whole, in light of the Company’s current needs and its business priorities. The board believes that it should include some directors with a high level of financial literacy and some directors who possess relevant business experience as a Chief Executive Officer or a President or like position. Marketing is the core focus of our business and the Company seeks to develop and deploy the world’s most innovative and effective marketing and technology. Therefore, the board believes that marketing and technology experience should be represented on the board.
 
 
52

 
Set forth below are a chart and a narrative disclosure that summarize the specific qualifications, attributes, skills and experiences described above. An “X” in the chart below indicates that the item is a specific reason that the director has been nominated to serve on the Company’s Board. The lack of an “X” for a particular qualification does not mean that the director does not possess that qualification or skill. Rather, an “X” indicates a specific area of focus or expertise of a director on which the board currently relies.

 
Wang Chen
Guo Wei
Michael Marks
Jun Leng
Ruizhu Mu
High level of
financial literacy
 
X
X
   
Diversity of race,
ethnicity, gender,
age, cultural
background or
professional
experience
       
X
Extensive knowledge
of the Company’s
business
X
X
     
Marketing/Marketing
related technology
experience
 
X
 
X
 
Relevant Chief
Executive/President
or like experience
X
 
X
X
 
 
To our knowledge, during the last ten years, none of our directors and executive officers (including those of our subsidiaries) has:

·  
Had a bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time.

·  
Been convicted in a criminal proceeding or been subject to a pending criminal proceeding, excluding traffic violations and other minor offenses.

·  
Been subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities.

·  
Been found by a court of competent jurisdiction (in a civil action), the SEC, or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.

·  
Been the subject to, or a party to, any sanction or order, not subsequently reverse, suspended or vacated, of any self-regulatory organization, any registered entity, or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
 
Directors and Officers of Tianjin Shengkai
 
Under Tianjin Shengkai’s Articles of Association and PRC law, Shengkai is managed by one executive director instead of a board of directors. The executive director is elected and appointed by the shareholders for a term of three years and can be re-elected for consecutive terms.  The appointment and termination of the CEO (sometimes called the General Manager) is determined by the executive director.
 
In accordance with Tianjin Shengkai’s Articles of Association and PRC law, Tianjin Shengkai’s executive director is monitored by a supervisor, appointed by the shareholders for a term of three years.

The following table sets forth certain information as of the date of this Report concerning the directors and executive officers of Tianjin Shengkai:
 
 
53

 
Directors and Executive Officers
 
Position/Title
 
Age
         
Wang Chen
 
Chief Executive Officer, Chief Technology Officer, Executive Director
 
47
         
Guo Wei
 
VP International Sales
 
45
         
Guo Chuanji
 
Supervisor
 
81
         
He Li
 
Chief Operating Officer
 
35
         
Liu Xiaoqian
 
Chief Marketing Officer
 
32
 
 
The following is a summary of the biographical information of those directors and officers of Tianjin Shengkai whose biographical information does not appear above:

Mr. Liu Xiaoqian joined Tianjin Shengkai in July 2002 as a member of the sales staff and was appointed Chief Marketing Officer in January 2007. Mr. Liu graduated in 2002 with a bachelor’s degree in chemical machinery.

Ms. He Li joined Tianjin Shengkai in March 2006. She was appointed as Chief Operating Officer in January 2007. She has experience in human resources management and business administration. Prior to joining Tianjin Shengkai, Ms. He served as human resources manager of Wah Sang Gas (China) Investment Co., Ltd. from December 2001 through March 2006. Ms. He has a bachelor’s degree in economic management.

 Committees

The Company’s business, property and affairs are managed by or under the direction of the board of directors. Members of the board are kept informed of our business through discussion with the chief executive and financial officers and other officers, by reviewing materials provided to them and by participating at meetings of the board and its committees.

Our board of directors has three committees - the audit committee, the compensation committee and the nominating committee. The audit committee is comprised of Michael Marks, Jun Leng, and Ruizhu Mu, with Mr. Marks serving as chairman.  The compensation committee is comprised of Michael Marks, Jun Leng, and Ruizhu Mu, with Mr. Leng serving as chairman. The nominating committee is comprised of Michael Marks, Jun Leng, and Ruizhu Mu, with Dr. Mu serving as chairwoman. All of the directors who serve on each of the audit, compensation, and nominating committees are "independent" directors based on the definition of independence in the listing standards of the National Association of Securities Dealers.

Audit Committee. Our audit committee is involved in discussions with our independent auditor with respect to the scope and results of our year-end audit, our quarterly results of operations, our internal accounting controls and the professional services furnished by the independent auditor. Our board of directors has adopted a written charter for the audit committee which the audit committee reviews and reassesses for adequacy on an annual basis.  A copy of the audit committee’s current charter is available on our website at http://ir.stockpr.com/skii/governance-documents.

Our board of directors has determined that it has an "audit committee financial expert" as defined by Item 407(d)(5)(ii) and (iii) of Regulation S-K as promulgated by the Securities and Exchange Commission. Our audit committee financial expert is Michael Marks.

           Compensation Committee.  The compensation committee oversees the compensation of our chief executive officer and our other executive officers and reviews our overall compensation policies for employees generally.  If so authorized by the board of directors, the committee may also serve as the granting and administrative committee under any option or other equity-based compensation plans which we may adopt.  The compensation committee does not delegate its authority to fix compensation; however, as to officers who report to the chief executive officer, the compensation committee consults with the chief executive officer, who may make recommendations to the compensation committee.  Any recommendations by the chief executive officer are accompanied by an analysis of the basis for the recommendations.  The committee will also discuss compensation policies for employees who are not officers with the chief executive officer and other responsible officers.   A copy of the compensation committee’s current charter is available on our website at http://ir.stockpr.com/skii/governance-documents.

 
54

 
Nominating Committee.  The nominating committee is involved in evaluating the desirability of and recommending to the board any changes in the size and composition of the board, evaluation of and successor planning for the chief executive officer and other executive officers.  The qualifications of any candidate for director will be subject to the same extensive general and specific criteria applicable to director candidates generally.  A copy of the nominating committee’s current charter is available on our website at http://ir.stockpr.com/skii/governance-documents.  The nominating committee will consider qualified director candidates recommended by stockholders if such recommendations for director are submitted in writing to our Secretary at No. 106 Zhonghuan South Road, Airport Industrial Park, Tianjin, People’s Republic of China 300308, provided such recommendation has been made in accordance with the relevant by-laws.

At this time, no additional specific procedures to propose a candidate for consideration by the nominating committee, nor any minimum criteria for consideration of a proposed nomination to the board, have been adopted.

Code of Ethics
 
We have adopted a code of ethics to apply to our principal executive officer, principal financial officer, principal accounting officer and controller, or persons performing similar functions. The Code of Ethics is currently available on our website at http://ir.stockpr.com/skii/governance-documents.

Board Attendance

The board and its committees held the following number of meetings during the fiscal year ended June 30, 2011:
 
 
Board of Directors
1  
Audit Committee
5  
Compensation Committee
1  
Nominating Committee
1  
 
The meetings include meetings that were held by means of a conference telephone call, but do not include actions taken by unanimous written consent. 

Each director attended at least 75% of the total number of meetings of the board and those committees on which he served during the year.

Our non-management directors met twice in executive sessions during fiscal 2011.

Board Leadership Structure and Role in Risk Oversight

Wang Chen is our chairman and chief executive officer. At the advice of other members of the management or the Board, Mr. Wang calls meetings of Board of Directors when necessary. We have three independent directors. We do not have a lead independent director. Our Board has three standing committees, each of which is comprised solely of independent directors with a committee chair. The Board believes that the Company’s chief executive officer is best situated to serve as chairman of the Board because he is the director most familiar with our business and industry and the director most capable of identifying strategic priorities and executing our business strategy. In addition, having a single leader eliminates the potential for confusion and provides clear leadership for the Company, with a single person setting the tone and managing our operations.  The Board oversees specific risks, including, but not limited to:

 
·
appointing, retaining and overseeing the work of the independent auditors, including resolving disagreements between the management and the independent auditors relating to financial reporting;
     
 
·
approving all auditing and non-auditing services permitted to be performed by the independent auditors;
     
 
·
reviewing annually the independence and quality control procedures of the independent auditors;
     
 
·
reviewing, approving, and overseeing risks arising from proposed related party transactions;
     
 
·
discussing the annual audited financial statements with the management;
     
 
·
meeting separately with the independent auditors to discuss critical accounting policies, management letters, recommendations on internal controls, the auditor’s engagement letter and independence letter and other material written
 
 
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communications between the independent auditors and the management; and
     
 
·
monitoring the risks associated with management resources, structure, succession planning, development and selection processes, including evaluating the effect the compensation structure may have on risk decisions.

Our Board of Directors is responsible to approve all related party transactions according to our Code of Ethics. We have not adopted written policies and procedures specifically for related person transactions.

Compliance with Section 16(a) of the Securities Act of 1934

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers and directors and persons who own more than 10% of a registered class of our equity securities to file with the Securities and Exchange Commission initial statements of beneficial ownership, reports of changes in ownership and annual reports concerning their ownership of the our common stock and other equity securities, on Form 3, 4 and 5 respectively. Executive officers, directors and greater than 10% shareholders are required by the Securities and Exchange Commission regulations to furnish our company with copies of all Section 16(a) reports they file.

Based solely on our review of the copies of such reports received by us, and on written representations by our officers and directors regarding their compliance with the applicable reporting requirements under Section 16(a) of the Exchange Act, we believe that, with respect to the fiscal year ended June 30, 2011, our officers and directors, and all of the persons known to us to own more than 10% of our common stock, filed all required reports on a timely basis-.

Item 11.  Executive Compensation.

The following is a summary of the compensation we paid to our CEO and CFO for the two years ended June 30, 2011 and 2010.   
 
Summary Compensation Table
 
Name and
Principal
Position
 
Fiscal
Year
 
Salary
($)
 
Bonus
($)
 
Stock
Awards
($) (4)
 
Option
Awards
($)(4)
 
Non-equity
Incentive Plan
Compensa-
tion
($)
 
Change in
Pension
Value and
Nonqualified
Deferred
Compensa-
tion
Earnings
($)
 
All Other
Compensa-
tion
($)
 
Total
($)
 
Wang Chen(CEO)(1)
   
2011
 
18,000
   
-0-
 
-0-
   
303,604
 
-0-
   
-0-
 
-0-
   
321,604
 
     
2010
 
18,000
   
-0-
 
-0-
   
6,655
 
-0-
   
-0-
 
-0-
   
24,655
 
                                                 
David Ming He (CFO)(2)
   
2011
 
120,000
   
-0-
 
254,500 (3)
   
396,863
 
-0-
   
-0-
 
-0-
   
771,363
 
     
2010
 
40,000
   
-0-
 
-0-
   
99,758
 
-0-
   
-0-
 
-0-
   
139,758
 

(1)
Wang Chen was appointed CEO and chairman of the board of directors of the Company on June 9, 2008. The compensation listed in the table above includes salary received in Mr. Wang’s capacity as CEO of Shengkai. On June 22, 2010, Mr. Wang received an option to purchase an aggregate of 150,000 shares of common stock at $8.13 per share. The option shall become exercisable during the term of Mr. Wang’s employment in three equal annual installments of 50,000 shares each, the first installment to be exercisable on the first anniversary of the date of option, and each subsequent installment exercisable on every anniversary thereof.
(2)
David Ming He was appointed CFO of the Company on March 1, 2010 at an annual salary of $120,000. On March 31, 2010, Mr. He received an option to purchase an aggregate of 221,125 shares of common stock at $7.97 per share. The option shall become exercisable during the term of Mr. He’s employment in three equal annual installments of 73,708 (save for the last installment of 73,709 shares) shares each, the first installment to be exercisable on the first anniversary of the date of the option, and each subsequent installment exercisable on every anniversary thereof.
(3)
Mr. He was granted stock awards in the aggregate amount of 100,000 shares of common stock of the Company pursuant to the Company's 2011 Incentive Stock Plan, 50,000 shares of which were issued to him on March 18, 2011, and the remaining 50,000 shares of which will be issued to the reporting person in six months from March 18, 2011.
 
 
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(4)
These columns reflect the aggregate grant date fair value of stock awards in accordance with FASB ASC Topic 718. For a discussion of the assumptions and methodologies used to value the awards reported in these columns, please see the discussion of stock awards and option awards contained in Part II, Item 8, “Financial Statements and Supplementary Data” of the Annual Report in Notes to Consolidated Financial Statements at Note 13, “Share-Based Compensation.”
 
Employment Agreements

We, via our operating entity, Shengkai, have an employment agreement with Mr. Wang Chen effective as of December 1, 2000 and a confidentiality and non-compete agreement effective as of June 7, 2001. Pursuant to these agreements, Mr. Wang receives no set salary compensation for his services as Chief Executive Officer of Shengkai, but Shengkai provides for his government-mandated social security insurance fees and certain dormitory expenses. In the event that Mr. Wang leaves his position at Shengkai, he stands to receive a monthly confidentiality and noncompete payment of RMB2,000 (approximately $293).

Effective March 1, 2010, Mr. He entered into an employment agreement with the Company to serve as the Company’s chief financial officer. Pursuant to the employment agreement, Mr. He’s initial term of office as the chief financial officer of the Company is one year and shall be continued on a year-to-year basis unless terminated by either party. For Mr. He’s service during his term of office, Mr. He shall receive an annual salary at the rate of US$120,000 and an option to purchase 221,125 shares of the Company’s common stock at an exercise price equivalent to the closing price per share of common stock on the date of the grant, which shall vest in one-third installments over three years.  The option may be exercised on a cashless basis.

Apart from the abovementioned agreements, there are no current employment agreements between the Company and its executive officers.

Compensation of Directors

The following table sets forth a summary of compensation paid to our directors who are not listed in the Summary Compensation Table during the fiscal years ended June 30, 2011 and 2010:
 
Director Compensation
 
Name and
Principal Position
Year
 
Fees
Earned
or Paid
in Cash
($)
   
Stock
Awards
($)
   
Option
Awards
($)(5)
   
Non-Equity
Incentive Plan
Compensation
($)
   
Nonqualified
Deferred
Compensation
Earnings($)
   
All Other
Compensation ($)
   
Total
($)
 
 
Wei Guo, Director(1)
2011
  $ 18,000       -       202,655       -       -       -       220,655  
 
 
2010
  $ 18,000       -       4,443       -       -       -       22,443  
Michael Marks,
Director(2)
2011
  $ 40,000       -       328,425       -       -       -       368,425  
 
 
2010
  $ 26,667       -       213,566       -       -       -       240,233  
Jun Leng,
Director(3)
2011
  $ 25,000       -       134,191       -       -       -       159,191  
 
 
2010
  $ 16,667       -       87,261       -       -       -       103,928  
Ruizhu Mu,
Director(4)
2011
  $ 25,000       -       134,191       -       -       -       159,191  
 
 
2010
  $ 16,667       -       87,261       -       -       -       103,928  

(1) Compensation attributed to Wei Guo includes salary of $18,000 in the fiscal years ended June 30, 2010 and 2011, received by Ms. Guo in her capacity at Tianjin Shengkai, our operating entity, as chief financial officer until March 1, 2010 and as Vice President of International Sales thereafter. On June 22, 2010, Ms. Guo received an option to purchase an aggregate of 100,125 shares of common stock at $8.13 per share. The option shall become exercisable during the term of Ms. Guo’s service in three equal annual installments of 33,375 shares each, the first installment to be exercisable on the first anniversary of the date of option, and each subsequent installment exercisable on every anniversary thereof.

 
57

 
(2) Effective November, 2009, the Company entered into an appointment letter with Michael Marks.  Pursuant to the agreement, Mr. Marks was appointed our director and shall receive an annual salary of $40,000, payable on a monthly basis.  Mr. Marks was also granted an option to purchase 150,000 shares of common stock of Company at a fixed exercise price of $3.00 per share. Such option shall be exercisable in three equal installments, the first being on the first anniversary of the date of grant.

(3) Effective November 5, 2009, the Company entered into an appointment letter with Jun Leng. Pursuant to the agreement, Mr. Leng was appointed our director and shall receive an annual salary of $25,000, payable on a monthly basis.  Mr. Leng was also granted an option to purchase 80,000 shares of common stock of Company at a fixed exercise price of $3.00 per share. Such option shall be exercisable in four equal installments, the first being on the first anniversary of the date of Mr. Leng’s appointment as director.

(4) Effective November 5, 2009, the Company entered into an appointment letter with Ruizhu Mu. Pursuant to the agreement, Mr. Mu was appointed our director and shall receive an annual salary of $25,000, payable on a monthly basis. Dr. Mu was also granted an option to purchase 80,000 shares of common stock of Company at a fixed exercise price of $3.00 per share. Such option shall be exercisable in four equal installments, the first being on the first anniversary of the date of Dr. Mu’s appointment as director.

(5) Calculations are based on the Black-Scholes option pricing model with the following assumptions: volatility of 100%, the risk-free interest rate of 1.6%, expected dividend yield of 0% and expected life of 3.5 to 4 years.

Other than the appointment letters described above, there are no understandings or arrangements between Mr. Marks, Mr. Leng, or Dr. Mu and any other person pursuant to which Mr. Marks, Mr. Leng, or Dr. Mu was appointed as a director. Neither Mr. Marks, Mr. Leng, nor Dr. Mu has any family relationship with any director, executive officer or person nominated or chosen by us to become a director or executive officer.

Outstanding Equity Awards at Fiscal Year-End

The following options were outstanding for the Company’s executive officers as of the end of the fiscal year 2011:
 
Outstanding Equity Awards At Fiscal Year-End
OPTION AWARDS
STOCK AWARDS
Name
(a)
Number
of
Securities
Underlying
Unexercised
options
(#)
exercisable (b)
Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Earned
Options
(#)
unexercisable
(c)
Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)
(d)
Option
Exercise
Price
($)
(e)
Option
Expiration
Date
 
(f)
Number of
Shares or
Units of
Stock that
have not Vested
(#)
(g)
Market
Value of
Shares or
Units of
Stock that
Have not Vested
($)
(h)
Equity Incentive
Plan Awards:
Number of
Unearned Shares,
Units or
Other
Rights that
have not
Vested
(#)
(i)
Equity Incentive
Plan Awards:
Market or
Payout Value
of Unearned
Shares, Units
or other
Rights that
have not
Vested
($)
(j)
Wang Chen
 50,000 (1)
100,000 (1)
8.13(1)
 6/22/2015(1)
 -
 -
 -
 -
David Ming He
 73,708 (2)
-
147,417 (2)
7.97 (2)
3/31/2015 (2)
-
 -
50,000 (3)
66,000
 
(1)  
On June 22, 2010, Mr. Wang received an option to purchase an aggregate of 150,000 shares of common stock at $8.13 per share. The option shall become exercisable during the term of Mr. Wang’s employment in three equal
 
 
58

 
 
annual installments of 50,000 shares each, the first installment to be exercisable on the first anniversary of the date of option, and each subsequent installment exercisable on every anniversary thereof.
(2)  
Pursuant to an option agreement with the Company on March 31, 2010, David Ming He was granted an option to purchase 221,125 shares of common stock of Company at a fixed exercise price of $7.97 per share. Such option shall be exercisable in three equal installments, the first being on the first anniversary of the date of grant.
(3)  
Mr. He was granted stock awards in the aggregate amount of 100,000 shares of common stock of the Company pursuant to the Company's 2011 Incentive Stock Plan, 50,000 shares of which were issued to him on March 18, 2011, and the remaining 50,000 shares of which will be issued to the reporting person in six months from March 18, 2011.
 
Pension and Retirement Plans

 Currently, except for contributions to the PRC government-mandated social security retirement endowment fund for those employees who have not waived their coverage, we do not offer any annuity, pension or retirement benefits to be paid to any of our officers, directors or employees. There are also no compensatory plans or arrangements with respect to any individual named above which results or will result from the resignation, retirement or any other termination of employment with our company, or from a change in our control.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
        
The following table sets forth certain information with respect to the beneficial ownership of our voting securities by (i) any person or group owning more than 5% of any class of voting securities, (ii) each director, (iii) our chief executive officer and president and (iv) all executive officers and directors as a group as of September 20, 2011.

         
Amount and Nature of Beneficial Ownership (1)
       
Name and Address of
Beneficial Owner
 
Common
Stock
   
Options
   
Preferred
Shares
(2)(11)
   
Warrants
(3)(11)
   
Total (4)
   
Percentage of
Common
Stock (%)
 
Owner of More than 5% of Class
                                   
                                     
Vision Opportunity China LP
20 West 55th Street
New York, NY 10019 (5)
   
2,711,600
     
0
     
1,115,526
(13)
   
7,098,632
(13)
   
10,925,750
(11)
   
9.9
(11)%
                                                 
NewQuest Asia Investments Limited
5th Floor, Barkly Wharf
Le Caudan Waterfront
Port Louis, Republic of Mauritius (6)
   
0
     
0
     
1,971,842
(11)
   
2,366,211
(11)
   
4,338,053
(13)
   
9.9
(11)%
                                                 
Long Sunny Limited (7)(9)
P.O. Box 957
Offshore Incorporations Centre
Road Town, Tortola
British Virgin Islands
   
17,400,000
     
0
     
0
     
0
     
17,400,000
     
52.29
%
                                                 
Directors and Executive Officers (8)
                                               
                                                 
Mr. Wang Chen (Chairman and CEO) (9)
   
17,400,000
     
83,375
     
0
     
0
     
17,483,375
 (9)
   
52.41
%
                                                 
David Ming He (CFO) (15)
   
50,000
     
73,708
     
0
     
0
     
123,708
 (15)
   
*
 
                                                 
Ms. Guo Wei (director) (10)
   
17,400,000
     
83,375
     
0
     
0
     
17,483,375
 (10)
   
52.41
%
Mr. Michael Marks (12)
   
0
     
100,000
     
0
     
0
     
100,000
 (12)
   
*
 
Mr. Leng Jun (13)
   
0
     
40,000
     
0
     
0
     
40,000
 (13)
   
*
 
Mr. Mu Ruizhu (12)
   
0
     
40,000
     
0
     
0
     
40,000
 (14)
   
*
 
                                                 
All Directors and Executive Officers (5 persons)
   
17,4500,000
     
337,083
     
0
     
0
     
17,787,083
     
52.92
%
 
(1)   In determining beneficial ownership of our common stock as of a given date, the number of shares shown includes shares of common stock which may be acquired on exercise of warrants or options or conversion of convertible securities within 60 days of that date. In determining the percent of common stock owned by a person or entity on September 20, 2011, (a) the numerator is the number of shares of the class beneficially owned by such person or entity, including shares which may be acquired within 60 days on exercise

 
59

 
of warrants or options and conversion of convertible securities, and (b) the denominator is the sum of (i) the total shares of common stock outstanding on September 20, 2011 (33,276,611), and (ii) the total number of shares that the beneficial owner may acquire upon conversion of the preferred and on exercise of the warrants and options, subject to limitations on conversion and exercise as more fully described in note 11 below. Unless otherwise stated, each beneficial owner has sole power to vote and dispose of its shares.
 
(2)   An aggregate of 7,887,368 Series A Preferred Stock were issued in two private placement financings in 2008 (collectively, the “Private Placements”), of which 5,915,926 shares were issued to Vision Opportunity China LP in a financing in June 2008 (the “June 2008 Financing”) and 1,971,842 shares were issued to Blue Ridge Investments, LLC, in a financing in July 2008 (the “July 2008 Financing”). Each share of Series A Preferred Stock is initially convertible, at the option of the holder, into one share of our common stock, subject to a 9.9% limitation on beneficial ownership of common stock on each Series A Preferred Stock holder as more fully described in note 13 below.

(3)   The purchasers in the Private Placements have also been issued Warrants to purchase up to a total of 9,464,843 shares of our common stock at $3.52 per share (subject to a 9.9% limitation on beneficial ownership of common stock as more fully described in note 13 below), of which 7,098,632 shares underlie the Warrant issued to Vision Opportunity China LP in the June 2008 Financing and 2,366,211 shares underlie the Warrant issued to Blue Ridge Investments, LLC, in the July 2008 Financing. The Warrants have a term of five years.
 
(4)   As of September 20, 2011, we had outstanding (i) 33,276,611 shares of common stock, (ii) 3,087,368 Series A Preferred Stock, which were issued to purchasers in the Private Placements, (iii) Warrants to purchase an aggregate of 9,464,843 shares attributable to the purchasers, and (iv) 2,211,250 shares of common stock underlying options issued out of our 2010 Incentive Stock Plan.
 
(5)   Vision Opportunity China LP acquired Series A Preferred Stock convertible into 5,915,526 shares of common stock and Warrants to purchase up to 7,098,632 shares of common stock (each subject to a 9.9% limitation on beneficial ownership of common stock as more fully described in note 11 below) in the June 2008 Financing that closed on June 11, 2008. As of September 20, 2011, Vision Opportunity China LP owns Series A Preferred Stock convertible into 1,115,526 shares and Warrants to purchase up to 7,098,632 shares of common stock. Adam Benowitz has sole voting power and sole dispositive power over the shares.
 
(6)    On April 14, 2011, NewQuest Investments Limited acquired from Blue Ridge Investments, LLC 1,971,842 Units, consisting of 1,971,842 shares of Preferred Stock of the Company and 1,971,842 Warrants to purchase 2,366,211 shares of Common Stock of the Company for $10,431,628 in cash. NewQuest Investments Limited’s ownership is subject to a 9.9% limitation on beneficial ownership of common stock as more fully described in note 13 below.  Amit Gupta has sole voting and dispositive power over the shares of NewQuest Investments Limited.
 
(7)   On June 9, 2008, we acquired Shen Kun in a reverse merger transaction (the “Reverse Merger Transaction”) with Long Sunny Limited and other Shen Kun Shareholders. In the Reverse Merger Transaction, as merger consideration for the Shen Kun shares we received from the Shen Kun Shareholders we issued and delivered to the Shen Kun shareholders 20,550,000 of our newly-issued shares of common stock, of which Long Sunny Limited received 17,400,000 shares.
 
(8)   The address of each of the officers and directors named in the table is No. 106 Zhonghuan South Road, Airport Industrial Park, Tianjin, People’s Republic of China 300308.
 
(9)   Mr. Wang is our chairman and CEO as of June 9, 2008. Mr. Wang’s beneficial ownership in the Company includes Mr. Wang’s indirect ownership of 17,400,000 shares of our common stock through his 100% interest in our controlling shareholder, Long Sunny Limited. It also includes the indirect ownership of an option to purchase 100,125 shares of common stock via his wife, Guo Wei, subject to the vesting terms of the option. Additionally, on June 22, 2010, Mr. Wang received an option to purchase an aggregate of 150,000 shares of common stock at $8.13 per share. The option shall become exercisable during the term of Mr. Wang’s employment in three equal annual installments of 50,000 shares each, the first installment to be exercisable on the first anniversary of the date of option, and each subsequent installment exercisable on every anniversary thereof. As of September 20, 2011, the option to purchase 50,000 shares had vested or was exercisable within 60 days.

(10)   Guo Wei is a director as of June 24, 2008. Wang Chen and Ms. Guo are husband and wife. Ms. Guo’s beneficial ownership in the Company includes Mr. Wang’s indirect ownership of 17,400,000 shares via Long Sunny Limited and his direct ownership of an option to purchase 150,000 shares of common stock, subject to the vesting terms of the option.  Additionally, On June 22, 2010, Ms. Guo received an option to purchase an aggregate of 100,125 shares of common stock at $8.13 per share.  The option shall become exercisable during the term of Ms. Guo’s service in three equal annual installments of 33,375 shares each, the first installment to be exercisable on the first anniversary of the date of option, and each subsequent installment exercisable on every anniversary thereof.  As of September 20, 2011, the option to purchase 33,375 shares had vested or was exercisable within 60 days.
 
 
60

 
(11)   Pursuant to the terms of the Warrants and the certificate of designation for the Series A Preferred Stock, at no time may a purchaser of Series A Preferred Stock or Warrants convert or exercise such purchaser’s Series A Preferred Stock or Warrants into shares of our common stock if the conversion or exercise would result in such purchaser beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act and the rules thereunder) more than 9.9% of our then issued and outstanding shares of common stock; provided, however, that upon a purchaser providing us with sixty-one (61) days’ notice that such purchaser wishes to waive the cap, then the cap will be of no force or effect with regard to all or a portion of the Series A Preferred Stock referenced in the waiver notice. The 9.9% beneficial ownership limitation does not prevent a shareholder from selling some of its holdings and then receiving additional shares. Accordingly, each shareholder could exercise and sell more than 9.9% of our common stock without ever at any one time holding more than this limit.
 
(12)  Pursuant to his appointment letter with the Company on November 5, 2009, Michael Marks was granted an option to purchase 150,000 shares of common stock of Company at a fixed exercise price of $3.00 per share. Such option shall be exercisable in three equal installments, the first being on the first anniversary of the date of grant.  As of September 20, 2011, the option to purchase 100,000 shares had vested or was exercisable within 60 days.
 
(13) Pursuant to his appointment letter with the Company on November 5, 2009, Leng Jun was granted an option to purchase 80,000 shares of common stock of Company at a fixed exercise price of $3.00 per share. Such option shall be exercisable in four equal installments, the first being on the first anniversary of the date of grant. As of September 20, 2011, the option to purchase 40,000 shares had vested or was exercisable within 60 days.
 
(14) Pursuant to his appointment letter with the Company on November 5, 2009, Mu Ruizhu was granted an option to purchase 80,000 shares of common stock of Company at a fixed exercise price of $3.00 per share. Such option shall be exercisable in four equal installments, the first being on the first anniversary of the date of grant.  As of September 20, 2011, the option to purchase 40,000 shares had vested or was exercisable within 60 days.
 
(15)  Pursuant to an option agreement with the Company on March 31, 2010, David Ming He was granted an option to purchase 221,125 shares of common stock of Company at a fixed exercise price of $7.97 per share. Such option shall be exercisable in three equal installments, the first being on the first anniversary of the date of grant.  As of September 20, 2011, the option to purchase 73,708 shares had vested or was exercisable within 60 days. Mr. He was granted stock awards in the aggregate amount of 100,000 shares of common stock of the Company pursuant to the Company's 2011 Incentive Stock Plan, 50,000 shares of which were issued to him on March 18, 2011, and the remaining 50,000 shares of which will be issued to the reporting person in six months from March 18, 2011.

* Under 1 percent of the issued and outstanding shares as of September 20, 2011.

Item 13.  Certain Relationships and Related Transactions, and Director Independence.
 
On December 10, 2009, Shengkai and Industrial Bank Co., Ltd., Tianjin Branch (“Industrial Bank”) entered into a line of credit loan agreement (“LOC Agreement”) with a valid period of December 10, 2009 to October 22, 2010. The maximum amount Shengkai may draw down on the line of credit is RMB 1,500,000 in the form of a short-term cash flow loan at an interest rate of no lower than 110% of the base interest rate or in the form of a bank acceptance draft. Industrial Bank may unilaterally change the maximum amount available under the line of credit and the term of the line of credit.

The line of credit loan is secured by properties owned by Shengkai and the personal properties and income of Wang Chen and Guo Wei through a mortgage agreement and two personal guarantees, described in more detail below.

In conjunction with the LOC Agreement, on December 10, 2009, Shengkai entered into a mortgage agreement for a maximum of RMB 8,682,000 with the Industrial Bank to secure repayment of the LOC Agreement. The collateral covered by the agreement is certain real property owned by Shengkai, valued at RMB17,540,000 and located at Wanggang Road, Shuanggang Economic Development Zone, Jinnan District, Tianjin, PRC. The mortgage agreement is valid from December 10, 2009 until all the principal, interest, and other expenses under the LOC Agreement are paid in full.

In connection with the LOC Agreement, Wang Chen, our CEO and director, and Guo Wei, our director, (each, a “Guarantor”) each made an irrevocable personal guarantee of the LOC Agreement on November 5, 2009 and on November 9, 2009, respectively, valid for two years from the date the loan becomes payable. Each Guarantor is jointly and severally liable for the payment of the loan principal, interest, damages and the expenses incurred relating to the collection of the payment and guarantees the repayment of the loan by all his/her personal property and income.

 
61

 
As of June 30, 2011, all the outstanding balance of the loan has been paid off.

Except as disclosed above, at no time during the last two fiscal years has any executive officer, director or any member of these individuals’ immediate families, any corporation or organization with whom any of these individuals is an affiliate or any trust or estate in which any of these individuals serves as a trustee or in a similar capacity or has a substantial beneficial interest been indebted to the Company or was involved in any transaction in which the amount exceeded $120,000 and such person had a direct or indirect material interest.

Procedures for Approval of Related Party Transactions
 
Our board of directors is charged with reviewing and approving all potential related party transactions.  All such related party transactions must then be reported under applicable SEC rules. We have not adopted other procedures for review, or standards for approval, of such transactions, but instead review them on a case-by-case basis.

Director Independence

The Company currently has three independent directors, Michael Marks, Jun Leng, and Ruizhu Mu, as that term is defined under the National Association of Securities Dealers Automated Quotation system.  

Item 14.  Principal Accounting Fees and Services
 
Audit Fee

The fees incurred by the Company’s independent registered public accounting firms, for professional services rendered for the audit of our annual financial statements for the year ended June 30, 2011 were approximately $120,000; and for the review of the interim consolidated financial statements included in quarterly reports for the three quarters ended September 30 and December 31, 2010 and March 31, 2011 were approximately $30,000.

Audit-Related Fees

The Company did not incur any fees from its independent registered public accounting firms for audit-related services during the year ended June 30, 2011.
 
Tax Fees

The Company incurred approximately $5,000 in fees from its independent registered public accounting firm, Albert Wong & Co., for services of preparing U.S. corporate income tax return during the year ended June 30, 2011.

All Other Fees

The Company did not incur any fees from its independent registered public accounting firms for services rendered to the Company, other than the services covered in "Audit Fees" and “Tax Fees” for the fiscal year ended June 30, 2011.
 
Audit Committee’s Pre-Approval Policies and Procedures
 
The Audit Committee has policies and procedures regarding the pre-approval of the performance of audit and non-audit services by our independent registered public accounting firm. Our independent registered public accounting firm may not perform any service unless the approval of the Audit Committee is obtained prior to the performance of the services, except as may otherwise be provided by law or regulation. All services described above were approved by the Audit Committee.
 
PART IV

Item 15. Exhibits, Financial Statements Schedules

Footnote
 
Exhibit No.
 
Description
(1)
 
3.1
 
Articles of Incorporation.
 
 
62

 
 
(2)
 
3.2
 
Articles of Amendment to the Articles of Incorporation.
         
(1)
 
3.3
 
Bylaws.
         
(3)
 
3.4
 
Articles of Amendment to the Articles of Incorporation, setting forth the Certificate of Designations authorizing the Series A Preferred Stock.
         
(10)
 
3.5
 
Articles of Amendment to the Articles of Incorporation filed on November 2, 2010 with the state of Florida.
         
(3)
 
3.6
 
Specimen of common stock certificate.
         
(3)
 
4.1
 
Form of Series A Warrant, June 2008 Financing.
         
(3)
 
4.2
 
Securities Purchase Agreement, dated as of June 10, 2008, by and among the Company and the Purchasers.
         
(3)
 
4.3
 
First Amendment to Securities Purchase Agreement, dated as of June 23, 2008, by and among the Company and the Purchasers.
         
(3)
 
4.4
 
Registration Rights Agreement, dated as of June 10, 2008, by and among the Company and the Purchasers.
         
(3)
 
4.5
 
Registration Rights Agreement dated as of June 10, 2008, by and among the Company and the Shell Shareholders.
         
(3)
 
4.6
 
Form of Lock-Up Agreement, dated as of June 10, 2008, by and among the Company and certain Shareholders.
         
(4)
 
4.7
 
Form of Series A Warrant, July 2008 Financing.
         
(4)
 
4.8
 
Securities Purchase Agreement, dated as of July 18, 2008, by and among the Company and Blue Ridge Investments, LLC.
         
(4)
 
4.9
 
Registration Rights Agreement, dated as of July 18, 2008, by and among the Company and Blue Ridge Investments, LLC.
         
(11)
 
4.1
 
Shengkai Innovations, Inc. 2011 Incentive Stock Plan
         
(3)
 
10.1
 
Merger Agreement and Plan of Reorganization, dated as of June 9, 2008 between the Company, the controlling shareholders of the Company, Shen Kun Acquisition Sub Limited, Shen Kun International Limited, and the shareholders of Shen Kun International Limted. (3)
         
(3)
 
10.2
 
Securities Escrow Agreement, dated as of June 10, 2008, by and between the Company, Vision Opportunity China LP as representative of the Purchasers, Li Shaoqing, and Loeb & Loeb LLP, as escrow agent.
         
(3)
 
10.3
 
Investor and Public Relations Escrow Agreement, dated as of June 10, 2008, between the Company and Vision Opportunity China LP as representative of the Purchasers and Sichenzia Ross Friedman Ference LLP, as escrow agent.
         
(3)
 
10.4
 
Escrow Agreement, dated as of June 2, 2008, between the Company, Shen Kun International Limited, Vision Opportunity China LP, and Loeb & Loeb LLP, as escrow agent.
         
(3)
 
10.5
 
First Amendment to Escrow Agreement, dated as of June 4, 2008, between the Company, Shen Kun International Limited, Vision Opportunity China LP, and Loeb & Loeb LLP, as escrow agent.
         
(3)
 
10.6
 
Engagement Letter Agreement between Shengkai and Aegis Capital Corp., dated May 26, 2008.
         
(3)
 
10.7
 
Equity Pledge Agreement, dated as of May 30, 2008.
 
 
63

 
 
(3)
 
10.8
 
Exclusive Purchase Option Agreement, dated as of May 30, 2008.
         
(3)
 
10.9
 
Consigned Management Agreement, dated as of May 30, 2008.
         
(3)
 
10.10
 
Loan Agreement, dated as of May 30, 2008.
         
(3)
 
10.11
 
Technology Service Agreement, dated as of May 30, 2008.
         
(3)
 
10.12
 
Financial Consulting Agreement, dated as of September 16, 2007 between Shengkai and Mass Harmony Asset Management Limited.
         
(3)
 
10.13
 
Assignment of Intellectual Property, dated as of June 9, 2008 between the company and Michael Jordan.
         
(4)
 
10.14
 
Supplementary Agreement dated as of July 3, 2008 to the Equity Pledge Agreement dated as of May 30, 2008.
         
(4)
 
10.15
 
Securities Escrow Agreement, dated as of July 18, 2008, by and between the Company, Blue Ridge Investments, LLC, Li Shaoqing, and Loeb & Loeb LLP, as escrow agent.
         
(5)
 
10.16
 
Second Amendment to Securities Purchase Agreement, dated as of July 31, 2008, by and between the Company and Vision Opportunity China LP.
         
(5)
 
10.17
 
First Amendment to Securities Escrow Agreement, dated as of July 31, 2008, by and among the Company, Vision Opportunity China LP, Li Shaoqing, and Loeb & Loeb LLP, as escrow agent.
         
(5)
 
10.18
 
First Amendment to Securities Purchase Agreement, dated as of July 31, 2008, by and between the Company and Blue Ridge Investments, LLC.
         
(5)
 
10.19
 
First Amendment to Securities Escrow Agreement, dated as of July 31, 2008, by and among the Company, Blue Ridge Investments, LLC, Li Shaoqing, and Loeb & Loeb LLP, as escrow agent.
         
(6)
 
10.20
 
Land Use Agreement dated January 23, 2009, between Shengkai (Tianjin) Ceramic Valves Co., Ltd. and Tianjin Airport Industrial Park Land Bureau.
         
(8)
 
10.21
 
Employment Agreement, dated March 1, 2010, by and between the Company and David Ming He.
         
(9)
 
10.22
 
Warrant Amendment Agreement dated April 30, 2010, by and between Company and Vision Opportunity China, LP.
         
(9)
 
10.23
 
Warrant Amendment Agreement dated April 30, 2010, by and between Company and Blue Ridge Investments LLC.
         
(12)
 
10.24
 
Underwriting Agreement dated as of November 19, 2010 by and between the Registrant and Maxim Group LLC and Global Hunter Securities, LLC
         
(13)
 
10.25
 
Intellectual Property Development Protection Service Agreement with Iron Mountain Intellectual Property Management, Inc. dated as of November 24, 2010
         
(13)
 
10.26
 
Trade Secret Identification and Confirmatory Assignment between the Company and Mr. Chen Wang dated as of November 24, 2010
         
(13)
 
10.27
 
Confidentiality and Rights Agreement between the Company and Mr. Chen Wang dated as of November 24, 2010
         
(13)
 
10.28
 
Confidentiality and Rights Agreement between the Company and Ms. Wei Guo dated as of November 24, 2010
         
(13)
 
10.29
 
Non-Disclosure Letter Agreement between the Company and Ms. Chuanye Guo dated as of November 24, 2010
 
 
64

 
 
(14)
 
10.30
 
Underwriting Agreement dated as of December 17, 2010 by and between the Registrant and Maxim Group LLC and Global Hunter Securities, LLC
         
   
10.31
 
Property Lease Agreement, dated September 1, 2011, by and between Tianjin Shengkai and Tianjin Development Zone Binhai Investment Service Co., Ltd.
         
   
10.32
 
Plant and Office Building Lease Agreement, dated August 3, 2011, by and between Tianjin Shengkai and Tianjin Longhan Jingmi Industrial Co., Ltd.
         
(7) 
 
14.1
 
Code of Ethics. 
         
(15)
 
21.1
 
List of Subsidiaries.
         
   
23.1
 
Consent of Independent Registered Public Accounting Firm (BDO China Li Xin Da Hua CPA Co., Ltd.).
         
   
23.2
 
Consent of Independent Registered Public Accounting Firm (Albert Wong & Co.).
         
   
 
31.1
 
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
   
31.2
 
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
   
32.1 
 
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
         
 
  
32.2
  
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
         
 
(1)
Incorporated by reference to the exhibit of the same number to our registration statement on Form SB-2 filed with the SEC on May 26, 2005.
(2)
Incorporated by reference to our current report on Form 8-K filed with the SEC on April 14, 2008.
(3)
Incorporated by reference to our current report on Form 8-K/A filed with the SEC on June 23, 2008.
(4)
Incorporated by reference to our current report on Form 8-K filed with the SEC on July 24, 2008.
(5)
Incorporated by reference to our current report on Form 8-K filed with the SEC on July 31, 2008.
(6)
Incorporated by reference to our quarterly report on Form 10-Q filed with the SEC on February 13, 2009.
(7)
Incorporated by reference to our current report on Form 8-K filed with the SEC on November 6, 2009.
(8)
Incorporated by reference to our current report on Form 8-K filed with the SEC on March 1, 2010.
(9)
Incorporated by reference to our current report on Form 8-K filed with the SEC on May 3, 2010.
(10)
Incorporated by reference to our quarterly report on Form 10-Q filed with the SEC on November 15, 2011.
(11)
Incorporated by reference to our proxy statement on Schedule 14A filed with the SEC on January 26, 2011.
(12)
Incorporated by reference to our current report on Form 8-K filed with the SEC on November 19, 2010.
(13)
Incorporated by reference to our current report on Form 8-K filed with the SEC on November 24, 2010.
(14)
Incorporated by reference to our current report on Form 8-K filed with the SEC on December 17, 2010.
(15)
Incorporated by reference to our annual report on Form 10-K filed with the SEC on September 28, 2010.
 
65

 


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Tianjin, PRC, on the 26th day of September, 2011.

 
SHENGKAI INNOVATIONS, INC.
   
 
By:  
/s/ Wang Chen
   
Wang Chen
   
Chief Executive Officer and Chairman

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Company in the capacities and on the dates indicated.

/s/ Wang Chen 
 
September 26, 2011
Wang Chen
   
Chief Executive Officer (principal executive officer) and Chairman
   
     
/s/ David Ming He
 
September 26, 2011
David Ming He
   
Chief Financial Officer (principal financial and accounting officer)
   
 
/s/ Guo Wei 
 
September 26, 2011
Guo Wei
   
Director
   
     
/s/ Michael Marks
 
September 26, 2011
Michael Marks
   
Director
   

/s/ Jun Leng 
 
September 26, 2011
Jung Leng
   
Director
   
     
/s/ Ruizhu Mu
 
September 26, 2011
Ruizhu Mu
   
Director